KUALA LUMPUR: Malaysia's steep hike in tobacco excise duties nearly a decade ago proved counterproductive, fuelling one of the world's largest illicit cigarette markets and costing billions in lost revenue, according to the Centre for Market Education (CME).

In its report, Indirect Taxation and Innovation: An Asean Framework, CME said the 2015 Budget raised tobacco excise duties by 43 per cent, from RM280 to RM400 per thousand sticks, in a bid to bolster government coffers and curb smoking.

Instead, the move opened the floodgates to smuggling, which saw the illicit share of the cigarette market leap from 36.9 per cent to 52.3 per cent within a year.

By 2020, contraband had captured almost two-thirds of the market, reaching 63.8 per cent, a surge of 72.9 per cent over five years.

Following this, retail revenue losses swelled from RM1.82 billion in 2015 to RM4.28 billion, while legitimate players were squeezed by smugglers offering cut-price products.

As a result, CME said criminal networks grew stronger, undermining both fiscal policy and public health goals.

"Unsurprisingly, the introduction of a tobacco tax moratorium, combined with stronger enforcement, reversed the trend, with illicit market share slipping for four consecutive years to 55 per cent in 2024. Yet the level remains alarmingly high," it said.

The research institute highlighted that the excise system is part of the problem: fragmented, unpredictable and riddled with complexity. It mixes ad valorem and per-unit measures that change frequently depending on fiscal needs.

Such a regime, it said, violates principles of equity and makes long-term planning for businesses nearly impossible.

"These characteristics act as a powerful incentive for smuggling and reduce revenues for legitimate businesses," CME said.

As a remedy, CME called on the government to shift toward a differential excise tax based on the level of harm.

Under this framework, high-risk products such as cigarettes would face higher levies, while safer alternatives, including e-cigarettes and low-alcohol or alcohol-free beverages, would be taxed at lower rates.

"This approach would encourage consumers to move toward healthier options while spurring industries to innovate and develop more sustainable products," it added.