In Pakistan, domestically produced cigarettes are subject to two major indirect taxes – the Federal Excise Duty (FED) and the General Sales Tax (GST). The FED accounts for almost 80% of the revenue from the sector. Both taxes are collected at the production stage. The cigarette manufacturing sector in Pakistan is an example of an imperfect market, with only three companies dominating domestic production. Despite the small number of large manufacturers, the Federal Board of Revenue (FBR) relies on manufacturers’ self-declaration of production to determine their tax liability. In the absence of an effective audit system, this mechanism contains a built-in incentive to under-report production to evade taxes and thus causes inefficiencies in the tax collection.