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The simple analytics of tobacco taxation with illegal supply

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  • Ian Irvine
  • William Sims

Abstract

This paper examines the impact of tobacco excise taxes where legal and illegal supplies coexist. The government's objective is to minimize cigarettes smoked in the economy (or to maximize revenue or to minimize illegal activity). It reacts to a competitive illegal supply in an adjoining jurisdiction. A model of consumer choice is used to demonstrate how demand response to tax changes can yield counterintuitive results. While the model mimics the Canadian market, similar situations characterize the US and European markets. A novel element of the paper is the treatment of externalities on the supply side rather than the demand side. Analytique simple des taxes sur le tabac quand il y a offre illégale. Ce mémoire examine l'impact des taxes sur la vente de tabac quand des offres légale et illégale coexistent. L'objectif du gouvernement est de minimiser les cigarettes fumées dans l'économie (ou de maximiser le revenu fiscal ou de minimiser l'activité illégale). Il doit prendre en compte l'offre concurrentielle illégale dans une juridiction contiguë. On utilise un modèle de choix du consommateur pour montrer comment la réaction de la demande aux changements dans les taxes peut engendrer des résultats contre‐intuitifs. Bien que le modèle soit conçu pour le marché canadien, on trouve des situations avec des caractéristiques similaires dans les marchés américain et européens. Un élément novateur du mémoire est sa prise en compte des externalités du côté de l'offre plutôt que du côté de la demande.

Suggested Citation

  • Ian Irvine & William Sims, 2014. "The simple analytics of tobacco taxation with illegal supply," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 47(4), pages 1153-1172, November.
    • Handle: RePEc:wly:canjec:v:47:y:2014:i:4:p:1153-1172
    DOI: 10.1111/caje.12112
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    1. Anindya Sen, 2017. "Smokes, Smugglers and Lost Tax Revenues: How Governments Should Respond," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 471, February.

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