Cigarette smuggling undermines policymakers’ efforts to curb smoking while also leading to tax revenue leakages. Policymakers around the world are trying to obtain a better understanding of how to combat cigarette smuggling. This paper adds to the literature on cigarette demand and related smuggling by considering the cross-border influences of both the price differentials and the shadow economy. While price/tax differentials induce both casual and organized smuggling, the presence of the shadow economy facilitates smuggling and opens up possibilities for arbitrage in smuggled goods. Using data across U.S. states for the years 1997–2008, results show that border price effects are positive and statistically significant, and the average shadow economy in bordering states facilitates smuggling, with own shadow economy sometimes showing signs of facilitating intra- and cross-border smuggling. The other findings regarding the negative own-price elasticities and habit persistence for smoking are in line with the larger literature.
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See Goel (2008) for an alternate consideration that addresses price and non-price (corruption) differences.
Further, organized smugglers might be able to use scale economies of lower transportation costs to smuggle cigarettes to more distant locations.
The present study can be viewed as complementary to an earlier study by Goel (2008) where the spatial prevalence of corruption was considered along with the price. The presence of corruption (both own and neighboring) was found to not significantly impact U.S. cigarette demand.
Prieger and Kulick (2014) also note another spillover of illicit trade where stricter enforcement could lead to greater violence.
Incidentally, the start of our sample also corresponds with the time of the Master Settlement Tobacco Agreement that provided for substantial payments from tobacco companies to individual states (see Goel and Zhang (2013) and https://en.wikipedia.org/wiki/Tobacco_Master_Settlement_Agreement).
Following the extant literature, we take the available cigarette sales to denote cigarette consumption.
It has, however, to be kept in mind that not all underground activities can be precisely measured.
We do not have corresponding data on regional shadow economies on America’s foreign borders (i.e., Canada and Mexico) that would enable us to consider the spillovers to and from those jurisdictions (see Goel (2004b) for a study on U.S.-Canada cigarette smuggling, without accounting for the shadow economy).
The statistical significance of border prices in Panel B is relatively lower.
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Goel, R.K., Saunoris, J.W. Cigarette smuggling: using the shadow economy or creating its own?. J Econ Finan 43, 582–593 (2019). https://doi.org/10.1007/s12197-018-9454-x
- Shadow economy
- United States