Illegal tobacco trade booming in Canada

Commentary
By Joseph Quesnel
and Danny LeRoy

Canada’s illegal tobacco trade is not just a domestic issue but a substantial financial boon to organized crime and terrorist organizations worldwide, including terrorist groups like Hamas.

Ignoring Canada’s growing illicit tobacco trade also results in provinces losing billions in tax revenue while enriching organized criminal networks both domestically and internationally.

As of 2023, the RCMP estimates that 175 criminal organizations are involved in illicit tobacco. They are taking advantage of high cigarette taxes and lax enforcement of the Indian Act’s on-reserve tax exemption intended only for First Nation people.

This problem, once confined to parts of Ontario, Quebec, and Atlantic Canada, has ballooned across the country, notably expanding in British Columbia and Alberta due to the high revenue potential.

The policy response to the COVID-19 pandemic revealed how pervasive the contraband tobacco trade had become in Canada. At the start of the pandemic, governments across Canada made the extraordinary decision to shut down tobacco manufacturing operations and smoke shops on First Nations reserves. This made it possible to quantify and compare the levels of illegal and legal sales.

Indigenous communities, especially in Ontario and Quebec, have been implicated in cross-border illegal tobacco trafficking, with law enforcement reluctant to enforce the law on reserves. First Nations have become complicit with organized criminal networks that ship illicit tobacco across the country. The large price differential between legal and illegal cigarettes and the widespread use of technologies allows individuals to exploit cost-saving and profitable opportunities.

The rise of e-commerce in Canada and around the world has further complicated the issue, as First Nations exploit tax advantages and enforcement gaps to sell untaxed cigarettes online and use their entrepreneurial drive to build online businesses. Payment is by Interac e-Transfer to increase the ease of purchasing in mass quantities.

Despite the clear connection between higher taxes and lower smoking rates, the resulting price differential has inadvertently fueled the growth of an extra-legal cigarette market, challenging the enforcement of tax exemption laws and contributing significantly to the complexities facing Canadian law enforcement and taxation policies.

The implications of online transactions include the expansion of the extra-legal cigarette market, enabling sellers to reach customers far from reserves and avoiding the complications associated with sophisticated organized crime networks. However, this also increases the challenges for law enforcement and raises the cost to Canadian taxpayers.

The inconsistent enforcement of tax exemption laws and on-reserve law enforcement represents a departure from a rules-based system where everyone is treated equally. Although selling untaxed cigarettes to non-Status Indians is illegal, many First Nation communities have turned this into a common practice and a source of income. While research consistently shows that higher taxes lead to lower smoking rates, it also highlights the direct relationship between increased taxes and the expansion of the illegal cigarette market.

Tougher enforcement of laws designed to lower cigarette use modifies and enhances the incentives throughout the cigarette marketing channel. Law enforcement often refrains from strict legal actions on First Nation territories in Ontario and Quebec to dodge political conflicts. However, 2023 data from Quebec showed that dedicated enforcement efforts halved the illegal tobacco market.

Yet, in late 2023, the Quebec Superior Court stayed criminal proceedings against two Mohawk men accused of breaking Canada’s customs and excise laws by smuggling illegal tobacco from the United States into Canada. The ruling seemed oblivious to how First Nation smugglers collaborate with organized crime within the illegal tobacco trade.

In an effort to reduce smoking and meet public health objectives, both the federal and provincial/territorial governments impose taxes on tobacco products. However, this strategy unintentionally fuels the growth of the illicit tobacco market due to the high tax rates. Scholars argue that cigarette demand remains strong despite price increases, leading consumers to turn to the black market for cheaper, untaxed options.

This illicit market operates on basic principles of supply and demand: as profits soar, more entities are drawn to distribute these illegal products. The absence of stringent enforcement and the ambiguity in legal regulations further encourage the emergence of new players in this profitable illegal trade.

To confront the rampant growth of Canada’s illegal tobacco trade effectively, a multifaceted approach is urgently required. This approach must address the intertwined issues of high taxes, insufficient law enforcement, and the exploitation of legal loopholes.

With the illegal trade not only depriving provinces of billions in tax revenue but also fueling organized crime and terrorist organizations, the stakes couldn’t be higher.

Joseph Quesnel is a senior research fellow with the Frontier Centre for Public Policy. Danny LeRoy is an associate professor of economics and co-ordinator of the agricultural studies program at the University of Lethbridge.