Association for Public Policy Analysis & Management

Restricting access to tobacco through regulation and taxation may stimulate evasion of the law by consumers. Illicit trade in tobacco products (ITTP) creates its own detrimental social and economic impacts, since some of the health benefits of regulation will be offset by enforcement costs and the negative impacts of ITTP on the public. Tobacco policymaking should therefore consider ITTP in the social calculus.

To be able to analyze the outcomes following from particular regulations, policymakers should learn as much as possible about the current state of affairs regarding illicit trade. Accurately describing ITTP is difficult: market participants try to hide, have reasons not to be frank in surveys, etc. Analysts interested in tobacco policy and those interested in illicit markets more generally therefore have limited data to study in order to compose policy recommendations.

To improve greatly the state of knowledge in this area, we analyze a large, novel set of data from discarded pack studies in California. In discarded pack studies, teams of researchers are sent out to find all discarded cigarette packs in a defined geographic area. Packs are examined for the tax stamps for the local area or other telltale signs that indicate an illegal purchase. Data from several collections in three major California cities during 2011-2015 are available, encompassing 32,000 pack observations. There is modest evidence of tax avoidance (up to 19.8% of packs in San Diego) and illicit trade (no more than 10% in Los Angeles, 17% in San Francisco, or 20% in San Diego under the broadest assumptions), which includes bootlegging, counterfeits, cigarettes produced for illicit-market sales, and cigarettes without any tax stamps.

In our econometric investigation, we explore the determinants of ITTP. Given the importance of tax rates and tax differentials with nearby areas, it is possible that public policy decisions explain a significant share of the variation in ITTP. We investigate the impact of cigarette excise taxes (both in the area and in nearby jurisdictions) on ITTP, and (in accord with much previous literature) find that tax levels and differentials are highly important. In particular, prices in other states matter a lot. A dollar increase in the price differential is estimated to increase a pack's probability of tax avoidance by 49 percentage points.

We also explore neighborhood effects. The probability of per-pack tax avoidance rises with the percentage of the adult population that are current smokers in the county, which we hypothesize is due to social norms. Tax avoidance also rises with income inequality and population density. Other parts of the variation in ITTP are due to the differing demographic makeup of the areas. Only a few of the demographic variables have significant coefficients. Income, at least in some ranges, was found to have a negative impact on tax avoidance. The fraction of the population that is Black has a negative effect on tax avoidance, compared to the omitted race/ethnicity category of Whites. Finally, the median age of the area has an inverted U-shaped impact on avoidance.