The Legal and Illegal Markets for Taxed Goods

Pure Theory and an Application to State Government Taxation of Distilled Spirits

Rodney T. Smith

Expert InsightsPublished 1976

The paper extends the traditional model of taxed markets by considering the presence of illegal activity. The discussion concentrates on partial equilibrium analysis of one taxed market, and develops a two-market model of the legal and illegal markets for the taxed good. According to the two market model, the observed legal market demand and supply curves should possess properties that differ from the predictions of the traditional analysis. Analysis of state government taxation of distilled spirits offers evidence supporting the predictions from the alternative analysis.

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Smith, Rodney T., The Legal and Illegal Markets for Taxed Goods: Pure Theory and an Application to State Government Taxation of Distilled Spirits. Santa Monica, CA: RAND Corporation, 1976. https://www.rand.org/pubs/papers/P5639.html.
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