A Tax Hike Al Capone Could Have Loved

(Editor’s note: This commentary originally appeared the Heartland Institute’s Health Care News on Nov. 19, 2013.)

The administration of Chicago Mayor Rahm Emanuel is considering a 75 cents per-pack cigarette excise tax hike on a product already carrying a $1.01 federal tax, a 68 cents city tax, a $3 Cook County tax and a $1.98 state excise tax.

If adopted, cigarettes in Chicago would displace those in New York City as the most expensive in the country and carry with it an increase in smuggling and other unintended consequences. Mayor Emanuel should reject this tax hike scheme.

During Prohibition, the Windy City was beset by alcohol smuggling, government corruption and violence, among other problems. Al Capone and other gangsters profited from smuggling alcohol. Cigarettes are legal but high tobacco taxes have created an era of what we call "prohibition by price."

Cigarette smuggling is already rampant in the United States. Our 2013 research on state excise taxes and smuggling indicates that as much as 60 percent of New York's total cigarette consumption is smuggled into the state.

If Mayor Emanuel's plan passes, Illinois could displace New York as America’s No. 1 smuggling state. In our 2010 cigarette smuggling report (using 2009 data), we estimated Illinois' smuggling rate was less than 6 percent of total consumption. But the state cigarette tax has increased $1 a pack since that report. We estimated that higher tax could cause smuggling to jump to more than 26 percent of the total market. And this was before Cook County's $1-a-pack increase earlier this year.

Cigarette smuggling involves both commercial (such as large-scale criminal operations involving long-distance hauls) and casual (usually done by individuals making cross-border purchases for personal use).

Our statistical study is not city specific, so while additional smuggling would be picked up, we could only pinpoint overall smuggling for all of Illinois, not that which is specific to the Chicago area. That type of work has been done though. A 2010 study (using 2007 data) by economist David Merriman of the University of Illinois-Urbana examined the tax stamps on discarded cigarette packs found in Chicago. The stamp is evidence taxes had been paid in a particular jurisdiction. Merriman found that 75 percent of the packages collected did not bear the city tax stamp and 29 percent originated in Indiana.

In 2012, a similar analysis was published regarding South Bronx, New York, an area described as "socioeconomically deprived." Similarly, the authors found that 76.2 percent of the packs collected did not bear the stamp showing that state or city excise taxes had been paid.

In September 2013 Merriman again released a cigarette tax and smuggling study using littered cigarette packs, but this time examining New York City smuggling before and after the state's 2008 excise tax hike. His findings indicate that, "The share of littered packs with no tax stamp increased from 15 to 24 percent after the tax increase." (They also registered a decline in consumption.) The study was conducted with Howard Chernick.

This is of particular importance for two reasons. First, because Chicago is on the cusp of becoming the next high-tax New York; and, second, because the regressive nature of high excise taxes hurts lower-income people more.

A 2012 paper from Research Triangle Institute scholars shows that in 2010-2011, New York’s "lowest income group spent 23.6 percent of its annual household income on cigarettes," which was up from 11.6 percent in 2003-2004.

But smuggling isn't the only result of effectively banning a product. Essentially every misdeed associated with real Prohibition has been found lurking in its prohibition by price corollary. Consider some parallels:

Capone's gang (and others) bribed key officials — including police officers — to overlook or participate in their illicit trade.

The Chicago Tribune recently reported that a Cook County sheriff's deputy had been sentenced for his role in extorting money to ensure a smuggling operation. His co-conspirators have apparently been videotaped exchanging guns, drugs and cash for $20 million in illicit smokes. In 2012, undercover Federal Bureau of Investigation officers busted a Cook County revenue inspector for giving notice to retailers of future tobacco-related visits in exchange for money. Also last year a Maryland police officer in Prince George's County was sentenced for his role in smuggling, which included the use of his patrol car, uniform and pistol.

Even rumrunners were known for getting hijacked during deliveries. Legitimate tobacco wholesalers and retailers are also victimized by robberies.

Cigarette truck hijackings occur in modern America, too. One wholesaler in Michigan had to hire commando units to guide his cigarette shipments away from his warehouse after several hijackings. In 2010 in East Peoria, Ill., trucks stuffed with cigarettes were stolen from warehouses. Meanwhile, in November of this year, Chicagoan Charles Watson was sentenced for his role in robbing a retail store of cigarettes while posing as a policeman.

Prohibition had its share of murderers and some — like Vernon Miller — would do it on a contract basis for other bootleggers. (Miller, incidentally, had also worked as a bootlegger and as sheriff's deputy).

Last month men associated with a cigarette smuggling case were charged in a plot to murder witnesses in a case against them, according to the New York Attorney General's Office. This is not the only such case in recent years.

Cigarette taxes do lower smoking rates and usually raise government revenues, but typically not by as much as projected. And while proponents of higher taxes can point to decreased smoking rates and claim success, research shows the consumption rate largely shifts from legal smokes to illegal ones. Even then, these benefits are rarely weighed against the remarkable costs associated with high excise taxes.

Properly weighing the true costs against the potential gains of raising the cigarette tax should lead Mayor Emanuel to oppose such an increase.

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Michael D. LaFaive is director of the Morey Fiscal Policy Institute at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich.