Do Cigarette Tax Hikes Increase the Illegal Market? Brazil's Data Says No

Increasing tobacco taxes is the single most effective and cost-effective tool to reduce smoking, reduce health care costs, and increase government excise tax revenues. Despite considerable evidence supporting higher tobacco excise taxes, policy makers–particularly in low- and middle-income countries–have been slow to adopt such taxes. This failure is largely driven by concerns about potential negative economic repercussions from tax increases, often perpetuated by the tobacco industry.

One such myth, is that tax increases result in an uptick in illicit trade, thus reducing government revenue from legal cigarette sales and increasing smuggling from other countries or generating domestic illicit production.[1] Because tobacco companies often use the threat of illicit trade to halt the implementation of tobacco control policies, it is essential to correct their claims with an accurate and reliable representation of the dynamics of illicit trade.  One part of this myth is the assumption that smokers of legal brands will automatically switch to illicit ones when the prices of legal cigarettes increase from higher excise taxes. In their latest publication in the Journal of Applied Economics, researchers from the Universidade Católica de Brasília (UCB), an Economics for Health collaborator, and colleagues tested this assertion, examining how smokers respond to price changes in legal and illegal cigarettes in Brazil.

Illegal brands make up a large share of the Brazilian cigarette market—around 30–40% of all cigarettes smoked by most estimates. UCB used data from the National Health Surveys (PNS) from 2013 and 2019, which tracks smoking behavior across the country, to assess the market. The researchers applied propensity score matching (PSM), an advanced econometric method, to create “statistical twins,” matching smokers with similar social and economic profiles who smoke legal and illegal products. This allowed them to isolate how consumers respond to price changes in each market.

From this analysis, UCB was able to show that raising legal cigarette prices doesn’t push smokers to the illicit market. On the other hand, the empirical evidence demonstrates clearly that when illicit cigarette become more expensive, a share of smokers switch to legal options (which will actually increase tax revenues). Specifically, the researchers found that:

Raising cigarettes prices affects consumption for legal and illegal products

• A 10% increase in the price of legal cigarettes would lead to a 4.1% drop in legal cigarette consumption: higher prices reduce smoking, especially for legal brands.
• A 10% increase in the price of illegal cigarettes would lead to a 2.5% drop in their consumption: illegal cigarette consumers are less price-sensitive than legal ones.

Smokers do not switch to illegal cigarettes when legal prices go up

• Increasing the price of legal cigarettes did not have a statistically significant effect on consumption in the illegal market: thus, there is no evidence that smokers shift to the illegal market after price increases.

Some smokers do switch to legal brands when illegal prices increase

• A 10% increase in illegal cigarette prices would increase legal cigarette use between 0.7% and 1.4%: controlling the supply chain to increase smuggling costs and raise illegal prices would push some smokers to the legal market where taxes are paid and health warnings are displayed.

This research has substantial implications for public health and fiscal benefits. For many years, Brazil has had one of the most successful tobacco control programs in the world, but more recently, political resistance to raising taxes has grown—often based on fear of illegal trade. UCB’s study confirms that this fear is overstated and misunderstood. Smokers are not rushing into the arms of illegal sellers every time the government raises prices. Instead, most will either keep buying legal cigarettes, or quit. On the other hand, fighting cigarette smuggling and shrinking the illicit market through stronger law enforcement, customs controls, and international cooperation, will make illegal cigarettes more expensive, encouraging some smokers to quit and others to switch to the legal market.

Brazil’s current comprehensive tax reform, which includes a selective tax (i.e., excise) on tobacco, is an opportunity for policy makers to reap the benefits of increasing cigarette taxes, guided by research findings from independent, trustworthy sources. Contrary to industry claims, significantly raising tobacco taxes would effectively discourage smoking, while increasing tax revenue collection—all without increasing the size of the illicit market. Moreover, if the tax reform is paired with further improvements in the government’s efforts to secure the tobacco supply chain, the benefits will be even greater.

[1]Warner, K.E. (2000). The economics of tobacco: myths and realities. Tobacco Control(9), 78-89. https://doi.org/10.1136/tc.9.1.78