Sinful Sin Taxes

Counterfeiting operations have become so sophisticated it is nearly impossible to tell genuine cigarette packaging (left) from illegal, counterfeit packaging (right).

In mid-February, Gov. Jennifer Granholm introduced her fiscal year 2005 state budget. Designed to wipe out an anticipated $1.3 billion deficit, her proposals included almost $400 million in new taxes, $295 million of which would be raised though a tax hike of 75 cents per pack of cigarettes. The cigarette tax hike would raise Michigan’s per-pack tax to $2.00, second only to New Jersey’s.

Such a tax hike is not a harmless revenue raiser. It will kill thousands of Michigan jobs, increase cigarette smuggling, and possibly even help fund terrorism. State lawmakers should nix it and rely instead on deeper budget cuts.

While economic modeling programs can never precisely estimate the impact of tax and other policies on the state economy, the Mackinac Center for Public Policy does use the well-known State Tax Analysis Modeling Program (STAMP), produced by the Beacon Hill Institute at Suffolk University in Boston, to come up with ballpark figures indicating benefit or harm. The model indicates that Michigan would lose more than 5,000 jobs in the year following a 75-cent cigarette tax increase. About 40 percent of these losses would occur in the retail sector.

Because Michigan’s cigarette tax is so high, it encourages interstate smuggling. In North Carolina, cigarette taxes are just a nickel per pack. The difference between that amount and what Michigan charges is known as the tax differential, and is precisely what smugglers try to capture as profit.

Late last year Dearborn resident Hassan Moussa Makki negotiated a plea bargain in which he admitted smuggling cigarettes from North Carolina to Michigan. He was using the profits to help Hezbollah, a well-known terrorist organization with links to Al-Qaeda. According to the Detroit Free Press, Makki said in his plea agreement that he smuggled $38,000 to $72,000 worth of cigarettes each month for two years.

Raising cigarette taxes simply raises these smuggling profits, and will encourage more such activity. By raising cigarette taxes from $2.50 per carton to $12.50 per carton since 1994, the Michigan Legislature has effectively created a “terrorism subsidy.” This subsidy will expand if the Granholm proposal passes.

High cigarette taxes have also led to brazen retail theft, the hijacking of cigarette vans, counterfeiting of “stamps” designed to thwart smuggling itself, counterfeiting of cigarettes and packaging, and to large increases in Internet purchases of cigarettes (which are illegal in Michigan). In January, the Michigan State Police confiscated 550 cartons of cigarettes from a Warren man who purchased them through the Internet.

In October 2002, just two months after the state raised cigarette taxes to $1.25 per pack, the Sam’s Club in Port Huron experienced a particularly brazen cigarette theft. During store hours, thieves removed a sofa recliner from its box, filled the box with $10,000-worth of cigarettes, proceeded to the check-out counter, and paid the several hundred dollars for the “recliner.” The thieves were never brought to justice.

In September 2000, an Ypsilanti resident was charged with possession of 600-plus sheets of legal cigarette “stamps” stolen from a local wholesaler. Mandated by the state, stamps provide evidence that the cigarettes are being sold legally. The thieves intended to paste the legitimate stamps on contraband cigarettes to make them easier to sell.

In 1999, Michigan State Police received approximately 100 complaints of counterfeit cigarette stamp usage, and made at least two arrests involving more than 13,000 counterfeit stamps.

Counterfeit cigarettes are also a problem. On Jan. 28, 2004 the U.S. Department of Homeland Security announced it had helped dismantle a five-state smuggling ring’s Chinese-made counterfeit cigarettes worth more than $37 million. Approximately $190 billion-worth of such cigarettes are produced in China each year.

As U.S. Immigration and Customs Enforcement chief Michael Dougherty has told the Associated Press, “Because the profits are so fantastic, we’re now seeing drug traffickers, other criminal organizations, and even terrorists involved in tobacco smuggling.”

Because of their popularity, most counterfeits are packaged in Altria Group, Inc. (formerly Phillip Morris) brand names, such as Marlboro. But the counterfeits can be far more dangerous. Some counterfeit cigarettes have been found to contain sand and other dangerous filler material as well as more tar and nicotine than legally produced cigarettes.

The unintended consequences of hiking cigarette taxes are becoming more evident with time and experience. Michigan’s Legislature should avoid exacerbating these problems and instead turn to real budget cuts to solve Michigan’s budget deficit.

Michael LaFaive is director of fiscal policy at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Michigan. More information is available at www.mackinac.org. Permission to reprint in whole or in part is hereby granted, provided the author and his affiliation are cited.