Contraband tobacco and the cobra effect

Higher taxes almost always make things worse.

(This column originally appeared in the Toronto Sun)

By: Candice Malcolm

They never run out of creative ways to waste our money.

We learned this week the federal government spent $1 million over three years on two tobacco-sniffing dogs at Canadian customs.

This was their latest plan to combat the booming contraband market.

After three years, however, the dogs only prompted nine tobacco seizures — totalling a mere $1,000 in unpaid tobacco taxes — so the program was quietly unleashed.

Why did it take three years to cancel such an obviously futile program?

We can chalk it up to bureaucratic incompetency, a less than stellar track record at the Canadian Border Security Agency or perhaps a lack of oversight by the Harper government.

But a more appropriate answer is that the government is desperate.

To state the obvious, Canada, and particularly Ontario, has a massive contraband tobacco problem.

There is a thriving black market that, by some estimates, comprises nearly 50% of all tobacco sales in Ontario.

The Ontario and federal governments forego as much as $1.1 billion annually from untaxed, underground sales.

Tackling this problem is top of mind for governments, particularly for cash-strapped Ontario.

But as governments look for solutions to this problem, they should consider what economists call the “cobra effect.”

The term dates back to colonial India, when British officials become concerned about the number of cobras lurking in the streets of Delhi.

The government devised a scheme to combat the cobra infestation, by placing a bounty on each cobra; citizens would to be paid per cobra skin submitted to officials.

It didn’t take long for entrepreneurial Delhi residents, responding to incentives, to begin breeding and farming cobras in order to earn more cash rewards.

The British officials became overwhelmed by the number of cobra skins being submitted, and realized their plan wasn’t working.

They cancelled it, leaving urban cobra farmers with no further reason to raise cobras.

Not wanting to deal with the hassle of looking after dangerous snakes without any potential financial reward, many farmers simply released their cobras into the city.

This significantly increased the cobra population and made the danger posed by cobras in Delhi far greater than ever before.

A similar case can be made about our tobacco policies.

In a well-intended scheme to improve public health outcomes and drive down smoking rates, both the federal and provincial governments in Ontario have steadily increased tobacco taxes over the past two decades.

In 2014 alone, Ontario hiked its tobacco taxes by 12%, while the feds raised the federal excise tax by 23.5%.

Both governments claimed these higher taxes would curb smoking rates and also raise hundreds of millions of dollars in additional revenues.

Those two claims are contradictory and cannot both be accurate.

The far more likely scenario is for smokers to find their nicotine kick elsewhere.

The average pre-tax price for a carton of cigarettes in Ontario is less than $30; when taxes are added, the total carton price is nearly $90.

At that price point, it isn’t surprising that the black market is flourishing.

That is a 200% markup.

You can’t be surprised when contraband dealers capitalize on an opportunity to take advantage of margins like that.

Just as the British officials in Delhi did, the federal and Ontario governments are inviting otherwise law-abiding citizens to engage in illegal and potentially dangerous activities.

The risk is worth the reward.