The Single Income Tax - The 2020 Tax Commission

Higher taxes on
goods that have ready
substitutes in illicit
markets can have
drastic immediate
effects on tax
revenues too
In a 2010 Australian study, PricewaterhouseCoopers found that the most
common reason for using illegal tobacco was cheaper prices.623 Geis, in another
Australian study, acknowledges World Bank research that suggested tax increases
bring more revenues and reduce smoking even with high rates. But he goes on to
say that such research leaves:624
[unanswered] questions about the consequences for smuggling … what
results might ensue if the tax reached what the public believes is an
unacceptable level.
Gabler and Katz carried out a study in Canada and their findings were stark:625
Contraband cigarettes are perceived to be a near-perfect substitute for
lawfully purchased cigarettes. As such, contraband tobacco use neutralises
the deterrent effect of higher taxes.
They also highlighted that previous governments in Canada had been aware
of these effects, with varying results:626
This dynamic was recognised by government officials in the mid-1990s, and
tobacco excise taxes were reduced in order to weaken incentives to purchase,
manufacture, distribute, and smuggle contraband tobacco. But the federal
government began to raise tobacco taxes again in the early 2000s. Predictably,
the higher taxes stimulated trade in contraband tobacco, resulting in a
flourishing black market that now constitutes an estimated 27 per cent
share of the overall tobacco market.
Higher taxes on goods that have ready substitutes in illicit markets can also
have drastic immediate effects on tax revenues. For instance, when taxes on cigarettes
were increased in New York City in 2002, the combined state and local taxes
were $3 a pack. But, during the four months that followed, sales of taxed cigarettes
fell by 50 per cent compared to the same period the previous year.627 Worse still,
a study conducted by a small business trade association found that there was a loss
of $127 million for small businesses and 10,000 job losses.628 There is also strong
evidence in America that consumers cross state borders to purchase cigarettes with
lower tax rates.629 An important 2004 study found that the tax avoidance response
to tax changes is at least twice the consumption response and that tax avoidance
accounted for up to 9.6 per cent of sales between 1998 and 2001.630
623. PricewaterhouseCoopers Australia’s illegal tobacco market: Counting the cost of Australia’s black
market, February 2010
624. Geis, G. Chop-Chop: The Illegal Cigarette Market in Australia, Australian National University
Working Paper No. 48, 2005
625. Gabler, N. & Katz, D. Contraband Tobacco in Canada: Tax Policies and Black Market Incentives,
Studies in Risk and Regulation, Fraser Institute, 2010, pg. 38
626. Op cit. pg. 1
627. Fleenor, P. Cigarette taxes, black markets, and crime lessons from New York’s 50-Year losing battle,
Cato Institute Policy Analysis No. 468, 2003
628. Barret, J., Kurian, T., and Moryl, R. How New York City’s high tobacco taxes hurt small businesses,
taxpayers and consumers, Small Business Survival Committee, 2003
629. Chiou, L and Muehlegger, E, Crossing the line: The effect of cross border cigarette sales on state excise
tax revenues, Kennedy School of Government, Harvard University, 2008
630. Stehr, M, Cigarette tax avoidance and evasion, Journal of Health Economics, 24, 2005
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