Smuggling Would Rise Along with Tobacco Tax

An initiative that may appear on Colorado’s November’s ballot would, if adopted, nearly triple the state’s current cigarette excise tax. This, we believe the evidence shows, will usher in a wave of cigarette smuggling and other undesirable consequences.

Voters should think twice before adopting this tax increase. Research shows high excise taxes invite scofflaws to traffic in illicit cigarettes, encourage corruption among public officials and trigger violence against people, property and police.

We created a statistical model in 2008 to measure how many packs of cigarettes are smuggled into or out of American states and have updated it routinely since then. In our latest analysis, which uses data through 2013, we find that Colorado has a relatively low smuggling rate of about 12 percent. Most of the smuggling comes from what we call “casual” smuggling.

The casual smuggler is the Coloradan who crosses into a different city, county, state or taxing jurisdiction to buy cigarettes, or buys them online. The key is that the person buys cigarettes for his or her own use. Contrast this with “commercial” smuggling, which is an organized crime that brings in truckloads of cigarettes from distant locales to be sold illegally in Colorado. This happens all over the country — for example, cigarettes with Virginia tax stamps have been confiscated in California. (A tax stamp is evidence that the pack is subject to the taxing authority of a particular state.)

We have spent much of our working lives since 2006 studying cross-border economic activities, including cross-border tax avoidance and evasion. When cigarettes are involved, we typically call both tax avoidance and tax evasion “smuggling,” although not all tax avoidance is illegal. Using our statistical model, we have calculated what would happen if Colorado were to increase its excise tax from 84 cents per pack to $2.59 per pack.

Our model tells us that smuggling would leap from 12 percent of all cigarettes consumed to a stunning 36 percent, a tripling of the smuggling rate to go with the tripling of the excise tax. Half of those smokes would come from casual smuggling and half from commercial smuggling.

About half the smuggled cigarettes would be bought in from nearby states with lower excise taxes, including Wyoming, Utah, Arizona, New Mexico, Oklahoma, Kansas and Nebraska. The other half would come from more distant states, but only Kansas separates Colorado from the lowest taxed cigarettes in the country: Missouri, which levies just 17 cents of tax per pack. It would be naive to think that smuggled cigarettes wouldn’t roll into Colorado by the truckload from Missouri and more distant states if this tax hike were adopted by voters.

We are not the only scholars to calculate smuggling rates nationwide. Economist Michael Lovenheim published a study in 2008 estimating the national smuggling rate among consumers to be between 13 percent and 25 percent. Other estimates we have reviewed place national evasion and avoidance rates as low as 4 percent and as high as 21 percent. Studies that zero in on particular localities peg rates much higher.

On July 25 of this year, a New Jersey man was charged with smuggling $9.5 million worth of cigarettes. He is accused of smuggling low-tax (30 cents per pack) Virginia cigarettes into the high-tax ($2.70 per pack) Garden State for resale. Late last year, a New Jersey corrections officer was sentenced to two years for his role in smuggling cigarettes into the Essex County Correctional Facility.

The lessons from these two New Jersey events should not be lost on policymakers. If officials can’t keep contraband smokes out of prisons, how could they possibly keep them from entering a state’s borders? If the proposed ballot initiative were approved, Colorado would have a tax rate nearly equal to New Jersey’s. It would also have all the smuggling related problems faced by law enforcement there.

Public policy decisions require tradeoffs. Raising taxes on a good, for example, will discourage its use (an intended consequence of taxing cigarettes, but a negative one in taxing income). But it could also incentivize illegal trafficking of that good. This illegal trafficking is an unintended and costly consequence of raising cigarette taxes. Colorado policymakers, and voters, should take these consequences into account when they are deciding how much to tax these goods.

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