Higher Cigarette Taxes Create Lucrative, Dangerous Black Market

Cigarette taxes have been in the news lately, and not just because politicians keep raising them. What’s new is that state and local levies have grown so onerous in some parts of the country that they almost could be called “prohibition by price.” And like other forms of prohibition, this one has led to a spike in smuggling-related criminal activity as smokers turn to illicit distribution channels. We estimate that for 2011, 29.3 percent of all cigarettes consumed in the Great Lake State were smuggled in.

The destructive consequences of rampant tobacco smuggling include the corruption of government officials, violence, theft, counterfeiting and dangerous, adulterated products. Moreover, while very high taxes are often sold as a way to finance government health programs, in many cases the money goes to fund unrelated spending.

We have just completed our third set of estimates for tobacco smuggling in 47 of the 48 contiguous states, this one based on data through 2011, with previous editions released in 2008 and 2010. Each statistical model matches actual legal sales against predicted state consumption based on reported smoking rates, with the difference representing our estimate of smuggling.

Michigan’s smuggling rate is up 12.7 percent since our previous study of 2009 data was published. Despite the increase, Michigan retained its rank as the 10th highest smuggling rate among the 47 states in our model. The big changes in smuggling rates and ranks occurred elsewhere in the country.

We find that New York currently holds the top position as the highest net importer of smuggled cigarettes in 2011, with smuggled cigarettes totaling a staggering 60.9 percent of the total market. Not coincidentally, New York also has the nation’s highest state cigarette tax at $4.35 per pack, plus another $1.50 levied in New York City.

Other notable results from our model include:

• Massachusetts increased its cigarette tax from $1.51 to $2.51 per pack in 2010, and in 2011 became an even larger market for smugglers, advancing 13 spots since our 2010 report.

• Florida moved up 12 places on the smuggling index after hiking cigarette taxes in 2010 from 33.9 cents per pack to almost $1.34.

• Utah moved up 10 positions. You guessed it — the Beehive State increased is cigarette tax from 69.5 cents to $1.70 in 2011.

A few states saw dramatic decreases in estimated smuggling. New Jersey fell by 12 positions, probably because large tax hikes in neighboring states made it a relatively less attractive destination for smugglers. In 2010, New Jersey’s cigarette tax was almost 48 cents higher on average compared to its bordering states.  In 2011, the tax in the Garden State averaged around 39 cents lower than its neighbors.

By our estimate, New Hampshire was the highest ranking “export” state. For every 100 packs of cigarettes consumed there, almost 27 packs were smuggled out.

We also modeled for Maryland the impact of a recently proposed 50 percent hike in its excise tax, from $2 per pack to $3. If such an increase were enacted in Maryland, the proportion of smuggled cigarettes consumed by its smokers would leap from 26 percent of the total market to 52 percent, and would actually result in a net decline in tobacco tax revenues.

These findings are troubling enough, but even more disturbing is what appears to be an increase in criminal activity related to illicit tobacco smuggling. In just one egregious example from last summer, a Maryland police officer in Prince George’s County was sentenced for running illicit cigarettes while using his duty firearm, uniform and patrol vehicle. In 2010, a Virginia man admitted to hiring someone to kill another over smuggled smokes. Prison guards have been busted smuggling smokes into prisons.

Consumers of smuggled cigarettes also incur greater risks. Counterfeiting of legitimate brands is a growing problem, and the phony butts are often adulterated with fillers containing anything from sawdust to human excrement. It’s today’s version of the toxic “bath tub” gin of the alcohol prohibition era. Official state stamps that are placed on packs to show taxes were paid are also being counterfeited, or sometimes simply stolen, or ignored by sellers of “loosies” — individual cigarettes sold illicitly for 25 cents to 50 cents each.

Cigarette tax hikes come with harsh and real unintended consequences. Before reaching deeper into smokers’ pockets, state lawmakers should consider the deeper social costs of creating a lucrative black market for smuggled cigarettes.

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Michael D. LaFaive is director of the Morey Fiscal Policy Initiative and Todd Nesbit, Ph.D., is an adjunct scholar at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Nesbit is also a senior lecturer at The Ohio State University