Large price differentials that result from high taxation in one jurisdiction relative to others create economic incentives for illicit trade. However, illicit trade depends on other factors, such as the availability of illicit products, which is a function of the strength of the customs and tax administrations and the industry’s motivation to supply the market via illicit trade channels. In a nutshell, illicit trade is the result of a combination of forces that includes governance, price differentials between jurisdictions, and industry behavior.
The risk of illicit trade can be mitigated when governments exercise greater border control and adopt policies that enhance law enforcement. There are a number of effective measures to deal with illicit trade that can be taken alongside an increase in taxes. This case study shares the recent experience of Colombia in mitigating the risk of illicit trade while successfully increasing tobacco and alcohol taxes.