High cigarette taxes have led to thriving black market across America

High cigarette taxes have led to thriving black market across America

State and even federal lawmakers have over the years turned to higher taxes on cigarettes to raise revenue and combat the “sin” of smoking. There are, however, unintended consequences to such policies. These include tax evasion and avoidance (collectively referred to as smuggling) and other activities, often illegal. This is why getting a handle on the degree to which smuggling occurs is so important. Each year, we (along with the Tax Foundation of Washington, D.C.) try to estimate the amount of smuggling that occurs in states across the country.

Our latest estimates are complete and use data through 2016. Here is a preview of our results. We find illicit smokes continue to play the largest role in New York, where nearly 56 percent of all cigarettes consumed are smuggled in or are otherwise of questionable legal provenance. The Empire State is followed by Arizona (44 percent), Washington state (43 percent), New Mexico (41 percent) and Minnesota (35 percent).

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Nevada, the sixth-ranked state, bears mentioning. It leapt a staggering 35 places year-over-year from its previous position as 41st in the nation. This change is no doubt a function of a 2015 tax hike of $1 a pack. We expect Nevada’s rank to drop in next year’s estimates, however. Our data set only goes through 2016, so it doesn’t reflect California’s $2 a pack increase in 2017, which brings that state’s tax to $2.87 a pack. Due to that hike, Nevadans will have one less convenient source of cheaper cigarettes from which to choose.

 

California presents an interesting case. Its high excise tax on cigarettes, border with Mexico and coastline of busy ports may turn it into the Golden State of smuggling. Late last month, authorities in Los Angeles arrested two traffickers who are now accused of obtaining and trying to distribute tax-free smokes. One publication about the arrests indicate that the smugglers peeled off cigarettes meant for export through the Port of Los Angeles. The arrests were part of a larger investigation that uncovered two million illegal smokes.

Cigarettes are also smuggled out of states, particularly when their neighbors have a much higher excise tax. The opportunity is large, not only for individuals trying to save a buck by crossing into another taxing jurisdiction, but also for organized crime cells seeking to make thousands of dollars. The top outbound smuggling state in this year’s study is New Hampshire, at 85 percent. For every 100 cigarettes consumed in the Live Free or Die State, another 85 are smuggled elsewhere, probably to neighboring states.

The states rounding out the top five export states include Idaho (25 percent), Wyoming (22 percent), Delaware (21 percent), and West Virginia (20 percent). Virginia, the sixth-ranked state for outbound smokes at 19 percent, is often identified as a significant source state for New York’s inbound traffic.

Just last week it was announced that a resident from Virginia was sentenced to a three year prison term for his role in smuggling cigarettes up into New York. That’s just one individual, and the total revenue lost from the illicit trade is staggering. Absent smuggling, New York would generate an additional $1.5 billion in cigarette excise tax revenue. 

Our model of state cigarette smuggling compares legal-paid sales of cigarettes by state to smoking rates in those same states. The difference between the rate of smoking — a legal activity — and what is being sold in the state must be explained. We — and other scholars — lay that difference at the feet of tax evasion and avoidance.

Tax evasion and avoidance is not the only unintended consequence of high excise tax rates. Public corruption, violence against property and police, theft of cigarettes and tax stamps, truck hijackings and more have all been tied to illicit cigarette trafficking.

Many state governments around the country need to reassess their reliance on cigarette excise taxes. The taxes themselves undermine health goals by driving illicit shopping while inspiring rafts of other unwanted behavior.

Michael LaFaive is senior director of fiscal policy for the Mackinac Center for Public Policy, a free-market research institute based in Michigan. Todd Nesbit is an assistant professor of economics at Ball State University. Both are individual contributors to the new Mercatus Center book “For Your Own Good: Taxes, Paternalism and Fiscal Discrimination in the 21st Century.”