The Demand for Cigarette Smuggling

When taxes raise the full price of a good above that in nearby jurisdictions consumers have an incentive to cross into the lower‐price jurisdiction to make purchases. Using a simple microeconomic model of the consumer's border‐crossing decision, we derive an econometric model to test the significance of border crossing and estimate the magnitude of the resulting sales. Examining cigarette sales in the continental U.S. over the period 1960 to 1986, we find strong evidence that border crossing is a significant factor in explaining sales differentials between states. Implications for demand estimation and excise tax policy are discussed.