Sales Tax Rate Versus Black Market Sales

One product where high sales taxes and its effect on black market sales has been studied extensively is tobacco.

The Cato Institute report Cigarette Taxes, Black Markets, and Crime: Lessons from New York’s 50-Year Losing Battle by Patrick Fleenor, the chief economist of the Tax Foundation and senior economist at the Joint Economic Committee of Congress, concludes:

When governments try to extract tax revenue from the economy, they foster an array of responses from citizens who have an economic incentive to avoid the tax. Higher tax rates create even greater incentives for avoidance, evasion, and black-market activity. New York City's experience with cigarette taxes vividly illustrates these problems.

New York s high cigarette taxes have spawned a massive black market that has diverted billions of dollars from legitimate businesses and governments to criminals. More troubling than the financial losses is the crime associated with the city's illicit cigarette market. The enormous profits that can be made smuggling cigarettes into New York have lured small time crooks, mobsters, street gangs, and terrorists into the racket. Those criminals have engaged in a host of violent activities, including murder, kidnapping, and armed robbery, to earn and protect their illicit profits. Such crime has frustrated law enforcement efforts to curtail it and exposed regular citizens, such as truck drivers and retail store clerks, to violence.

The failure of New York policymakers to consider the broader effects of high cigarette taxes has been a mistake repeated across the country in the stampede to maximize taxes on this demonized product. Too often, policymakers do not consider those effects in the erroneous belief that people do not respond to government-created economic incentives. The negative side effects of high cigarette taxes in New York provide a cautionary tale that high tax rates have serious consequences even for such a politically unpopular product as cigarettes.

This conclusion is echoed numerous other places. For example, between 1984 and 1993, Canada doubled its tax on cigarettes with the aim of reducing smoking and increasing tax revenues. As a result, an estimated 40 percent of Canada's cigarettes are now sold on the black market. These sales have spawned violence and nurtured organized crime. About 23 percent of cigarettes are sold on the black market in California.

The tax rates on cigarettes are substantially higher than 200% (typically more than 400%). Nonetheless, this is one product only. If every good had the potential to be traded on the black market, the gearing up of organized crime would likely happen at a much lower threshold.

As a result, I think the black market issue is a serious impediment to the viability of a 200% sales tax (or even a 50% sales tax for that matter).