Published in The Wall Street Journal , April 8, 1994, p. A-15.

Canada's Taxing Pols Outwitted by Underground Economy
by
Pierre Lemieux

 

MONTREAL--After he took over as federal finance minister, Paul Martin was quoted in the Jan. 4 edition of this paper as saying that "hundreds of thousands of otherwise honest people...have withdrawn their consent to be governed" by escaping in the underground economy.

Shortly afterwards, Mr. Martin's colleague, Department of Revenue Minister David Anderson, went further by suggesting that Canada becomes a nation of government snitches. In the Feb. 12 Toronto Globe and Mail, Mr. Anderson put Canadians on notice: "People who are currently in the underground economy...will suddenly start realizing that any day of the week, any hour of the day, Revenue Canada may get a phone call and someone may rat on them."

Obviously, the bureaucrats smell something rotten in the state of Canada. Smuggling is only one facet of the underground economy that has developed in response to high taxes and regulation. But the practice of smuggling--especially the smuggling of alcohol and tobacco--is what the government mainly has his sights on.

Until last February, federal and provincial tax increases forced up the legal price of a cartoon of cigarettes to nearly $50 (Canadian). Tobacco smuggled primarily from the U.S. sold for roughly half the legal price. According to industry sources, three-fourths of cigarettes consumed in Quebec and 40% in the whole country were contraband. Ordinary, honest citizens purchased smuggled cigarettes at local convenience stores. Enterprising teenagers carried profitable side businesses at school. In Quebec, a shopkeepers' alliance called Movement to Abolish Cigarette Taxes openly defied the law by staging sales of smuggled cigarettes. The chief of the Quebec Provincial Police had to warn his officers against smoking smuggled tobacco.

Finally the government cried "Uncle." On February 8, the federal and the Quebec government announced a joint $20 tax reduction on a cartoon of cigarettes in an effort to fight smuggling. In Quebec, this led to a drop of 50% in legal tobacco prices. Police officials estimate that smuggling has now diminished by 80% to 90% in this province. The provinces that have not cut their own tax rates (or have not cut them by as much as Quebec) are now complaining about interprovincial smuggling.

Nevertheless, the government still doesn't get it. When he announced the tax reduction, Prime Minister Jean Chretien suggested that once the smuggling networks have been dismantled, the government "will be able to restore the appropriate level of taxation." Two days later, his health minister repeated the warning. The fact that not every voter is a complete sucker partly explains why some international smuggling still goes on.

Moreover, the smugglers' networks have switched to other lucrative underground markets. According to industry sources, Canadian taxes on liquor products amount to some 83% of the retail cost--twice the average U.S. level of taxation. Not surprisingly, the Quebec Provincial Police have noted an increase in alcohol and perfume smuggling, often through the tobacco connection. Indeed, alcohol smuggling is probably equivalent to 15% to 25% of the legal market. Firearms smuggling is apparently also on the rise following 1991 and 1992 legislation that basically aims at disarming Canadians.

Like the underground economy in general (household services, constructions and repairs, barter, etc.), the development of smuggling networks during the past few years has had an impact on government revenues, as illustrated by the accompanying table. After growing for some years, total government revenues (federal and provincial) from alcohol and tobacco taxes started dipping in 1992 and then fell significantly (a 7.9% drop) in 1993. At least at the federal level, the recent revenue shortage comes mainly from tobacco, but alcohol tax revenues have remained stagnant since the late 1980's.

But more ominous effects of these trends are becoming apparent. New police powers have been or are in the process of being introduced against suspected smugglers (for example, an amendment to Ontario's Tobacco Tax Act would give Ontario police the power to search private cars without a warrant) or even against individuals found in possession of smuggled tobacco (steep fines in Quebec). Officer Michel Brunet of the Quebec Provincial Police admits that smuggling can never be totally eradicated: "There will always be bank robbers," he says.

Of course, not all Canadians would argue that smuggling should be ranked with bank robbery. As a matter of fact, confiscatory taxation is a much more likely candidate for the comparison. The underground economy is actually a useful built-in restraint to the fiscal appetites and power hunger of Leviathan. If the citizen did not have this escape hatch, he would be a much easier prey for the rulers.

This is not to say that the underground economy releases all pressure of an overtaxed and overregulated economy and, thus, establishes an acceptable equilibrium to such a society. Confiscatory taxes and galloping regulation destroy public morality. While Canadians may be morally justified in resisting state intrusion by retreating in the underground economy, the danger is that these justified cheating habits against government may well spread to other fields.

Canada would not be the first instance where the tyrant destroys public morality. Let all revenue ministers of the world hear the following segment from a 1923 speech before the Italian Senate by Prime Minister Benito Mussolini: "The Government has been compelled to levy taxes which unavoidably hit large sections of the population. The Italian people are disciplined, silent and calm, they work and know that there is a Government which governs, and know, above all, that if this Government hits cruelly certain sections of the Italian people, it does not so out of caprice, but from the supreme necessity of national order."

I wrote to the Canadian minister of revenue suggesting that Mussolini would certainly understand his fiscal program. He has not yet replied.

Mr. Lemieux is an economist, author and visiting professor at the University of Quebec in Hull.

Reprinted with permission of The Wall Street Journal © 1994 Dow Jones & Company, Inc. All rights reserved.