By – Inika Gupta
Abstract
The January 2026 fiscal policy, introducing a permanent Health Security-cum-National Security Cess and 40% GST on tobacco, centralises revenue, eroding state fiscal autonomy. This aggressive taxation creates massive price arbitrage, inadvertently subsidising the illicit black market. Consequently, compliant manufacturers must pivot from tax management to aggressive Intellectual Property litigation to survive.
Introduction
The first trading session of 2026 will likely be remembered not for optimism, but for the sea of red that engulfed the FMCG sector. On January 1, 2026, the Ministry of Finance fundamentally altered the fiscal framework for the tobacco industry by notifying the transition from the temporary GST Compensation Cess to a permanent, non-lapsable Health Security-cum-National Security Cess (HS-NSC), alongside a steeper 40% GST slab for sin goods. The market’s verdict was swift. ITC Ltd. shed over ₹60,000 crore in market capitalisation within hours, while peers like Godfrey Phillips saw double-digit erosion.
This health cess is not exclusively a corporate shake-up; India’s fiscal federalism risks being compromised as well. Yet, the consequences extend beyond constitutional debates. While the government’s intent is to secure long-term revenue for healthcare infrastructure, this aggressive fiscal policy has inadvertently created a massive arbitrage opportunity. The January 2026 reconstruction does more than just tighten margins; it effectively subsidizes the black market, forcing compliant corporations to pivot their legal strategy from mere tax compliance to aggressive Intellectual Property (IP) litigation to survive the rising tide of counterfeit illicit trade.
Constitutional Implications and the Erosion of Fiscal Federalism
Excise levy duties are procured from specific domestically produced goods, a manifestation of which are cigarettes. The introduction of the HS-NSC on tobacco products threatens not only the tobacco industry, but also state autonomy and funding, posing a hit to India’s fiscal federalism. While the levy is officially designed for public health and national security, its implementation effectively replaces the GST Compensation Cess, which was originally designed to reimburse states for revenue losses.
Under Article 270, the net divisible pool of taxes that must be shared with states, leaves out two increasingly utilised fiscal instruments, these being levies and cesses. By replacing a state-oriented compensation measure with a non-shareable Union cess, the central government secures these funds exclusively for itself. This legislative move effectively bypasses the mechanism of revenue devolution, the collateral damage of which includes, constraining the fiscal autonomy and income potential of the states.
Quantitative Analysis of the Revised Taxation Regime
This new excise levy is being charged per 1000 cigarettes sold in addition to the already applicable GST charges, significantly hiking up their retail prices. Previously cigarettes were taxed through GST and ad valorem Compensation Cesses, which in totality amounted to roughly 50-60% of its MRP, GST alone making up 28% of that component. Under the revised regime, the GST rate itself is estimated to hike to 40%, along with the new excise levy.
This compounding effect, a higher percentage-based GST combined with a flat volume-based excise, is expected to raise the cost of each cigarette by at least Rs. 1.5 to Rs. 2.5. Depending on whether the cigarette is filtered and its length measured in millimetres, the excise levy ranges from Rs. 2,700 to Rs. 11,000 per 1,000 cigarettes. The total tax collected on tobacco products is expected to rise to approximately 70% of its MRP, still unable to reach the WHO’s 75% yardstick. While taxation is an important instrument used to regulate tobacco consumption, to make it effective, it is vital to precedingly understand the pattern of Indian tobacco consumption and in what forms it is so consumed.
Price Elasticity and Demographic Distribution of the Tax Base
Tobacco consumption is shaped by a complex matrix of demographics including age, gender, literacy and income; but price sensitivity stands out as the primary behavioural lever. Tobacco products are generally price inelastic; their demand does not decrease proportionately to price hikes, characterising the irrationality of addiction. Furthermore, the tax base is precariously narrow, relying almost entirely on cigarette smokers. Despite representing only 15% of tobacco consumers, this segment effectively subsidizes the remaining 85% of non-cigarette tobacco consumers who contribute just a meagre 15% to total collections.
Price elasticities vary by product. Bidis and leaf tobacco harbour almost perfect inelasticity. The tax hike up in bidis to 18% rather than the 40% tax imposed on cigarettes is highly inefficient. About 20% of all smokers consume both bidis and cigarettes, making the policy shift a gateway to increased bidi usage. Small scale bidi producers fall under tax exempt categories, making up roughly 31% of the market.
