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.
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