Cigarette taxes and illicit trade in Europe

Cigarettes are highly taxed in Europe to discourage tobacco use due to the health harms of smoking and to fund public-health measures to encourage smoking cessation. The WHO and other national and international health policy organizations strongly advocate for higher taxes on tobacco. An unintended consequence of higher taxes can occur, however. At higher prices (more precisely, at higher differentials between licit and illicit prices) consumers substitute more toward illicit cigarettes. Illicit retail trade in cigarettes (IRTC) includes counterfeiting and smuggling—either of legally purchased products, from lower-tax to higher-tax jurisdictions, or of entirely non-tax-paid cigarettes.

Objectives

The existing health literature on tobacco control includes claims that taxes are not an important factor determining the scale of IRTC. In particular, some in the literature claims that: 1) High cigarette prices are associated with low levels of IRTC; 2) Raising cigarette taxes does not tend to increase IRTC; 3) Corruption in a country is a more important determinant of IRTC than are taxes; and 4) Examining IRTC in levels instead of as a share of total cigarette trade would lead to opposite conclusions about the impact of taxes on IRTC. Our objective is to investigate these claims and to discuss the implications for health policy.

Data/Methods

Our data on the size and market share of illicit cigarettes and the prices of licit cigarettes are from 1999–2013 in the European Union. Our methodology is to regress illicit market share (or illicit quantity) on licit prices, controlling for other factors through the additional of regressors, fixed effects, and the use of instrumental variables.

Results

We find that while the simple correlation between licit cigarette prices and the market share of illicit cigarettes in consumption is negative, raising prices in any one country would, on average, lead to substantial increases in the expected illicit market share and volume in that country. A one euro increase in tax per pack in a country is expected to increase illicit market share by 5 to 12 percentage points and increase illicit cigarette sales by 25% to 120% of the average consumption. We also find that the role of prices in stimulating IRTC is, empirically, far more important than the role of corruption. The results are robust to a host of alternative specifications and sources of data. We conclude with discussion of implications for health policy.