Exports to Smuggle and Smuggling Technologies

Our analysis is motivated by cases of cigarette smuggling in Canada and in the UK. In the 1990s, domestic cigarettes were legally exported to be subsequently illegally imported. At first, smuggling was done by individual consumers who bought cigarettes abroad and brought them back through policed points of entry. This Mom and Pop smuggling was a mechanism to implement a second-degree price discrimination scheme by cigarette manufacturers. Regrets from committing tax evasion and labels on exported cigarettes packs permit vertical differentiation of illegal and legal cigarettes. Paradoxically, labeling measures can make illegal sales more resilient to tax reductions, and stricter border enforcement encourages a switch to a less benign smuggling technology exclusive to criminal organizations. High export taxes terminated export-to-smuggle schemes, but brought about a surge of counterfeit cigarettes. Because of a second-degree price discrimination scheme, the elimination of taxes need not suffice to eradicate smuggling.