Tax revenue goes up in smoke

One of the disadvantages of indirect taxes, particularly the so-called ‘sin taxes’ levied on tobacco and alcohol, is that they can give rise to a black market in the goods in order to avoid the tax, and this is a source of government failure. An article in The Times highlights this in the market for cigarettes. To quote the article “According to estimates by HM Revenue & Customs, up to 54 per cent of handrolling tobacco and 17 per cent of cigarettes consumed in the UK are smuggled, costing the Treasury £3 billion in lost tax revenue in 2007-08 alone.” With the current fiscal deficit, the treasury needs that revenue!

As we approach the budget next week, the tobacco industry is calling for the Chancellor to abandon plans to add another 12p to tobacco duty in order to avoid adding to the pressure which encourages this black market - clearly manufacturers would prefer tax not to be increased still further. However, with up to £1,500 net profit to be made from an illegal lorry load of the goods, it is easy to understand the temptation to break the law. The graphic attached to the article emphasises the consequences of the illegal tobacco trade, encompassing many unintended consequences of government failure. It also compares the high tax burden per 1,000 cigarettes in the UK with several other European countries, which could lead to a discussion about whether such a high indirect tax rate on addictive demerit goods might cause more problems than it solves.