- Excessive taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rates on cigarettes in some states induce substantial black and gray market movement of tobacco products into high-tax states from low-tax states or foreign sources.
- New York has the highest inbound smuggling activity, with an estimated 52.2 percent of cigarettes consumed in the state deriving from smuggled sources in 2019. New York is followed by California (43.4 percent of consumption smuggled), Washington (42.6 percent), New Mexico (37.2 percent), and Minnesota (35.2 percent).
- New Hampshire has the highest level of outbound smuggling at 71.3 percent of consumption, likely due to its relatively low tax rates and proximity to high-tax states in the northeastern United States. Following New Hampshire is Idaho (29 percent outbound smuggling), Virginia (29 percent), Wyoming (23.1 percent), and North Dakota (18.3 percent).
- Oklahoma, following a cigarette tax increase from $1.03 to $2.03 in the Summer of 2018, has seen a significant increase in smuggling into the state, moving it from a ranking of 30th to 17th highest inflow of cigarettes in the U.S.
- Cigarette tax rates increased in 39 states and the District of Columbia between 2006 and 2019.
- Lawmakers interested in taxing and regulating flavored tobacco and nicotine products should understand the policy trade-offs related to high taxation or bans. With distribution networks already well-developed, criminal gangs are poised to expand into nicotine products.
Tobacco Tax Differentials across States Cause Significant Smuggling
The crafting of tax policy can never be divorced from an understanding of the law of unintended consequences, but it is too often disregarded or misunderstood in political debate, and sometimes policies, however well-intentioned, have unintended consequences that outweigh their benefits. One notable example of this is the ever increasing tax rates on tobacco products. A consequence of high state cigarette excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. rates has been increased smuggling as people procure discounted packs from low-tax states and sell them in high-tax states. Growing cigarette tax differentials have made cigarette smuggling both a national problem and, in some cases, a lucrative criminal enterprise.
Each year, scholars at the Mackinac Center for Public Policy, a Michigan think tank, use a statistical analysis of available data to estimate smuggling rates for each state. Their most recent report uses 2019 data and finds that smuggling rates generally rise in states after they adopt cigarette tax increases. Smuggling rates have dropped in some states, often where neighboring states have higher cigarette tax rates. Table 1 shows the data for each state, comparing 2019 and 2006 smuggling rates and tax changes.
New York is the highest net importer of smuggled cigarettes, totaling 52.2 percent of total cigarette consumption in the state. New York also has one of the highest state cigarette taxes ($4.35 per pack), not counting the additional local New York City cigarette tax ($1.50 per pack). Smuggling in New York has risen sharply since 2006 (+46 percent), as has the tax rate (+190 percent). In October 2019, three people were charged in connection with smuggling cigarettes on the Staten Island Ferry. They were in possession of 30,000 untaxed cigarettes and $63,000 in cash, and they are just the tip of the spear. The inbound flow of cigarettes, not appropriately taxed by New York, is estimated to cost the state almost $1.2 billion.
Smuggling in Oklahoma has increased sharply since the last data release. The state increased the cigarette excise tax from $1.03 to $2.03, which resulted in increased inflow from barely any in 2018 to 15 percent in 2019. As a result, Oklahoma jumped 13 places on our ranking. Over the same period, inbound smuggling decreased in nearby Arkansas, from 6.3 percent to 2.3 percent, suggesting that Oklahoma’s tax increase impacted interstate smuggling. This effect can also be seen in Kentucky. In 2018, Kentucky had outbound flow of 8.7 percent but, after a tax increase of $0.50 per pack, this net outflow has become a net inflow of 0.2 percent in 2019. Maryland experienced the steepest decline in outbound smuggling, going from 10.4 percent inflow in 2018 to a negligible 0.11 percent inflow in 2019. However, since these figures are two years old, and Maryland increased its tobacco tax rate to $3.75 a pack in 2021, it is highly likely that 2019 was a short respite.
Other peer-reviewed studies provide support for these findings. A 2018 study in Public Finance Review examined littered packs of cigarettes across 132 communities in 38 states, finding that 21 percent of packs did not have proper local stamps.
As noted by LaFaive and Nesbit, primary authors of the Mackinac Center study, smuggling comes in different forms: “casual” smuggling, where smaller quantities of cigarettes are purchased in one area and then transported for personal consumption, and “commercial” smuggling, which is large-scale criminal activity that can involve counterfeit state tax stamps, counterfeit versions of legitimate brands, hijacked trucks, or officials turning a blind eye.
The Mackinac Center has cited numerous examples over the many editions of this report, including stories of a Maryland police officer running illicit cigarettes while on duty, a Virginia man hiring a contract killer over a cigarette smuggling dispute, and prison guards caught smuggling cigarettes into prisons.
Policy responses in recent years have included banning common carrier delivery of cigarettes, greater law enforcement activity on interstate roads, differential tax rates near low-tax jurisdictions, and cracking down on tribal reservations that sell tax-free cigarettes. However, the underlying problem remains: high cigarette taxes amount to a “price prohibition” on the legal product in many U.S. states.
International Cigarette Smuggling and Counterfeiting Puts Consumers at Risk
While buying cigarettes in low-tax states and selling in high-tax states is widespread in the United States, other methods for evading federal, state, and local taxes are popular. One way that criminals grow their profits is by avoiding the legal market completely. They produce counterfeit cigarettes with the look and feel of legitimate brands and sell them with counterfeit tax stamps. Many of these products are smuggled from China, with one source estimating that Chinese counterfeiters produce 400 billion cigarettes per year to meet international demand.
