Smuggling and Other Unintended Consequences of Cigarette Taxation

As we mentioned earlier, cross-border disparities in prices on an easily concealed and transported commodity like cigarettes can induce cross-border smuggling. The cost of such smuggling is not only the loss of projected revenue to the treasuries of higher-tax states. Crime can beget more crime, especially when commercial smuggling is involved. Thus, as we discuss in the pages that follow, the costs of

cigarette smuggling in Michigan include a host of unintended - and sometimes surprising - consequences:

  • 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.

This list of ancillary crimes may seem bizarre. After all, cigarettes are a commonplace product that is legal, relatively inexpensive and readily available in convenience stores and gas stations across the state. Who ever heard of potato chip smuggling, nail polish bootlegging or root beer-related violence?

But a key difference between those products and cigarettes is the presence of a cigarette excise tax that fluctuates from state to state. Michigan's high cigarette taxes and proximity to low-tax states make it an ideal destination for illicit cigarettes and other tobacco products. Michigan's border along Ohio and Indiana runs for more than 178 miles,[31] making detection of illegal cross-border movement difficult to track.

A large semitrailer can hold more than 200,000 packs of cigarettes. This estimate is conservative because the trailers are usually not stuffed with cigarettes, since they need to be hidden among other goods to thwart possible detection at weigh stations or during direct inspections. Bootleggers smuggling 200,000 packs can rake in around $400,000 per tractor-trailer load before expenses.

Enforcement of Michigan's Tobacco Products Tax Act is not easy, given the ease of crossing state borders. Nevertheless, arrests of commercial smugglers, illicit distributors and other violators of the law are made with some frequency. According to records obtained from the Michigan State Police, 95 people were convicted of violating the act between July 1, 2004, and Aug. 14, 2008. Most of the convictions resulted in light punishment.[†]

Obviously, much of the tax-induced smuggling of cigarettes to Michigan is casual smuggling. Such cross-border shopping, whether in bordering states or at military bases and Indian reservations (two other sources of lower-tax cigarettes), typically does not result in arrests or violent crime. Casual smuggling has only one primary illegal result: reducing state tax revenues through unpaid state cigarette taxes.

Internet sales have also made it easier for Michiganders to purchase low-tax or tax-free cigarettes without even leaving home. Michigan's Treasury Department still maintains a tobacco information Web page with the following State Police warning: "Beware! It's a crime to purchase cigarettes and other tobacco products by mail, over the Internet, or in any other way unless the seller is properly licensed by the State of Michigan and each cigarette pack is affixed with a Michigan tobacco stamp. Violations are punishable by up to five years imprisonment, along with seizures of assets from anyone possessing illegally purchased cigarettes."[32]

The Treasury's Web page also provides the following instructions for law-abiding cross-border shoppers and any other smokers who purchase untaxed cigarettes: "Should a Michigan purchaser become aware that they have acquired cigarettes without Michigan stamps/taxes, Treasury has provided forms with which taxpayers can send in the Tobacco and Use taxes that should have been paid. By promptly doing so, these individuals can avoid costly penalties that would otherwise be due."[33] Of course, most smokers who purposely buy untaxed cigarettes are not likely to follow these instructions.

But it is conceivable that some smokers unknowingly purchase smuggled cigarettes, given how much contraband is in the market. Indeed, one study estimates that nearly one in 10 cigarettes purchased nationwide — through the Internet, legal border crossing and smuggling — are associated with tax evasion.[34]

Technically, the cross-border shopping in Michigan typically results in a "smuggled" product. Once Michiganders who purchase their cigarettes in Indiana have crossed the border with the product, they are carrying contraband materials (though penalties are currently light for small amounts).

The same is true for the importation of other untaxed tobacco products. Michigan imposes a 32 percent tax on the wholesale price of these noncigarette tobacco products, including loose tobacco for hand-rolling (usually referred to as "HRT," or "hand-rolled tobacco"). The state of Pennsylvania imposes no taxes on such products, making the state an attractive destination for casual smugglers from Michigan, New York and other nearby states.

Because cigarette sales represent the vast majority of the tobacco sales marketplace, our primary focus is on cigarette taxes and their unintended consequences. Legal cigarette sales in the state accounted for almost 96 percent of the total tobacco revenue generated to the state in August 2008.[‡]

[31] Tony Olkowski (Center for Geographic Information, Michigan Department of Information Technology), e-mail message to James Hohman of the Mackinac Center for Public Policy, Sept. 23, 2008.

[32] Michigan Department of Treasury, Michigan Taxes: Tobacco Tax Information,1607,7-238 -43542_43547---,00.html (accessed Sept. 30, 2008).

[33] Michigan Department of Treasury, Michigan Tobacco Enforcement, (State of Michigan Department of Treasury, November 6, 2006), 3, EnforcementReportltrhead_178062_7.pdf (accessed Oct. 4, 2008).

[34] Mark Stehr, "Cigarette tax avoidance and evasion," Journal of Health Economics 24 (2004): 277.

[*] Counterfeit cigarettes - frequently imported from China - are a major concern of manufacturers and government officials alike. Not only do they enter into the states and elsewhere illegally and untaxed; they are often found to be adulterated with everything from sawdust, sand or arsenic to dangerous levels of pesticides. A 2007 report on activities of the European Commission indicates that between 50 percent and 75 percent of seizures involved counterfeit cigarettes. A 2006 report by the Royal Canadian Mounted Police covering the Canadian illicit market in tobacco reports that 22 percent of all tobacco-related RCMP seizures were counterfeit cigarettes from China. (See Royal Canadian Mounted Police Criminal Intelligence, Federal Tobacco Control Strategy, The Illicit Tobacco Market in Canada: January-December 2006. (accessed Sept. 24, 2008)). In 2004 the U.S. Department of Homeland Security announced its largest single investigation into cigarette smuggling up to then of both genuine and counterfeit cigarettes.

[†] There is currently federal and state legislation wending through Congress and the Michigan Legislature that would attempt to boost enforcement and increase penalties for those caught in the illicit tobacco trade. In March 2008, the Michigan Senate voted to pass Senate Bill 882, which would amend the state Tobacco Products Act to increase penalties for persons possessing comparatively small amounts of untaxed cigarettes. Senate Bill 883, which the Senate also passed, would amend the General Sales Tax Act and punish retailers for not complying with Michigan cigarette tax laws.

[‡] Calculated from data provided by Scott Daragh, State of Michigan Office of Revenue and Tax Analysis, in an interview conducted by James Hohman, Mackinac Center for Public Policy, September 26, 2008.