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Raising tobacco taxes not the answer to deficits

By Kevin Gaudet
web posted August 16, 2010

The growing black market for cigarettes in Canada is becoming a larger and larger problem. It is a source of violent and organized crime and it deprives governments of the full taxes from the sale of a legal product. To deal with this problem, governments must not further hike tobacco taxes, as doing so merely spurs black market trade.

In the 1980s and 90s governments faced large and growing deficits and mounting debt loads. They also faced decreased public acceptance of smoking. In response to both, government raised tobacco excise taxes. The raising of the taxes drove a growing black market.

Different studies, including data from Statistics Canada, all estimate that between 1987 and 1993 contraband cigarettes grew from 1 per cent of the market to between 27 and 33 per cent. This growth came at the same time that federal tobacco taxes more than tripled from $6 per carton to over $19 per carton. Many provinces matched these hikes.

Taxes were reduced in 1994, in part to address the growing black market, but have since crept back up. Today taxes comprises 45 per cent of the cost of a carton of cigarettes, which cost as much as $74.49 in Ontario.

The return of high taxes has seen a return of the illegal tobacco trade. A 2009 study by the Convenience Store Association revealed that illegal cigarettes used by teens in Ontario schools had grown to 30 per cent and as high as 45 per cent in Quebec. Their research estimates that contraband cigarettes may be as much as 40 per cent of the total tobacco market today.

With large deficits and mounting debt again being experienced by most governments, they may be tempted to look to tobacco tax hikes to raise revenue.

Such hikes do not receive the same public backlash as does hiking most other taxes and fees. In fact, in many cases non-smokers relish the thought of higher taxes on products they do not consume. Unfortunately, higher tobacco taxes won’t likely raise the revenue hoped.

Recent Fraser Institute research shows that a 10 per cent increase in the price of tobacco products can reduce lawful cigarette sales by about 3 per cent to 10 per cent. To the extent that some smokers evade excise taxes by purchasing contraband, the use of excise taxes to discourage smoking and increase government revenues is rendered ineffective. 

It is further estimated that the illegal tobacco trade deprives governments of $1.3 billion in tax revenues.

High and rising tobacco taxes are also hurting many small businesses and driving illegal activities onto some reserves. Much of the illegal tobacco can be traced back to native reserves in both Canada and the United States. Some of it is even sold at ‘smoke shacks’ on reserves. In addition to illegal cigarettes being sold, in some cases taxes aren’t being charged to off-reserve Indians and to non-Indians even though they ought to be.

The illegal activity is a result of people trying to avoid paying high taxes. Increasing tobacco taxes would further drive smokers away from legitimate small businesses and would make the illegal trade on and off-reserve even more lucrative.

Aversion to smoking should no longer be an excuse to ignore the problems of illegal tobacco. To deal with it, governments need to resist the temptation to hike tobacco taxes. Enforcing the rule of law would also help. ESR

Kevin Gaudet is the federal director of the Canadian Taxpayers Federation. © 2010, Kevin Gaudet

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