Interstate Cigarette Smuggling

Yawning gaps in tax rates between states — especially neighboring states, such as Indiana and Michigan — can tempt people to smuggle. In economic terms, smugglers are engaged in arbitrage, attempting to capture the difference between state tax rates as profit. As long as the financial cost of the smuggling is relatively low, some people will perceive the net profit as sufficient to justify the risk of the illegal activity.

Interstate cigarette smuggling is not new. Graphic 5 shows a Michigan state policeman inspecting contraband cigarettes in 1951, when tax rates were a mere 3 cents per pack.

Graphic 5: Michigan State Police Inspecting
Seized Cigarettes in 1951

Graphic 5: Michigan State Police Inspecting Seized Cigarettes in 1951 - click to enlarge

Source: Archives of Michigan. Photo taken in 1951 at the Jonesville Police Post in Hillsdale County.

As cigarette taxes have risen in recent years, however, so has smuggling. A number of scholarly studies have attempted to measure the degree to which cigarettes are smuggled across state borders.

  • In a May 2008 working paper entitled "Excise Tax Avoidance: The Case of State Cigarette Taxes," Phillip DeCicca, Donald Kenkel and Feng Liu of Cornell University's Department of Policy Analysis and Management use 2003 Tobacco Use Special Cessation Supplement survey data to estimate casual smuggling rates. The survey asks smokers about their cigarette tax avoidance behavior, and in reviewing the results, the authors find that in Washington, D.C., and Maryland, 21.5 percent and 15.7 percent of smokers admit to making cross-border purchases, respectively. The figure was 2.4 percent for California, almost 12.3 percent for New Jersey and just over 6 percent in Michigan. The authors estimate the national norm to be about 5 percent of smokers, though they note that other scholars have arrived at both higher and lower figures.[24]

  • In March 2008 professor Michael Lovenheim of Stanford University published "How Far to the Border?: The Extent and Impact of Cross-Border Casual Cigarette Smuggling" in the National Tax Journal (a study mentioned in our introduction). Lovenheim estimates that 13 percent to 25 percent of consumers buy cigarettes in "border localities." In other words, a significant number of smokers engage in casual cross-border smuggling.[25] Remember, casual cross-border smuggling is not legal for Michigan residents. Lovenheim's study includes a state-by-state summation table that pegs the "Percent of Consumers Who Smuggle" at 31.0 percent in New Jersey, 0.01 percent in California and about 8.6 percent in Michigan.[26]

  • In 2004 economist Mark Stehr concluded in a study published in the Journal of Health Economics that "up to 85 percent of the tax paid sales response" of cigarette consumption is a result of tax avoidance, rather than an actual decline in smoking. Similarly, in 1995, economist R. Morris Coats' study in the National Tax Journal concluded, "[A]bout four-fifths of the sales response to state cigarette taxes is due to cross-border sales."[*]

  • In "Taxing Choice: The Predatory Politics of Fiscal Discrimination," economist Richard Vedder reviews an example of cigarette smuggling between Kentucky and Ohio. He and two colleagues estimate that in 1991 and 1992, 42.9 percent of Ohio residents living in the Cincinnati area, where state excise taxes were 18 cents per pack, purchased cigarettes in Kentucky, where taxes were only 3 cents per pack.[27]

[24] Phillip DeCicca, Donald Kenkel, and Feng Liu, "Excise Tax Avoidance: The Case of State Cigarette Taxes," (Washington, D.C.: Annual Association for Public Policy Analysis and Management, 2008), 48, 3.

[25] How Far to the Border, 7.

[26] Ibid., 29.

[27] Richard Vedder, "Bordering on Chaos, Fiscal Federalism and Excise Taxes," Taxing Choice: The Predatory Politics of Fiscal Discrimination, ed. William F. Shughart II (New Brunswick, Conn.: Transaction Publishers, 1997), 280.

[*] R. Morris Coats, "A Note on Estimating Cross-Border Effects of State Cigarette Taxes" National Tax Journal, December 1995, 573. University of Michigan economist Joel Slemrod cites Coats' findings in his own 2007 paper, but points out the study does not consider "enforcement regimes" that may raise the cost of cross-border acquisition of cigarettes.