development of a sizeable black market

development of a sizeable black market

Impact of a Menthol Cigarette Ban: Economic Effects and
Unintended Consequences
November 15, 2010
1
LIKELY OUTCOMES
FROM A MENTHOL BAN
• No Significant Reduction in Aggregate Smoking
• Development of a Sizeable Black Market for Menthol Cigarettes
• Harmful Unintended Consequences
o
Increase in Organized Crime Activity
o
Increase in Youth Access to Cigarettes
2
NO SIGNIFICANT REDUCTION
IN
AGGREGATE SMOKING
• Overall cigarette demand is highly inelastic.
• Inelastic demand indicates that even if the menthol ban raised
the cost of all cigarettes, the decline in overall consumption
would be low.
• However, the menthol ban directly would affect the price of
menthol cigarettes only, as the legal sale of non-menthol
cigarettes would not be restricted.
• These facts indicate that a majority of menthol cigarette
smokers would either switch to non-menthol brands or purchase
contraband menthol cigarettes in response to a ban.
3
DEVELOPMENT
OF A SIZEABLE BLACK MARKET
• We estimate a low elasticity of demand for menthol cigarettes,
which implies that many menthol smokers have strong
preferences for menthol cigarettes. Hence, many menthol smokers
likely would purchase menthol cigarettes in the black market,
even if the price of these cigarettes would be high.
• Our study of previous black markets in cigarettes indicates that
the elasticity of substitution between legal and illicit cigarettes is
high. Namely, as the relative price of cigarettes sold through legal
channels increase, contraband cigarette sales expand greatly.
• Given a high demand for menthol cigarettes and a robust supply
of illicit menthol cigarettes that likely would be available after a
ban, the volume of transactions that would occur in a black
market likely would be large.
4
DEVELOPMENT
OF A SIZEABLE BLACK MARKET
• The eventual size of the black market is difficult to predict, as it
depends greatly on a number of uncertain factors, including:
o
o
o
The level of enforcement efforts, and the ultimate availability of supply
The reluctance consumers must overcome to purchase on the black
market
The overall demand structure for menthol and non-menthol cigarettes
• Nevertheless, we benchmark the post-ban size of the black
market using parameter estimates that emerge from our
preliminary economic analysis.
• In our paper, we evaluate a broad range of parameter estimates,
as the data upon which we rely are limited, and thus much
uncertainty exists for each parameter estimate.
• On the following slide, one estimate of black-market sales is
developed (from what we find to be reasonable empirical
approximations of these underlying parameters). We stress that
this estimate represents only a rough approximation of the black
market, given the limitations of currently available information.
5
DEVELOPMENT OF A SIZEABLE BLACK MARKET
•
Given a menthol own-price elasticity of -1.4; a cross price elasticity between
non-menthol cigarettes and the price of menthol ones of 1.1; and an increase
in the “full price” of menthol cigarettes of 25%, we find that the size of the
post-ban black market would be:
o
Approximately 70% of the current menthol cigarette volume
o
Over 85% of the current menthol cigarette sales revenue
o
•
Black market would be larger if the “full price” of menthol
cigarettes increased by less than 25% over current prices
Substantial federal, state and local governments taxes would be lost from this
shift towards black market sales from current legal channels.
6
UNINTENDED
CONSEQUENCES
• Increases in Organized Crime
o
o
Given the size of the potential black market for cigarettes, the
financial incentives to enter this market would be high.
Higher enforcement efforts, which likely would be needed for the
ban to have an effect on aggregate smoking, could result in greater
organized crime activity. Specifically, enforcement efforts could
increase the rents organized crime earns from selling banned
cigarettes (by reducing competition from “mom and pop”
distributors), and thus increasing incentives to be a large supplier.
• Increases in Youth Access
o
o
Increases in the supply of cigarettes through non-regulated sources
may lead to increases in youth access to all cigarettes.
Canadian black market experience suggests that youth access to
cigarettes increased as a result of the growth in the black market for
cigarettes.