Tax Evasion and Illicit Cigarettes in California: Part IV— Smokers’ Behavioral and Market Responses to a Tax Increase

Abstract

Appendix is available at: https://ssrn.com/abstract=3322092

We examine recent survey data from California to investigate smokers’ responses to an increase in cigarette excise-tax rates. We estimate how tax avoidance and the economic crimes of tax evasion and illicit trade in tobacco products (ITTP) changed from 2017 to 2018, during which time the tax rose by $2/pack. The prevalence of each suspicious outcome or illicit activity examined rose markedly after the tax increase—by anywhere from 11% to 331%. We examine how such behaviors correlate with demographic, economic, and attitudinal factors. Some 63% of those still smoking in 2018 acted in ways that undermine, at least partially, the public health rationale for raising tobacco taxes. On the other hand, 66% say they reduced their nicotine use or substituted the use of less harmful delivery systems for cigarette smoking.

About 44% of smokers engaged in some legal tax-avoiding behavior in the previous year, 15% evaded taxes through cross-border purchases, and 27% bought untaxed cigarettes in the state in the past month. (These behaviors overlapped substantially.) There is a much lower incidence of counterfeit product and sales of single cigarettes. Smokers who roll their own cigarettes, e-cigarette users, younger smokers, and those with more income and education are all more likely to engage in at least some of the suspect market behaviors examined. The driving time to the nearest cross-border retail locations is significantly associated with tax avoidance and evasion. However, respondents’ attitudes and moral sentiments appear to be more important predictors of suspect and illicit behavior. The results suggest that the tax increase led to significant amounts of adaptive behavior by smokers that likely reduced the intended health benefits of that policy change.

Keywords: ITTP, illicit trade in tobacco products, black markets, counterfeits, tax avoidance, tax evasion, survey, IRTC, illicit retail trade in cigarettes

JEL Classification: H26, I18, K42