The Laffer Curve & Illicit Trade: An AML Consultant's Analysis of Australia's Tobacco Crisis
Introduction: An Economic Theory in the Modern Spotlight
The Laffer Curve, a cornerstone of supply-side economics, has recently re-entered global policy debates. Its namesake, economist Dr. Arthur Laffer, has publicly criticised high-tax proposals in the UK and, notably, Australia’s tobacco excise policy, stating, “It’s not working at all. Your taxes are way too high.”
These interventions underscore a critical question: How can this decades-old theory help explain a growing crisis in Australia—the explosion of money laundering linked to the illicit tobacco and vape trade?
This analysis examines a consequential side effect: while achieving public health goals, Australia's high excise may have pushed the tobacco market into a prohibitive range on the Laffer Curve. This economic shift has correlated with declining tax revenue and fostered a rampant black market, creating fertile ground for organised crime and challenging the nation's Anti-Money Laundering (AML) regime.
The Laffer Curve in a Nutshell
At its core, the Laffer Curve is a simple model of the relationship between tax rates and government revenue. Its premise is twofold:
At a 0% tax rate, the government collects no revenue.
At a 100% tax rate, it also theoretically collects no revenue, as the incentive to engage in the taxable activity vanishes.
The model posits an optimal tax rate between these extremes that maximises revenue. The controversial implication is that under certain conditions, cutting tax rates can actually increase total revenue by stimulating greater economic activity.
The entire debate hinges on one question: where on this curve does a specific market sit?
Australia's Tobacco Policy: Public Health Success and Economic Distortion
Australia’s public health campaign against smoking is globally recognised. The strategy is fundamentally fiscal: make tobacco prohibitively expensive to deter use. This is executed through a permanent annual excise increase of 12.5%, plus bi-annual indexation.
The public health result is clear success: national smoking rates have plummeted to below 6% of adults.
However, the economic side effects are significant. Australia now has among the most expensive cigarettes in the world, with a pack often costing AU$40-$50.
The Perverse Incentives and the Illicit Market Response
For an addictive product, extreme pricing creates a harsh reality. While many quit, a residual demand remains, disproportionately in lower socio-economic groups. For these consumers, the choice is often not to quit, but to find cheaper alternatives.
This is where the Laffer Curve becomes acutely relevant.
Official excise revenue has sharply declined, from a peak of $16.3 billion in 2019/20 to an estimated $7.4 billion recently.
This suggests the market may be beyond the revenue-maximising peak. The high tax has catalysed a massive shift toward the illicit market.
The situation is compounded by vaping regulations. Australia's prescription model for nicotine vapes has unintentionally created a parallel, entirely illicit vape market, readily available in convenience stores.
The economic incentive for criminal suppliers is overwhelming. The profit margin created by high excise and prohibition is irresistible.
The AML Conundrum: From Illicit Trade to Money Laundering
The link between high-tax illicit markets and money laundering is historical and profound. Australia faces a modern Prohibition-era challenge:
The illicit tobacco trade is estimated to be worth $4 billion annually.
Illicit cigarettes may account for one in every five sold.
This generates enormous cash that must be laundered. A primary method, identified by authorities, involves convenience stores with private ATMs. Criminals use illicit cash to "fill" these ATMs; customer withdrawals then dispense "dirty" cash while generating a "clean" electronic transaction record.
The trade has also sparked a rise in violence, including firebombings and armed robberies, stretching law enforcement.
The Small Business Squeeze: A Catalyst for Complicity
To understand the trade's proliferation, consider the position of small retailers. Their traditional model is under severe pressure, with minimal margins on legitimate tobacco. Faced with rising costs, selling illicit products can become a matter of economic survival. The high margins drive a vicious cycle, normalising illegality within the legitimate retail sector.
Policy Crossroads: Enforcement as a Chosen Path
Confronted with this crisis, states are pursuing aggressive enforcement. Queensland provides a recent and stark example.
In late November 2025, under new laws, Queensland Health Authorities and police raided retailers across the state, ordering immediate 90-day closures. The new powers allow for:
On-the-spot business closures for up to three months.
Criminal penalties for complicit landlords (fines up to $161,300 and jail time).
Undercover operations within stores.
Health Minister Tim Nicholls called the laws “an absolute game changer,” designed to "cut off profits" and "remove the financial rewards" of the illegal industry. Industry groups supported the move, arguing the black market had "seen organised crime groups embed themselves in local retail strips."
Queensland’s policy decision is clear: intensified prohibition and stricter enforcement are the chosen mechanisms.
Conclusion: Balancing Acts and Future Challenges
The government faces a complex balance. The public health success is undeniable, but economic and criminal side effects are severe.
The situation illustrates a Laffer Curve dilemma: a policy can become so effective at suppressing a legal market that it stimulates a larger, uncontrolled illegal one. The 2026 expansion of Tranche 2 AML reforms to "gatekeeper" professions will help track the laundering of the proceeds from this illicit activity, but the primary response, as seen in Queensland, is shifting toward direct suppression.
The fundamental tension remains: finding an equilibrium that maintains public health gains without ceding vast market share to criminals. The experience of alcohol prohibition in the United States serves as a stark historical lesson. The ongoing challenge will be to see if enforcement can curb the criminal incentives that the current economic landscape has created.
