April 26, 2008

Beacon Hill’s Gift to the Black Market

This commentary appeared in the Boston Globe on April 26, 2008.

According to police, Richard “Pops” Picardi, a 76-year Revere man who hobbled about on a prosthetic leg, was a purveyor of many vices. For drug addicts he supplied OxyContin, Percocet, and other narcotics, investigators say. To smokers he supplied cheap, tax-free cigarettes out of a Chelsea taxi office.

This operation came to an end last week after police and Suffolk County prosecutors closed in on him. Yet such busts do little to stem the flow of illegal smokes into the Bay State. Massachusetts is awash in bootleg cigarettes.

High state cigarette taxes have turned packs of cigarettes into pots of gold for criminals, spawning a massive black market supplied by both smugglers and thieves who can quickly unload stolen cigarettes for cash.

Legislators on Beacon Hill are now planning to almost double the criminal profit margin by hiking the state cigarette tax by another buck a pack. This will only place more citizens in harm’s way.

The Bay State is no stranger to cigarette tax-induced crime. Soon after the state tax was enacted in 1939, legal, tax-paid sales fell, as cigarettes were smuggled in or diverted from tax-free stocks and sold in the ordinary market. Merchants in neighboring states also began advertising the tax-free prices available in their stores.

Massachusetts tax authorities responded by stationing agents in neighboring states to photograph border shoppers lured by bargain smokes. That failed, and so did more frequent audits of wholesalers and retailers. The criminals proved to be wily, and, like the famous liquor bootleggers during Prohibition, these “butt-leggers” sometimes outran enforcement agents in souped-up cars.

Over the next quarter century a stalemate of sorts set in between tax-enforcers and tax-evaders. Taxes increased slowly, only at about the rate of inflation, so evasion remained more or less constant.

The Surgeon General’s famous report on smoking and health in 1964 changed everything. Lawmakers reacted by more than doubling cigarette excises over the next decade, causing cigarette bootlegging and related crime to explode.

By the mid-1970s, the state’s highest-in-the-nation tax created horrendous evasion problems. A 1977 federal report found that Massachusetts smokers were buying 76 million untaxed packs annually, and labeled the state’s bootlegging problems as “serious.” A subsequent state report agreed, and state officials concluded that profits in the illegal cigarette trade were large enough to attract professional criminals who also supplied this vast, illicit market by hijacking cigarette trucks and robbing retail or wholesale locations.

At a 1977 congressional hearing on the national cigarette bootlegging problem, Senator Edward Kennedy noted that the Mob’s entry into the racket had led to “increasing violent crime: extortion and bribery, truck hijackings, armed robberies, serious assaults, and even murder.”

State officials made the usual futile gestures, forming task forces with federal authorities and nearby states. Nothing made a dent. In 1980, combined federal and state enforcement efforts netted just 5,800 cartons of illegal smokes, about the number smuggled in three hours on a typical day.

The emergence of this large illicit market, coupled with the inability of enforcement officials to do much about it, helped discourage additional large tax hikes for more than a decade and a half. This allowed inflation to gradually whittle down the excise to levels not seen since the early 1960s. By the early 1990s, this de facto tax reduction had largely eliminated the state’s problems with large-scale evasion.

But lawmakers’ memories are woefully short. At the beginning of 1993, the state cigarette excise nearly doubled to 51 cents per pack. Smoking in Massachusetts dipped slightly, following the nationwide trends. You would never know the effect was so modest from looking at the state’s records of tax-paid cigarettes—sales of those plummeted. But smuggling boomed.

Additional tax hikes in 1996 and 2002 have pushed the tax to its current level of $1.51 per pack. The resulting increase in border activity has helped push sales of tax-paid cigarettes to unprecedented lows.

Backers of the current hike argue that it will raise needed revenue while discouraging smoking. The first claim is myopic, since the tax imposes costs on society in terms of lawlessness. The widespread availability of cheap cigarettes via the black market also undermines the second.

Patrick Fleenor is chief economist of the Tax Foundation and author of “Cigarette Taxes, Black Markets, and Crime,” published by the Cato Institute.