On Taxes and Subsidies and Smuggling

An interesting item appeared in Cuenca HighLife, an expat publication in Cuenca, Ecuador. Apparently unconsciously, it makes a valuable point about one of the almost inevitable results of both subsidies and taxes – smuggling.

The article is actually about liquor retailers who have seen a terrible plunge in their sales since the government began raising liquor taxes a few years ago. The taxes are so high now that the price of a bottle of booze is more than double what it is in neighboring countries.

Cordovez said that a bottle of Johnny Walker Black Label whiskey that can be purchased for $37 in Peru, costs about $80 in Ecuadorian stores.

What would you do in such circumstances (assuming you had both entrepreneurial and criminal tendencies)? You’d buy booze in Peru and smuggle it into Ecuador, that’s what. And if your such tendencies were a bit less pronounced, but you needed to save a few bucks, you’d probably buy your booze from the neighborhood bootlegger. And apparently, there’s a lot of that going on.

Quito customs officer Luis Cortez says that as much as 60% of foreign liquor purchased in Ecuador is smuggled in. “We do not have the personnel to keep all of it out. We can control it in stores and bars but it is difficult with prívate sales.”

That’s what happens when the governments distort markets. Another way the Ecuadorian government distorts markets is by subsidizing natural gas (which most people there use for cooking). This subsidy gives the smugglers the opportunity to make money on both ends of the trips between Peru and Ecuador – why send empty trucks down to Peru to bring back liquor?

The government admits that there is a growing black market for foreign liquor brands, almost all of it coming over the borders with Peru and Colombia. According to Cordovez, much of it crosses the borders in gas trucks smuggling low-price LP gas out of the country.

So the Ecuadorian government is losing money twice (and Peru doubling up their wins) – Ecuador is subsidizing Peruvians’ use of gas and Peru is collecting taxes on the liquor Ecuadorians drink.

The funny thing is that Ecuador could probably make a lot more money by charging reasonable taxes. If they charged the same tax as Peru, or even just a little more, there would be no reason to smuggle booze (they are planning to cut out the gas subsidies soon). If 60% of the liquor is smuggled, then Ecuador is collecting $0.00 tax on most of the country’s liquor sales. It shouldn’t take an economics PhD to figure out that such high taxes actually reduce tax revenue rather than increasing it.

I mention the PhD, because the President of Ecuador, Rafael Correa, under whom the taxes have been raised so much, is an economist; his degree is from the University of Illinois. He is not reflecting much credit on the ol’ alma mater.