The economics of organised crime

The framework developed in this Chapter can also be applied to the analysis of organised crime. Schelling (1967) is one of the earliest economic examinations of organised crime in the literature. He argues that criminal activity is 'organised' if it has a hierarchical structure, entails a common use of legal and financial advice, common communication methods, and common methods of contract enforcement. In other words, the defining characteristic of organised crime is collusion and implicit agreement among criminals.

Taxation, black markets, and organised crime

Why does organised crime exist and prosper? One possible reason is excessively high taxation. This section develops a simple model to illustrate the effect that taxation of legal goods can have on the incentives to supply goods illegally.

Suppose that there is a single good that is produced in the legal and illegal sectors. Each good is of the same quality, and sells at the same price. Consumers cannot tell the difference between the two types of good. Taxes are only paid on legally produced goods. Suppose that, initially, there is a zero tax rate on legally produced goods. Let the consumer price be P. The supply curves in the legal (L) and illegal (I) sectors are:

The demand curve is:

Initially, in the absence of taxation, we have:

Now suppose that a tax is imposed on the production of legal goods. We then have:

We can now investigate the effect of a change in taxation on overall production, as well as production in each sector. Totally differentiating (9.47) with respect to t yields:

Rearranging this yields:

The expression in (9.49) simply states that the price paid by consumers

rises with the tax on legally produced goods. Hence — = — — < 0,


and quantity demanded for the good falls. We also have: and:

When a tax is placed on legally produced goods, the quantity supplied of illegally produced goods rises, and the quantity supplied of legally produced goods falls. Overall, however, demand falls - but not by as much as it would in the absence of illegal activity. As the tax rises, the legal sector contracts and the illegal sector expands.

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