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Why Flaherty's Sin Tax on Cigarettes Won't Work

02/14/2014 08:15 EST | Updated 04/16/2014 05:59 EDT

The latest federal budget hits smokers in the pocketbook, with an increase on the excise duty on cigarettes.

Often, governments can't resist the temptation to increase taxes on certain products deemed to be harmful like alcohol or tobacco. Because no one can be against virtue, these kinds of taxes are easier to justify in the eyes of the population than other consumption taxes or income tax hikes. Yet, as shown by the history of tobacco taxes in Quebec, far from being the panacea for budget and health problems, sin taxes rarely achieve their objectives and often have unintended consequences.

As numerous studies have shown, although the modification of consumer behaviour serves as a justification for setting up or increasing sin taxes in the eyes of the general public, this objective is not always attainable. For example, after an initial reduction, the prevalence of tobacco use in Quebec has reached a threshold around 24 per cent since 2003 beyond which, despite the fact that the price of cigarettes has doubled during this same period, remaining users tend not to modify their behaviour any further.

The goal of modifying smokers' behaviour through a price increase has thus not been attained for a decade in Quebec. The tax on tobacco has become the equivalent of a "punitive" tax for that part of the population that does not want to change its consumption habits and must shell out larger and larger sums in order to satisfy its wants.

In the case of the tobacco tax, it is a particularly regressive tax that hits the poor four times harder than it hits the wealthy, among other things because the rate of tobacco use among the poorest people is 50 per cent higher than among the wealthiest. An additional hike in tobacco taxes, which already account for 63 per cent of the price of a pack of cigarettes in Quebec, will thus impact low-income people in particular.

Another unintended consequence of sin taxes is that when the tax level for a product is too high, according to the "too much tax kills tax" principle, consumers turn to other, legal or illegal, sources, like the black market or cross-border shopping. The government's tax receipts therefore start to fall.

This is precisely what happened in Canada in the early 1990s. Indeed, following a steep increase in duties and taxes applicable to tobacco products by the federal government and the provinces, a vast illegal trade in cigarettes sprang up. Contraband's share in the Canadian tobacco market jumped from 1 per cent in 1987 to approximately 31 per cent by the end of 1993. In February 1994, taxes were slashed by the federal government and five eastern Canadian provinces, including Quebec, in order to put an end to the contraband and re-establish legal sales and tobacco tax receipts.

These measures largely achieved their goal. The federal government and the provinces do not seem to have learned the lesson of the early 1990s, however, since taxes were once again increased starting in 2001. As was to be expected, this led to a resurgence of the black market, which made up an estimated 27 per cent of the total tobacco market in 2008.

In its latest budget, the Quebec government once again raised the tobacco tax with the goal of increasing its revenue by $43 million in 2012-2013. In fact, however, revenue decreased, from $913 to $907 million. The historical evolution of tax revenue from tobacco for the Quebec government shows that when taxation becomes excessive, it entails a decrease in tax revenue.

Also, we may question the objectives of this measure. Either the tax will reduce the number of smokers, which is the stated goal, in which case, it should not bring much in terms of revenue as the number of people who will pay that tax will diminish. Or else, it will have no effect on the number of smokers and, if so, it will end up being a smoke and mirrors measure targeting a group of vulnerable taxpayers.

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