Executive Summary

States usually cite two major reasons for hiking their cigarette taxes: to decrease smoking, and to increase state tax revenue. Although these two goals can conflict, the "inelastic" nature of the cigarette market often allows policymakers to achieve both aims at once, with modest smoking reductions accompanying net increases in tax revenue.

This outcome may become increasingly difficult to achieve, however. Many states have raised their cigarette taxes significantly in recent years. These increases have likely furthered the growth of two types of cigarette smuggling: "casual" smuggling, in which individual consumers save money by buying their cigarettes in low-tax states or countries, and "commercial" smuggling, in which larger-scale operators buy cigarettes in bulk in a low-tax area and sell them tax-free in high-tax areas. This smuggling undermines both the revenue and health goals of higher cigarette taxes, while producing unintended consequences for individual states and American society as a whole.
In this study, the authors consider cigarette smuggling from two angles. First, they employ a statistical model to estimate the degree to which cigarette smuggling occurs in 47 of the 48 contiguous U.S. states. Second, they review the historical experiences of three states - Michigan, New Jersey and California - known to have problems with cigarette smuggling.

The authors' statistical model compares legal, per-capita sales of cigarettes from 1990 through 2006 with survey data from the Centers for Disease Control and Prevention on the percentage of smokers in each state. Apparent discrepancies between legal sales and smoking rates - for instance, relatively low sales in a heavy smoking state - are used to estimate smuggling import and export rates between states, including any imports from, or exports to, Canada and Mexico. The model also distinguishes between casual and commercial smuggling.

From 1990 to 2006, the authors estimate that the states with the top five average smuggling import rates as a percentage of their total estimated in-state cigarette consumption, including both legally and illegally purchased cigarettes, were California (24.5 percent of the state's total cigarette consumption), New York (20.9 percent), Arizona (20.6 percent), Washington state (20.1 percent) and Michigan (16.0 percent). Commercial smuggling import rates were highest in New Jersey (13.8 percent), Massachusetts (12.7 percent) and Rhode Island (12.7 percent). Casual smuggling import rates were highest in New York (9.9 percent), Washington (8.9 percent) and Michigan (6.0 percent).

The authors estimate that the states with the highest average smuggling export rates from 1990 to 2006 (excluding North Carolina)[*] were Delaware, Virginia and New Hampshire, where the volumes of the smuggling export markets were equal to 29.4 percent, 20.8 percent and 17.2 percent respectively of each state's total estimated in-state cigarette consumption.[†] Delaware's high export rate is driven by an estimated casual smuggling volume equal to 34.8 percent of the state's estimated total cigarette consumption, a figure that is partially offset by an estimated commercial smuggling import rate of 5.0 percent. Mexico is also estimated to have played a significant role as a source of smuggled cigarettes to California, Texas, New Mexico and Arizona, exporting quantities that represented 8 percent to 10 percent of each state's estimated total cigarette consumption.

The authors' 2006 smuggling estimates were much higher, with rapid cigarette tax increases since 2001 fueling greater tax-induced smuggling activity. In 2006, the states with the highest estimated cigarette smuggling import rates were Rhode Island (45.7 percent), New Mexico (42.4 percent)[‡] and the state of Washington (42.3 percent). All three states have raised their cigarette taxes significantly since 2003. The authors estimate that in 2006, no state had a higher export rate than Delaware, where outbound cigarette smuggling - fueled by casual smuggling - reached 82.8 percent of the state's estimated in-state cigarette consumption. (State smuggling estimates appear in Graphic 6 and Graphic 7.)

The authors' review of Michigan's, New Jersey's and California's cigarette smuggling experiences suggest that cigarette smugglers can realize large profits: tens of thousands of dollars for a single vanload of cigarettes, and hundreds of thousands of dollars for a single truckload. These sums represent a loss in estimated tax revenues to a state's treasury, but they have produced other unintended consequences, including a variety of crimes:

  • financing a terrorist organization;

  • thefts of untaxed cigarettes, including truck hijackings;

  • thefts of state tax stamps;

  • counterfeiting of tax stamps;[§]

  • property damage;

  • counterfeiting of name-brand cigarettes, which are replaced with adulterated products, including counterfeit cigarettes from China; and

  • violence against residents and police officers.

These societal costs are frequently borne by innocent people. This, together with the authors' cigarette smuggling estimates, suggests that state policymakers should reassess the value of cigarette taxes as a revenue and public health tool. States with high cigarette taxes, for instance, may want to consider reducing those taxes to reduce the smuggling incentive and the attendant ancillary crime. States with lower cigarette tax rates should be cautious about increasing the taxes, especially with an apparent growth in international smuggling. State policymakers should also recall that cigarette taxes are regressive, and that cigarette tax revenues are best spent on programs that mitigate the cost of smoking, not on general programs that would be more properly financed by the general taxpayer.

[*] For a variety of reasons, North Carolina was assumed to be a major source of commercially smuggled cigarettes and excluded from the model.

[†] Note that in an "export" state, the authors did not count exported cigarettes as part of the state's estimated total consumption of cigarettes, since the exported cigarettes are consumed outside the state. The export rate, therefore, simply represents a ratio between the exported cigarettes and the in-state consumption of cigarettes.

[‡] The authors estimate that cigarettes smuggled from Mexico accounted for 18.3 percent of New Mexico's total cigarette consumption in 2006.

[§] Most states require all packs of cigarettes to carry a state-authorized stamp indicating that state cigarette taxes have been paid.