Sin taxes in a sealed market: dilution and leakage related to cross‐border shopping

Abstract Excise taxes on goods with negative health outcomes (so‐called “sin taxes”) effectively reduce demand but are less effective when consumers can purchase similar goods in tax‐exempt markets. We investigate how cross‐border shopping affects the effectiveness of sin taxes by exploiting the de facto ban on cross‐border shopping during the COVID‐19 pandemic. Using a difference‐in‐differences design and Danish household panel data, we find that households living within 150 kilometers of the Danish–German border increased their spending on domestic sin goods by 21 percent relative to more distant households when the borders closed. Based on these findings, we show that cross‐border shopping weakens the revenue and health benefits of sin taxes mainly for the relatively few households living closest to the border, so its aggregate impact is smaller than commonly assumed.