The Effect of Joint-Product Export Smuggling on Export Tax Policy

This paper analyzes the effect of joint-product export smuggling on the revenue-maximizing export tax rate and tax revenue collection under the small country assumption. The results indicate that the effect of introducing joint product export smuggling is dependent on whether legal and illegal exports are considered a substitutable or complementary activity for the exporting firm. The results of the model are applied to the issue of cigarette smuggling in the United States. The paper concludes that if legal and illegal interstate trade in cigarettes are substitutable activities for firms in the wholesale and retail tobacco industry, then states levying relatively high excise taxes should reduce their tax rates. This action will increase legal trade at the expense of illegal trade and raise the level of tax revenue collected. The proposed increase in the federal cigarette excise tax to fund health care reform is also discussed within the framework of the paper\u27s model. The model suggests that a substantial increase in the federal cigarette tax may generate over-invoicing of cigarette exports and thereby reduce the market share of legal cigarettes. A rise in the cigarette tax rate could therefore have an ambiguous effect on tax revenues collected and jeopardize the funding of the health care program. (JEL: Fl3, H26, H21