Study: Cigarette Smuggling Widespread, Driven by Taxes

Published March 1, 2009

Many states are considering cigarette excise tax increases to plug holes in their budgets. But a new study finds potentially higher revenues from tax hikes may not materialize, or unintended consequences may limit the value of any new tobacco tax money.

“Cigarette Taxes and Smuggling: A Statistical Analysis and Historical Review,” by the Michigan-based Mackinac Center for Public Policy, shows tax-induced cigarette smuggling is occurring in 47 of the 48 contiguous states.

The report arrives hot on the heels of two 2008 academic papers addressing cigarette smuggling.

Both Casual, Commercial

From 1990 through 2006, the states with the highest average annual smuggling rates were California (24.5 percent), New York (20.9 percent), and Arizona (20.6 percent), according to the Mackinac study. Each figure represents the total annual average percentage of cigarettes (legal and illegal) consumed in each state that were smuggled in either through “casual” or “commercial” means.

Casual smuggling involves individual bargain-hunters crossing their state’s border to purchase cigarettes primarily for their own consumption. Commercial smuggling involves large-scale, long-distance smuggling of tobacco products that are frequently distributed to retailers for resale.

The top states for cigarette smuggling in 2006 were Rhode Island (45.7 percent), New Mexico (42.4 percent), and Washington (42.3 percent). All three states have raised their cigarette excise taxes since 2003.

New Mexico finds itself among the top three smuggling import states because of its border with Mexico. Mexico is also a major source of smuggled cigarettes for Arizona, California, and Texas.

Prices Drive Behavior

The study examines casual smuggling in detail, using the private sales data of a large Midwestern distributor of cigarettes at the ZIP code level from January 2006 through September 2008. This allowed the researchers to track changes in sales to retailers in Michigan border counties, and by extension enabled them to identify the sensitivity of retailers and consumers to tax-induced changes in price differentials between the states.

After Indiana hiked its taxes by 79 percent in July 2007, the authors found, sales to retailers on the Michigan side of the border leaped by more than 53 percent. Sales to Michigan retailers bordering Wisconsin also rose, though by a relatively modest 8 percent, when the Badger State increased its taxes in January 2008.

The numbers strongly indicate retailers and consumers in Michigan changed their behavior when presented with relative changes in price, the authors note.

Smuggling ‘Confounds’ Potential Gains

Another 2008 paper on smuggling, “How Far to the Border: The Extent and Impact of Cross-Border Casual Cigarette Smuggling,” estimates the “percent of consumers who smuggle” is between 13 percent and 25 percent nationwide.

The study was published last March in the National Tax Journal and written by Stanford economist Michael Lovenheim. “[C]ross-border smuggling confounds many of the potential health and revenue gains from cigarette taxation,” Lovenheim writes in the study. Other scholars have advanced similar theses.

A May 2008 working paper, “Excise Tax Avoidance: The Case of Cigarette Taxes,” by Phillip DeCicca, Donald Kenkel, and Feng Liu of Cornell University’s Department of Policy Analysis and Management, used 2003 survey data from the federal government regarding smokers’ tax avoidance behavior. The study concludes about 5 percent of smokers nationally engage in such activities.

Not only do high excise tax differentials encourage smuggling and a wide array of other crimes, they may not deliver the revenue the states and localities expect.

New Jersey—where the smuggling rate exceeds 40 percent—has seen a net cigarette tax revenue decline after hiking its cigarette excise tax four times in the past seven years to $2.58 a pack.

About 15 states are considering hiking cigarette taxes in 2009.

Michael LaFaive ([email protected]) is director of the Morey Fiscal Policy Initiative at the Mackinac Center for Public Policy and coauthor, with Patrick Fleenor and Todd Nesbit, of “Cigarette Taxes and Smuggling: A Statistical Analysis and Historical Review.”

For more information …

“Cigarette Taxes and Smuggling: A Statistical Analysis and Historical Review,” by the Mackinac Center for Public Policy: