When it comes to tobacco, governments have much in common. Tobacco taxes are viewed as essential around the world in order to achieve fiscal and health objectives.
But in truth, one size does not fit all when it comes to setting tobacco tax policy. Like other forms of taxation, a number of local political, economic, industry and demographic factors need to be considered prior to deciding on a tax structure and level.
In Ontario, where we will have a new Provincial Budget, one of the largest illicit tobacco markets in the world is flourishing. A study by the Canadian Taxpayers Federation showed that 1-in-3 cigarettes purchased in Ontario were illicit, forfeiting about $1.1 billion a year in potential tax revenues that would otherwise go to federal and provincial governments.
It is not hard to understand why. Despite the hefty fines for possession of illicit tobacco, non-taxed cigarettes in Ontario sell for as low as $8 per carton, compared to nearly $90 per carton for legally purchased, tax-included cigarettes.
Many people know me for my work popularizing the Laffer Curve, which demonstrates that increases in tax rates do not necessarily translate into increased government revenues. This is because large or unexpected tax increases encourage consumers to avoid the taxed activity—in this case purchasing tax-included cigarettes.
Looking at Ontario’s illicit tobacco problem, it is easy to spot this principle in action – large increases in tax rates have driven consumers to the illicit market, rather than increasing revenues to government by a similar percentage to that of the tax increase.
As provinces try to forge a fiscal path toward balanced budgets, they should look at seriously tackling the contraband tobacco problem with a smart approach to tobacco taxes.
For example, Ontario and other provinces could tie the rate of increase in tobacco tax to inflation, like the Federal government announced in its previous budget. Other jurisdictions have done this in the past as well, the most notable being Australia, which had bi-annual increases tied to inflation.
Consider that in Canada, the excise duty of tobacco rose 11% versus inflation of 2.1% last year; in 2013, the excise duty rose 6.2% versus inflation of 0.9%.
Remember, governments across the globe do not just use tobacco taxes to generate important revenue; they also use this tax to reduce tobacco consumption to produce a healthier population.
But the truth is that if an Ontario government tobacco tax increase prompts more consumers to shift to illicit tobacco products across the province, the tax increase is unlikely to lead to less smoking but will result in reduced tax collections for government.
Tax increases, if set at the rate of inflation, are more likely to achieve government goals of increasing tax revenue while also reducing consumption of tobacco products and beginning to curb the demand for illegal contraband tobacco.
Arthur B. Laffer, author of the International Tobacco Tax Handbook, is an American economist and tax policy expert who served as a member of President’s Economic Policy
