Smuggling Rampant in Minnesota

The unintended costs of cigarette 'sin' taxes

(Editor’s Note: This article was originally published on March 18, 2015 by Center of the American Experiment.)

Minnesota has a large smuggling problem and it is set to get worse. We estimate that the 130 percent excise tax increase on cigarettes in July 2013 raised Minnesota’s smuggling rate to 33.7 percent of the total market from a much lower 18 percent. This hike in tax evasion and avoidance is a direct function of high excise taxes — which will likely increase each year — and the ease with which consumers can acquire lower priced cigarettes places like North Dakota, Indian Reservations and the Internet.

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The most efficient answer to this smuggling problem is to roll back excise taxes. Short of that the state could repeal its annual automatic tax increase and let the real price of cigarettes drift back to more rational levels. Failure to do so means that Minnesota will probably remain a top five smuggling state.

We have created a statistical model designed to measure smuggling in most U.S. states. It tells us that — at a tax of $2.90 per pack — Minnesota’s elicit market may be equal to about one-third of Minnesota’s cigarette market. It is worth noting, though, that a modicum of cross border cigarette shopping is legally allowed for Minnesotans and is swept into our model’s estimates as “smuggled.”

The large increase in illicit trafficking is a problem that has been recognized at the state capital, both by the Governor and the Legislature. A bill (SF 1192) has been introduced to minimize such lawlessness which among other items would provide for additional state auditors. This solution is unlikely to be effective because of the potential profits involved in smuggling.

Too many politicians — in Minnesota and elsewhere — point to declines in legal paid sales of cigarettes and naively shout, “See! Tax hikes are working; people are quitting.” That may be true to a degree but it is still largely naïve. A better explanation is that people are turning to the illegal cigarette market, a less expensive legal alternative (such as loose tobacco) or both.

Economist Mark Stehr’s 2004 paper in the Journal of Health Economics estimates that up to 85 percent of after-tax-hike changes to legal paid sales may be from tax avoidance, not from kicking the proverbial habit. Even then, his paper was published in 2004, when excise tax rates were generally lower.

There are several reasons why automatic and annual increases in the tax on Minnesota cigarettes is unlikely to reduce the rate of smoking. It is likely that those who still smoke have a strong preference for doing so. Tax hikes on the margin do less to help smokers quit and more to drive them to illicit markets. Second, the illicit market is easy to access. North Dakota’s 44-cent per pack excise tax makes it an ideal source state for consumers in Minnesota, as do Internet retailers and Indian reservations.

Also, people may be channeled into less expensive but possibly more dangerous alternatives, such as “roll-your-own.” Cigarettes cost much less when you buy loose tobacco and roll your own smokes.

Roll-your-own smokes might also be more dangerous because, as smokers need not include filters, they can boost the amount of nicotine they receive with each puff. Think of it as the “bathtub gin” of cigarettes. As prices rise due to Prohibition (then) or taxation (now), people work to get more bang for their buck.

These are all vital considerations because legal paid sales of cigarettes and loose tobacco have both tanked — especially in border counties — and empirical evidence has shown that most of those changes are a function of tax avoidance and evasion and not from quitting. Even the governor’s proposed budget reported that a whopping 40 percent of retailer “inspections resulted in either a seizure or assessment related to the discovery of untaxed tobacco products.”

The response to an apparent large uptick in illicit trafficking has been a proposal to add 11 auditors to the state’s complement to help better ensure against non-compliance with state excise tax laws. This is an ineffective remedy.

Federal and state prison officials elsewhere have been busted for smuggling smokes into prisons. If you can’t keep illicit smokes out of the penitentiaries how does anyone expect 11 bean counters to keep them out of a state with open borders? You could make Minnesota a veritable police state and illicit tobacco would still find its way to consumers of every age.

A better solution is to roll back the excise tax burden on tobacco, or at least stop raising it on annual basis.


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