Cigarette Taxes and Illicit Trade in Europe

Cigarettes are highly taxed in Europe to discourage tobacco use and to fund public-health measures to mitigate the harms from tobacco consumption. At higher prices (more precisely, at higher differentials between licit and black-market 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. The existing literature includes claims that taxes are not an important factor determining the scale of IRTC. We investigate these claims with data from 1999-2013 in the European Union. 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