While increased bidi taxation faces administrative barriers, it offers huge revenue potential and health benefits. Conversely, for low-income and younger groups, who make up about 70% of consumers, keeping up with rising cigarette prices will become impossible.
Market Valuation Shocks and Supply-Side Economics
Companies are often equipped to offset policy-driven losses, yet the scale of the market’s reaction to the HS-NSC, where state-owned LIC alone lost ₹10,445 crore in valuation in just 48 hours was shocking. ITC and Godfrey Phillips, fell 10% and 19% respectively within the first two days of January and to approximately 21% from the effective date of February 1st.
The new tax structure creates a dual threat; it either slashes EBIT by over 40% or, if passed to consumers, threatens sales volumes. Passing the burden creates a legally induced, artificially high price floor. This cess causes an upward shift of the supply curve equal to the tax amount. Inevitably, the demand curve will not adjust to the same extent, creating deadweight losses in the economy.
Consumer Substitution and the Proliferation of Illicit Trade
When producers pass costs to consumers, the price of elastic tobacco products exceeds affordability. In consumer theory, individuals maximize utility within a finite budget. As the price-per-cigarette increases, the rational consumer does not necessarily exit the market; instead, they seek substitutes. The drive to satisfy addiction outweighs the financial incentives to quit, leading consumers to the black market. Despite the hidden costs associated with health and safety risks, counterfeit cigarettes offer a competitive price point, allowing consumers to maximize perceived utility.
This arbitrage allows illegal traders to undercut legal vendors by evading tax compliance. Illegal cigarette trade already accounts for as high as 26% of the Indian cigarette market, the 4th largest globally. This will spike starting February 1st. Ironically, this worsens public health, as they lack regulatory standards or quality checks, and are made in unhygienic conditions. Despite efforts to curb it, the sheer volume of illicit trade across rural and urban areas remains unchecked. Illegal vendors capture market share by mimicking brand packaging, maintaining the social signalling of premium brands while offering competitive prices, fuelling an Intellectual Property Rights (IPR) crisis.
Intellectual Property Rights and Trademark Infringement Challenges
A trademark, defined under S.2(zb) of The Trade Marks Act, 1999, constitutes a mark capable of graphical representation and is the identifying factor of that company’s product, (e.g., ITC’s “Gold Flake”). Owning a trademark grants exclusive rights and acts as a guarantor of quality, fostering consumer trust necessary for brand loyalty.
Counterfeiters infringe upon these rights under Section 29 by using deceptively similar identifiers. While owners have civil and criminal remedial routes, the hurdle is the sheer volume of illicit trade. To remain viable, big tobacco must spend heavily on IP litigation without guarantees of speedy justice in India’s overburdened courts. Although the HS-NSC targets public health, its adverse effects threaten tobacco farmers, public health standards, and producers by increasing reliance on the illegal sector.
Conclusion
The HS-NSC paradoxically risks compromising the very health standards it seeks to protect. It mistakenly focuses on cigarette-driven taxation rather than higher taxes on widely consumed products like bidis. By incentivizing a mass exodus to the unregulated illegal trade, the new regime penalizes the compliant while subsidizing the criminal.
The consequences are tripartite. The States lose revenue due to the constitutional bypass of the divisible pool, the legal cigarette industry faces an existential crisis, and consumers are pushed toward dangerous alternatives. As the gap between the legal and street price widens, the battle for the Indian market be fought not on brand equity, but in the courtrooms. For Big tobacco, the future is now a litigation warzone, where The Trade Marks Act,1999 becomes the last line of defence against a fiscal policy that has arguably done more to stimulate the counterfeit economy than any smuggler ever could.
About the Author
Inika Gupta is a third-year B. Com LL.B. (Hons.) student at Jindal Global Law School, and a research analyst at the Economics and Finance Cluster of Nickeled & Dimed. Her academic interests span Corporate Law, Alternate Dispute Resolution, and Intellectual Property Rights. She is passionate about critically examining emerging legal and economic policy trends through rigorous, data-backed analysis.
Image Source: Public health groups, doctors urge for hike in tobacco tax, ETHealthworld
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