Border-Crossing Sales, Tax Avoidance, and State Tax Policies: An Application to Alcohol

Abstract

When the full price of a commodity in one economic or political sphere is elevated above that of the same commodity in a nearby sphere, then there will be gains from arbitrage, smuggling and/or camouflaging activities. The organized forms of such activity include the smuggling of illegal substances such as drugs and weapons between countries. Less familiar, but of potentially great economic significance, is the casual smuggling of differentially-taxed but legal goods between political jurisdictions such as the U.S. states. Gasoline, tobacco, alcohol and a host of common consumer products are subject to widely varying tax treatments between states. When border crossing is feasible, one expects at least some consumers to exploit the welfare gains arising from lower prices by purchasing in neighboring, low-cost regions. This phenomenon, if widespread, could place significant limits on the ability of states to raise revenues through uncoordinated excise taxation.