Smokes, Smugglers and Lost Tax Revenues: How Governments Should Respond

There is widespread consensus that higher cigarette taxes are the most effective policy tool in reducing population smoking rates and tobacco-induced mortality, but the efficacy of such taxes is tempered by the possibility of a rise in smuggling and the availability of contraband tobacco. Understanding the extent to which stronger law enforcement affects the consumption of contraband tobacco is key given the significant tobacco tax increases recently implemented by the federal, Ontario and Quebec governments. Concerns have been raised about lost tax revenue and even the funnelling of black-market revenue to organized crime and terrorist activities. The study employs rigorous econometric methods in order to estimate the amount of smuggled cigarette cartons, along with associated lost tax revenues, in Quebec and Ontario from 2006 to 2014. While the amount of contraband has been quite significant in both provinces, it has been particularly high for Ontario, with lost tax revenue of approximately $816 million to $900 million in 2014. But the amount of contraband has declined over time for both provinces and coincided with an increase in excise cigarette taxes. The reduction in contraband since 2008 has been especially dramatic in Quebec. Lost tax revenue from current levels of contraband in Quebec is roughly a tenth of corresponding amounts in Ontario. The decline in illegal sales can be at least partially attributed to additional federal and provincial resources devoted to law enforcement. Given the magnitude of the decrease in estimated lost tax revenues as a likely consequence of stronger policing, and the risks to higher tobacco taxes undermining fruitful enforcement efforts, it appears that Ontario in particular would be better off by focusing on strengthening enforcement and regulation.