Does lowering taxes on tobacco lead to an increased consumption of cigarettes? According to a study prepared by associate professor Jean-François Ouellet of HEC Montréal, it appears unlikely.
HEC Montréal recently released a report examining the effects of a 1994 Canadian tobacco tax reduction on smoking rates. The report is based off of the largest study examining the effects of decreased tobacco taxes in the country to date. Through statistical analysis of the cigarette consumption of ten Canadian provinces, five of which lowered taxes with the 1994 tax reduction and five of which did not, the report concluded that decreasing excessive tobacco taxes does not increase smoking rates, even among the youth.
Why is there not an increase in the consumption of cigarettes when taxes are lowered in Canada? The answer is simply that people are buying cheap cigarettes anyway. The cigarette black market is alive and well and with higher taxes, rather than buy cigarettes from local stores, consumers buy contraband cigarettes smuggled in from nearby states with lower tobacco taxes.
The smuggling of illegal cigarettes is rampant: a recent study by the Mackinac Center for Public Policy found that in 2006 almost 35 percent of all the cigarettes consumed in Michigan (legal and illegal) were smuggled into the state. According to the study, in one bust in 2008, Michigan law enforcement discovered an unbelievable 104,300 cartons of illegal cigarettes worth more than $2 million in unpaid taxes. In an era of budget deficits, losing tax revenue to smugglers is the last thing America needs.
Data collected by Statistics Canada for the HEC Montréal report suggests taxation has precisely such effects. In the five provinces where tax decreases were implemented, 28.3% of respondents said they bought their cigarettes in the U.S. or through contraband networks before the tax decrease, a rate comparable to 9.3% in other provinces (a difference that is statistically highly significant). After tax decreases, both rates were no longer significantly different at 7.1% and 8.3% respectively. This suggests that beyond a particular threshold, tobacco taxes have very little impact as deterrents to smoking cigarettes, but merely incentivizes people to buy contraband cigarettes.
Additionally, some tobacco companies may choose to absorb most of the costs of higher tobacco taxes, keeping cigarettes at or near their previous price. Since the costs of higher taxes must be accounted for, the burden of the higher tax may fall on the laborers, resulting in lower wages and benefits for workers. Americans need more money in their pockets to propel us from these financial times, not less.