Smuggling Undermines Tobacco Tax Hike Goals

(Editor’s note: This is an edited version of a commentary was co-authored by Michael LaFaive, director of the Center’s Morey Fiscal Policy Initiative, and Zach Tiggelaar, executive director of the North Dakota Policy Council.)

North Dakota State Rep. Eliot Glassheim has proposed a hike (HB 1387) in that state’s cigarette excise tax from 44 cents to $1.00 per pack, a 127 percent increase. While his intentions are good — he says he wants to help people quit smoking — it’s doubtful as many people as he believes will do so due to tax avoidance.

Cigarette smuggling has become rampant in parts of the country in large part due to tax-driven cost differentials between states. Mackinac Center analysts have estimated cigarette smuggling rates for 47 of the 48 contiguous states. In some parts of the United States smuggling is rampant. New York’s estimated smuggling rate exceeds 60 percent of the total market.

According to the Mackinac Center’s recent report, in 2011 North Dakota was actually a net export state. That is, more cigarettes were taken out of North Dakota after purchase than were brought in. That will change should the new tax increase proposal become law. Smuggling into North Dakota will leap to almost 10 percent of total, in-state consumption. The figure would be higher but the Center report subtracts from its total any North Dakota cigarettes that are smuggled into Canada.

Legal paid sales would drop after such a hike and — as has happened elsewhere — politicians and people will be inclined to think that the decline is a function of quitting when it is actually more a function of smuggling and acquiring different tobacco products, such as pipe tobacco. The Mackinac Center estimates that North Dakota’s legal paid sales will drop by 4 million packs a year as a direct result of smuggling.

Scholars from different backgrounds and institutions and using different data sets and measuring techniques have come to similar conclusions about taxes and smuggling. Consider a handful by date order.

A 1995 study by economist Morris Coats in the National Tax Journal found that “[A]bout four-fifths of the sales response to state cigarette taxes is due to cross-border sales.” In other words, many smokers maintain their habit; they just do so with smokes purchased in lower-taxed jurisdictions.

Similarly, in 2004 economist Mark Stehr published a paper titled “Cigarette Tax Avoidance and Evasion” in the Journal of Health Economics that said “up to 85 percent of the tax paid sales response” was due to tax avoidance and not from a decline in smoking.

In his 2008 National Tax Journal article, “How Far to the Border?: The Extent and Impact of Cross-Border Casual Cigarette Smuggling,” economist Michael Lovenheim estimates casual smuggling rates by state. Using data that ends in 2002 he estimates the “percent of consumers who smuggle” in North Dakota at 3.4 percent.

The study’s abstract 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 2012 the Centers for Disease Control published “Consumption of Cigarettes and Combustible Tobacco — United States, 2000-2011” and reported “certain smokers” changed tobacco types to avoid the higher cigarette taxes. People are simply redirecting their tobacco purchases to lower-taxed products.

Also released last year was a report from the Public Health and Policy Research Program at RTI International, a private consultancy that found New York State’s low-income smokers spend 25 percent of their incomes on cigarettes. New York State has the highest state excise tax rate in the nation. Rather than quitting, many are simply dedicating a greater portion of their low incomes to the habit.

Higher cigarette taxes do, however, come with other unintended consequences: wholesale and retail thefts, truck hijackings, violence against people and even corruption of government officials.

Last summer a Prince George’s County Maryland police officer was sentenced for his part in a smuggling operation that included use of his patrol car, gun and uniform. Prison guards have been caught trying to smuggle cigarettes into prison.

Higher taxes to curb cigarette smoking are probably not as influential as some believe and they often come with every manner of unintended consequence. When considering this excise tax hike proposal it would be wise for state lawmakers to consider all of the costs associated with the purported benefits.

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