The Projected Effect of State Tax Changes on Smuggling

Before moving on to a historical review of taxes and smuggling, we would also note that our statistical model allows us to predict the effect of state cigarette tax hikes in any one of the 47 contiguous United States listed earlier.[*]

For example, there is a proposal in the Michigan Legislature to raise the state's current per-pack cigarette excise tax of $2.00 by another nickel. A second proposal would cut the same tax by 25 cents per pack.

Assuming that other states do not change their cigarette excise taxes,[†] and using Michigan's 2006 cigarette sales figures, we would estimate that another 5-cent increase in the cigarette excise tax would result in a drop in legal cigarette sales of 683,500 packs from an increase in casual smuggling alone. Another 3.8 million packs would be lost to commercial smuggling.[‡] On the other hand, if the state of Michigan chose to cut taxes by 25 cents per pack, legal sales would increase by about 24.8 million packs due to reductions in casual and commercial smuggling. This number appears in Graphic 9 along with the effect of 25-cent and 50-cent changes in state cigarette taxes for California, Michigan and New Jersey.

Graphic 9: Change in Legal Sales Due to Selected Changes in Tax Rates for Selected States

Graphic 9: Change in Legal Sales Due to Selected Changes in Tax Rates for Selected States - click to enlarge

Source: Authors' calculations based on 2006 legal sales of cigarettes for each state. (See Table 5 in "Appendix A: The Econometric Analysis.")

In short, a trade-off exists between taxes and legal sales. An increase in the tax rate will produce fewer legal, and more illegal, sales of cigarettes. Similarly, a decrease in the tax rate will produce more legal, and fewer illegal, sales of cigarettes.

The practical effects of this dynamic should become apparent in the historical review that follows. In the final section of the study, we'll consider what implications our findings might have for policymakers.

[*] North Carolina is the only contiguous state excluded, for reasons discussed above under "A New Estimate of Interstate Cigarette Smuggling Rates." A more detailed discussion of the model is available in "Appendix A: The Econometric Analysis" at the end of the book.)

[†] The model is based on the differences between a state's cigarette taxes and the cigarette taxes of other states. Hence, the model will generate considerably different results from the ones in the text above if we assumed that all of Michigan's bordering states increased their taxes by the same amount and at the same time Michigan did. In that (unlikely) case, the net change in smuggling would probably be small and limited to Indian reservations.

[‡] According to the state Treasury, more than 560 million packs of cigarettes were sold legally in Michigan in 2007. See "Cigarette Sales History: Calculated Packs Sold Taxed Based on Revenue Collections," Michigan Department of Treasury's  Office of Revenue and Tax Analysis, September 2008.