The Treasury is facing a £2.6 billion blackhole after a sharp rise in illegal tobacco sales, with smokers increasingly turning to the black market to avoid spiralling tax hikes. Under Rachel Reeves’ watch, the Government’s plan to boost tobacco duties has backfired, with the UK missing its expected target of £11.4 billion. Instead, the Treasury has raised just £8.8 billion – 12% lower than the previous year, the sharpest collapse in revenue on record.

The key driver behind the sudden downturn is the growing prevalence of illicit tobacco. According to official data, at least 14.5% of the UK’s tobacco market is now controlled by illegal suppliers, with some experts estimating the actual figure could be nearly double that. Cigarettes from Eastern Europe smuggled British brands, and counterfeit products are flooding the market, undercutting legal sales and leaving the Treasury with a significant shortfall.

Such an outcome would represent a significant setback for Ms Reeves, who is already under intense pressure to restore balance to the nation’s finances.

With inflation still rising and economic growth sluggish, her £10 billion fiscal headroom – the financial cushion meant to absorb unforeseen costs – has already been wiped out, according to the Office for Business Responsibility.

Now, as the Chancellor prepares for her crucial spring Statement on March 26, the looming £2.6 billion gap will only add to the pressure. There are growing concerns that she’ll be forced to announce further austerity measures, risking a backlash from Labour MPs already angered by reports of impending welfare cuts.

Reform UK MP Richard Tice has accused the Government of creating this problem through its “addiction to high taxes,” claiming that the rising levies on tobacco have simply driven smokers to the black market.

The Boston and Skegness MP told The Telegraph excessive duty hikes have failed to achieve the Government’s intended revenue targets and instead pushed people towards criminals.

Referring to the economic theory which posits that tax rates above a certain threshold can actually reduce government revenue, he said: “The Laffer Curve isn’t just a theory; it’s a reality.”

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The spike in illegal tobacco sales has also had serious implications for legal retailers. As retailers struggle to compete with cheaper, untaxed products, the legitimacy of the entire market is being undermined, and more businesses are being forced to close.

The latest drop in tobacco duty revenue follows a broader trend of high taxes backfiring in the UK. Last year, the Government raised cigarette duties by 2% above inflation, and hand-rolling tobacco saw a 12% increase.

Despite the increases, overall revenue has been shrinking. The trend echoes earlier warnings from campaigners, who have pointed out that when alcohol duties were frozen between 2020 and 2023, tax revenue from that sector actually increased.

The Chancellor will deliver a statement on March 26 in response to the latest forecast from the budget watchdog.

However, earlier this week Dr Isabel Stockton, a senior research economist at the Institute for Fiscal Studies (IFS), suggested that when faced with the options of breaking her self-imposed financial rules or keeping to the promise of only one fiscal event per year, “it seems likely that her commitment to a single fiscal event is the one that is likely to go”.