Minnesota Eyes Higher Tobacco Taxes

(Editor's note: This commentary was co-authored by Michael D. LaFaive, director of the Morey Fiscal Policy Initiative at the Mackinac Center, and Kim Crockett, executive director of the Minnesota Free Market Institute at the Center of the American Experiment in Minneapolis, Minn.)

Minnesota Gov. Mark Dayton’s proposal to raise cigarette excise taxes by 94 cents per pack to help thwart additional smoking appears well-intentioned, but he said he had to be talked into it (smoking raises health costs to the state) and that he was not doing it for the revenue (estimated by his administration at $370 million).

Unfortunately, it won’t work, at least not to the degree many believe. Most smokers are not sheep lining up to be sheared and will look for cheaper smokes elsewhere. Even those who pay full freight may unwittingly be buying contraband cigarettes smuggled in by organized traffickers.

The Mackinac Center’s newest cigarette smuggling study indicates that in 2011, almost 20 percent of all the cigarettes consumed in Minnesota were smuggled in through one of two means: casual and commercial. Casual smuggling typically involves border crossings and purchases made by individuals for personal consumption. Commercial smuggling is typically a function of large, long-haul shipments from distant states.

Using the same statistical model, we re-estimated Minnesota’s smuggling figures based on Gov. Dayton’s proposed higher rate (to $2.52). Under this scenario Minnesota’s smuggling rate would leap to 30.3 percent, 14.5 percent of which can be directly attributed to casual smuggling. This figure is important. It reminds us to take official post-tax hike declines in legal paid sales with a grain of salt. Those declines are not completely a function of people quitting but avoiding the legal cigarette trade.

The Center study is not the only one to come to this conclusion.

• In 2008 economist Michael Lovenheim published a study using data that ends in 2002 on the extent of casual smuggling and concludes that between 13 percent and 25 percent of cigarette consumers engage in casual smuggling. His casual smuggling percentage estimate for MN was just over 11 percent.

Lovenheim concludes that, “the central implication of this study is cross-border smuggling confounds many of the potential health and revenue gains from cigarette taxation.”

• In 2004, economist Mark Stehr published a study in the Journal of Health Economics that argued that “up to 85 percent of the tax paid sales response” to cigarette consumption is from avoiding taxes and not from declines in smoking.

• A 1995 study by Morris Coats — and published in the National Tax Journal — came to a similar conclusion. “[A]bout four-fifths of the sales response to state cigarette taxes is due to cross-border sales,” the study said.

Smuggling is not the only way in which people acquire the nicotine they desire. Some avoid federal taxes by going to Indian reservations to buy cigarettes. Some simply substitute manufacturer’s products for “roll your own.” Buying loose tobacco and making your own cigarettes is often cheaper than buying a pack of Camels or Marlboros. Worse, because the substitute products are handmade the smoker can forgo the use of filters, thus self-regulating the nicotine and tar intake upward.

In addition, high cigarette taxes have been associated with other unintended consequences, such as truck hijackings, counterfeiting of cigarettes and tax stamps, violence against police, corruption and robbery. Cigarettes are often like little gold bars to the criminal class. Do we really want to further line the pockets of bad guys with a feel-good sin tax?

Last summer, a police officer in Maryland was sentenced for his role in illicit cigarette trafficking. He had apparently used his official patrol car, uniform and gun while helping guide contraband smokes to their destination. Prison guards have been busted smuggling cigarettes into prison. With porous borders it is unlikely that Minnesota will be able to prevent a major uptick in illegal cigarette trafficking.

Just last month, a store in suburban Minneapolis was robbed of cigarettes and cash. Armed robbers (we’re talking ski masks and guns pointed at the nice folks who work there) took cigarettes and cash in two other Minnesota towns last fall. This happens with great frequency. In fact, YouTube maintains a treasure trove of such thefts caught on surveillance cameras. Does this remind anyone of the lessons we learned with Prohibition?

We do not doubt that — should Gov. Dayton’s excise tax hike proposal pass — some smokers may quit. But it may not be close to the numbers tax hike proponents believe. Moreover, the tax hikes will come with unintended consequences including increased crime. It should not be hard to conclude that the costs of this tax increase greatly outweigh the benefits.

Permission to reprint this blog post in whole or in part is hereby granted, provided that the author (or authors) and the Mackinac Center for Public Policy are properly cited.