Incentivizing smuggling

There is an interesting study conducted in the United States, which shows how excessive tax rates on cigarettes induce substantial black and gray market movement of tobacco products into high-tax states from low-tax states or foreign sources.

- MARY ANN LL. REYES

The study, titled "Cigarette Taxes and Cigarette Smuggling by States," was written by one Adam Hoffer for the Tax Foundation and published in 2023.

It revealed that New York has the highest inbound smuggling activity, with an estimated 54.5 percent of cigarettes consumed in the state derived from smuggled sources, followed by California with 44 percent, New Mexico with 38.3 percent, Massachusetts with 37.6 percent, and Washington at 37.3 percent.

It also showed that Colorado, Maryland, and Oregon significantly increased their cigarette tax rates from 2020 to 2021 and all three states saw major increases in cigarette smuggling.

According to Hoffer, policymakers interested in increasing tax rates should recognize the unintended consequences of high taxation rates. "Criminal distribution networks are well-established and illicit trade will grow as tax rates rise. Higher tax rates lead to more smuggling because people respond to incentives. As tax rates increase, consumers and suppliers search for ways around these costs. In cigarette markets, consumers tend to shop across borders where the tax rates are lower and dealers develop black and gray markets to sell illegally to consumers, paying little or no tax at all. Growing cigarette tax differentials have made cigarette smuggling both a national problem and a lucrative criminal enterprise," he said.

"The report finds a strong positive relationship between cigarette smuggling and tax rates across the country. The data also demonstrate that when states increase their cigarette taxes, smuggling rates increase, both in the form of increased purchases in neighboring states and through illicit international channels," he added.