The National Audit Office (NAO) said HMRC's latest tobacco strategy, launched in 2011, had so far prevented losses of £328 million - less than two-thirds of the total projected - and its target of saving £1.4 billion over four years now appeared "unachievable".
HMRC has estimated that in 2010/11 alone, duty was not paid on 9% of cigarettes and 38% of hand-rolling tobacco smoked in the UK at a cost of almost £1.9 billion in lost revenue.
The NAO acknowledged HMRC had achieved some success in building up its intelligence network overseas, resulting in the seizure of an estimated 1.27 billion cigarettes and 56 tonnes of tobacco overseas in 2012/13. But it said key initiatives to curb smuggling had been delayed or cancelled - in part due to legal concerns - while HMRC lacked a "good understanding" of the volume of prosecutions and other legal sanctions needed to provide an effective deterrent.
Under supply chain legislation passed in 2006, tobacco companies have a legal obligation not to facilitate smuggling, and while sales to high risk markets have fallen, the NAO said that the supply of some hand-rolling brands to certain countries was still estimated to exceed legitimate demand by 240%.
Margaret Hodge, chairman of the Commons Public Accounts Committee which oversees the work of the NAO, said HMRC needed to take a firmer approach. "HMRC has been too weak to fully enforce the law in this area and needs to be tougher to stop products being available to smuggle," she said. "HMRC's inability to crack down on unlawful tobacco smuggling not only affects the public purse, but undermines Government efforts to stop people smoking, as members of the public can access cheap illicit cigarettes."
HMRC insisted that it was committed to tackling tobacco smuggling, investing an additional £25 million between 2010 and 2015.
"The additional investment we received in 2010 has ensured that HMRC is able to do more to tackle tobacco smuggling than ever before," a spokesman said. "The illicit cigarette market has continued to decline and through our work with Border Force, in the last two years nearly 3.6 billion illicit cigarettes and 1,050 tonnes of rolling tobacco have been seized.
"This has resulted in 431 prosecutions and over 1,600 assessments and penalties issued with a value of nearly £24 million. We continue to work across government, to further improve our intelligence and ensure the organised criminal gangs behind this crime are brought to justice."