Global focus on counterfeit cigarettes has forced the criminals to innovate. A growing global problem is the so-called illicit whites or cheap whites. These products are produced legally in low-tax jurisdictions, but often intended for smuggling. Reports from this year indicate that the Chinese tobacco monopoly is playing a significant role in the “illicit whites” tobacco markets in Central and South America. Some of these activities spill over into the United States, and just in 2020, three men were arrested in Texas transporting illicit cigarettes. They admitted intentions to smuggle over 400 million cigarettes.
Smuggled and counterfeit cigarettes are dangerous products as they do not live up to the quality control standards imposed on legitimate brand cigarettes. Pappas et al. find that counterfeit cigarettes can have as much as seven times the lead of authentic brands, and close to three times as much thallium, a toxic heavy metal. Other sources report finding insect eggs, dead flies, mold, and human feces in counterfeit cigarettes.
During prohibition of alcohol in the United States during the 1920s, increased enforcement did not manage to significantly decrease the prevalence of bootlegging because the profit margins were so large, and the distribution networks sophisticated. The same is true for today’s cigarette smugglers.
In June 2019, Canadian authorities arrested nine people who reportedly smuggled over one million pounds of tobacco (valued at CA $110 million). According to police, the group was involved in both theft and arms trafficking. Also, that year, European authorities arrested 22 people across five countries representing an organized crime ring suspected of large-scale cigarette trafficking, drug trafficking, assassinations, and money laundering which had netted an estimated $750 million over two years. This year in Spain, authorities busted an underground illegal cigarette factory. The organized crime network behind the operation is suspected of large-scale cigarette trafficking with profits estimated at $647,000 per week.
Global illicit trade in tobacco is a growing problem, but is considered low-risk, high-reward. Billions of dollars are made each year, and the trade involves corruption, money laundering, and terrorism. According to the Financial Action Task Force (FATF): “Large-scale organized smuggling likely accounts for the vast majority of cigarettes smuggled globally.” These operations hurt governments, who lose out on revenue; consumers, because the products often don’t adhere to health standards; legal businesses, which cannot compete with illicit products; and the general respect of the law.
A Cautionary Tale
The impact of high taxes on cigarettes indicates how other policies directed towards tobacco and nicotine products may affect consumer behavior. For instance, most vapor product users also smoke or previously smoked cigarettes. With this in mind, we can imagine the behaviors of vapers to mirror those of smokers. Over the last few years, both federal and state lawmakers have called for flavor bans and cigarette-level taxation of vapor products. In fact, this fall, a proposal to tax nicotine products like cigarettes has been part of the funding package for the Build Back Better agenda. Moreover, the Food and Drug Administration (FDA) is currently reviewing applications for millions of vapor products, and, so far, the agency is denying almost all of them. It is still unclear what will remain of the nicotine market after the premarket tobacco application (PMTA) review process.
As the data from cigarettes clearly show, the risk of creating a new black market or fueling an existing one with operators willing and able to supply nicotine products to consumers is significant. There are already reports of nicotine-containing liquid coming into the U.S. from questionable sources. In addition to tax evasion—costing states billions in lost tax revenue—black market e-liquid and cigarettes can be extremely unsafe. In 2019, stories about serious pulmonary diseases prompted the FDA to publish a warning about black market THC-containing liquid (the psychoactive compound in marijuana). Reports of illicit products containing dangerous chemicals resulting in serious medical conditions also arose in 2019. Providing vapers with a well-regulated legal market will limit the distribution of illegal products.
In addition to the federal policies to limit access to nicotine products, several states have either implemented or are considering implementing flavor bans on cigarettes. These bans risk further escalating tax avoidance, tax evasion, and illicit sales in the U.S. 
In Massachusetts, the only state with a statewide flavor ban, sales data is available for the first 12 months following its implementation. Sales in the Bay State declined by almost 24 percent compared to the 12 months preceding the ban. This decline translates to $116 million less cigarette tax revenue for Massachusetts (not including sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. losses). The losses are even bigger if smokeless tobacco is included ($125 million). Importantly, these sales did not disappear; they merely moved to neighboring states. Sales of cigarettes in New Hampshire increased by 22 percent and sales in Rhode Island increased by 18 percent (see Figure 2). As such, this ban has not had a positive impact on public health.
In addition to the dangers to consumers, the legal market also suffers, as untaxed and unregulated products have significant competitive advantages over high-priced legal products. This impacts not only the large number of small business owners operating over 10,000 vape shops around the country, but also convenience stores and gas stations relying heavily on nicotine and tobacco sales. The impact on local businesses has led a number of Massachusetts lawmakers to consider repealing the state’s ban on flavored tobacco.
Policymakers should not lose sight of the law of unintended consequences as they set rates and regulatory regimes for tobacco and vapor products alike.
|State||2019 State Tax||2019 Consumption Smuggled (positive is inflow, negative is outflow)||2006 Consumption Smuggled (positive is inflow, negative is outflow)||2019 Rank||Rank Change since 2018||Excise Tax Rate change 2006-2019||Revenue Impact|
|District of Columbia||$4.50||N/A||N/A||N/A||N/A||350%||N/A|
|North Dakota||$0.44||-18.3%||3.0%||43||0||No change||$3,024,443|
Note: Alaska, Hawaii, North Carolina, and the District of Columbia are not included in the study. Cigarette tax rates have changed for eight states since 2019 (Colorado, Illinois, Kentucky, Maryland, New Mexico, Oklahoma, Oregon and Virginia) but are not reflected in the study.
Source: Mackinac Center for Public Policy; Tax Foundation.
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Al Qaeda has made millions of dollars selling counterfeit cigarettes. See
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