A Backup Analysis of Midwest Sales Data and State Tax Hikes

The model described above provides estimates of smuggling rates based in part on differences in state cigarette tax rates. This may strike some readers as overestimating the lengths people will go to in order to save money. Do people really respond to a tax difference between states by engaging in casual or commercial smuggling?

The historical record, which we discuss later, indicates that the answer is yes. But to make sure our model has not assumed too much about people's response to tax differentials, we acquired a large Midwest cigarette distributor's monthly cigarette sales from January 2006 through September 2008. The data included zip codes for sales in Michigan.

These figures allowed us to observe the county-level sales impact of the two changes in state cigarette taxes that occurred during this 33-month period: Indiana's cigarette tax increase from 55.5 cents per pack to 99.5 cents per pack in July 2007, and Wisconsin's cigarette tax increase from 77 cents per pack to $1.77 per pack in January 2008. Because the Michigan tax rate remained above Indiana and Wisconsin during the sample period, we would expect to observe cross-border shopping by Michigan residents in these two states.

The sales records indicate that the distributor's average shipments to Michigan counties along the Indiana border increased by 53 percent in response to the tax increase in Indiana. Similarly, the distributor's average increase in shipments to Michigan counties along the Wisconsin border increased by 8 percent in response to the tax increase in Wisconsin.

These figures are consistent with our model. They suggest that Michigan retailers along the borders of Indiana and Wisconsin were expecting more Michigan smokers to shop in-state as the cost savings of buying cigarettes in Indiana and Wisconsin declined and made casual smuggling less attractive to Michigan smokers.

There is also some evidence that cigarette retailers located in Michigan counties along the Indiana border changed their business plans in anticipation of the Indiana tax hike. Shipments to these retailers increased by 58 percent during the three months prior to the Indiana increase. No such behavior was observed, however, in counties along the Wisconsin border prior to the Wisconsin tax hike.