California Cigarette Tax Increase: A Boon for Organized Crime?

August 3, 2006

This November, Californians will vote on a potentially dramatic cigarette tax increase of $2.60 per pack, up from California’s relatively modest current rate of $0.87 per pack. An early poll released yesterday suggests 63 percent of likely voters support the measure.

These types of sharp increases in cigarette taxes are interesting to an economist because they provide a useful illustration of the power of economic thinking.

As with much policy, there’s a popular disconnect between the intentions of cigarette excise tax policy and its actual consequences. In the case of the California proposal, proponents are motivated primarily by noble intentions—the prospect of a healthier, longer-lived public, that kicks the smoking habit with a helping hand from California’s taxing authorities. Who can argue with that?

However, the merits of tax policies don’t just depend on their intentions. They also depend on consequences—many of which are not obvious at first. And without the help of an analytical framework that connects the dots between policies and the secondary effects they have on behavior in the marketplace, those consequences are largely invisible.

In the case of California’s proposed cigarette tax hike, the initial effects are easy to see—raising the price of cigarettes should lead to a drop in cigarette sales, improving public health. But what isn’t obvious without the aid of economic reasoning is that the higher the tax rate on cigarettes, the more profitable it becomes for sellers to avoid the tax altogether, and sell illegally in black markets.

With a tax of 5-cents per pack, there’s not much profit in avoiding taxes. Why risk getting caught for just a nickel? But when taxes reach today’s very high levels of over $2 per pack, taking the risk of selling illegally starts looking more attractive.

The result? Cigarette bootlegging, crime rates, and tax evasion all rise in tandem with cigarette excise tax rates.

What happens when cigarette taxes reach $2 per pack? Ask New York. By some estimates black-market sales account for half of cigarette sales in high-tax Manhattan. And simple economics shows the same is certain to occur in the Golden State if November’s referendum passes.

Always and everywhere, prohibitively high tax burdens make it more profitable move into black markets. And nothing makes crime pay like a sharp cigarette tax increase—regardless of the noble intentions underlying the policy.

One of the reasons economists have come to dominate public policy in recent decades is their relentless focus on consequences, rather than intentions. As Californians head to the polls this November, let’s hope they heed economists’ advice, and consciously weigh the health benefits of less smoking against the spike in crime that is certain to occur on California’s streets in the wake of a $2.60 per pack tax increase.


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