How Cigarette Taxes Impact Illicit Trade

January 16, 2014

High cigarette taxes may increase illegal trade without reducing consumption, say Katie Furtick, Candice Malcolm and Anthony Randazzo of the Reason Foundation.

Taxes lead to black markets because price-sensitive consumers look for ways to avoid the tax.

  • A study by Jean-Francois Ouellet, associate professor of marketing at HEC Montreal, found that each additional dollar in taxes raises the likelihood of consuming contraband cigarettes by 5.1 percent.
  • In the United States, cigarettes sold in low-tax areas can be bought and resold on the black market in states with higher tax rates, leading to a profit for the seller.
  • In fact, high taxes can lead to cigarettes being produced in illegal and unregulated factories and then sold on the black market, keeping them entirely outside of the tax regime.

Rather than reducing cigarette consumption, high cigarette taxes may only shift consumption around to the black market. Canada, whose cigarette tax rates have varied widely over the last 20 years, is a good example:

  • Illicit trade fell when taxes on cigarettes were reduced in Canada, and cigarette smoking rates also declined. When taxes were raised, the decline in smoking rates actually slowed down. The authors suggest that this slowdown could be due to the fact that consumers can easily access black market tobacco products because the supply chain is so large.
  • Canada has also suffered a loss of tax revenue as a result of black market cigarette sales. Data from Quebec indicates that CAD $125 million in cigarette excise taxes were not collected in 2011 thanks to contraband products.
  • Imperial Tobacco Canada reported a loss by the tobacco industry of CAD $900 million due to black market sales. Convenience stores lose $2.5 billion due to these sales.

Policymakers should keep in mind the unintended consequences of these types of measures and remember that high taxes do not always reduce consumption or increase revenues.

Source: Katie Furtick, Candice Malcolm, and Anthony Randazzo, "The Effect of Cigarette Tax Rates on Illicit Trade: Lessons Learned in Canada," Reason Foundation, January 2014.

 

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