CFN – Government efforts to tax cigarettes in Canada can have unintended consequences for tax revenues and the supply of contraband cigarettes, according to a report released today by the C.D. Howe Institute. In “A Taxing Dilemma: Assessing the Impact of Tax and Price Changes on the Tobacco Market,” Concordia University economists Ian Irvine and William Sims assess the effect of tax policy on tobacco use and, in particular, on prices and consumer choice between illegal and legal cigarettes.
Sales of contraband cigarettes in Canada constitute a sizable component of the tobacco market, note the authors. This illegal trade is associated with a loss in tax revenue and an array of illicit activities that involve gangs and organized crime. Concerned Canadians have called for action: some have urged governments to lower tobacco taxes in the belief that lower relative prices for the legal product would induce smokers to switch away from illegal to legal cigarettes, perhaps increasing tax revenues.
To assess the impact of different policy approaches to the problem, the authors model consumer choices under four policy scenarios: (i) decreasing taxes on the legal product; (ii) boosting the price of the illegal product through an intensified crackdown; (iii) a combination of (i) and (ii); and (iv) decreasing the price of discount cigarettes closer to that of the contraband product.
The authors’ modeling adds welcome rigor to research into the impact of taxes on the tobacco market. Among their main findings:
- Tax reductions on legal cigarettes would have only a modest impact on the share of the illegal product, cause a decline in tax revenues and result in a small increase in total consumption;
- For tax policy to drive out the illegal market, tax reductions would have to be substantial. But such tax reductions would reduce tax revenues dramatically and increase overall consumption;
- However, if the price of the illegal product could be raised with extra legal or enforcement pressures on suppliers, then the market share of the illegal product would decline.
The authors emphasize that tobacco tax policy should be based not only on its impact on the quantity of cigarettes purchased, but also on the social, legal and enforcement costs associated with the illegal supply.