LaFaive's Minnesota Senate Tax Committee Testimony

Fiscal policy expert shows analysis of cigarette taxes and smuggling

(The following is a transcript of the testimony given by Michael LaFaive, director of the Morey Fiscal Policy Initiative at the Mackinac Center for Public Policy, on February 26, 2015, in front of a Minnesota Senate Tax Committee.)

Good morning. My name is Michael LaFaive and I am director of fiscal policy for the Michigan-based think tank, Mackinac Center for Public Policy. I was invited to speak today by the Minnesota Wholesale Marketers, Grocers and Retailers Associations, respectively.

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I am the co-author of national studies on cigarette taxes and smuggling. My colleague, Dr. Todd Nesbit and I, first published a study on this subject in 2008, though our interest in cross-border economic activities pre-dates this work.

Our peer-reviewed statistical study is designed to estimate the degree to which cigarettes are smuggled in the United States. It does so by comparing published smoking rates with legal paid sales per-capita. If smoking rates tell us how much should be smoked but legal paid sales are much lower, the difference must be explained somehow. We believe it is explained by smuggling.

Through calendar year 2013 we estimated that Minnesota’s total smuggling rate was almost 18 percent. Minnesota currently has the 16th highest smuggling rate in our most recent study.

I stress, however, that our most recent study does not yet include the influence of the July 2013 excise tax hike. Our estimate is based on an excise tax rate of $1.60, not the higher cigarette tax rate of $2.83 per pack enacted July 1 2013, nor the automatic increase of another 7 cents per pack on January 1, 2015.  When the higher rate gets factored in next year we expect our estimate for Minnesota’s overall smuggling rate to leap, and dramatically.

To get an idea for the type of smuggling changes that may be reflected in next year’s model update (which would include the 2013 tax hike data) we used our statistical model to run “what if” scenarios for $2.83 and then again for $2.90. Our model told us that:

  • Cigarette smuggling would leap to 32.9 percent of the total market.

That is, of all the cigarettes consumed in Minnesota nearly one-third are illicit. This figure would be higher if we did not subtract out exports to Canada.

I realize this is just an estimate, but if confirmed next year, it would give Minnesota the 5th highest smuggling rate in the nation, displacing Rhode Island in our rankings.

  • When we re-ran the model at the higher excise tax rate of $2.90 the model told us smuggling would increase to 33.7 percent of the market.

That represents a 0.8 percentage point increase year-over-year. If such a figure becomes an annual average increase due to the automatic accelerator Minnesota will easily remain a top five smuggling state.

I know supporters of this hike are very well intentioned. They believe people will quit with higher taxes. They’re right. Theory and evidence show this, too. But not as many will quit as they believe.

Dr. Nesbit and I have pointed to studies that suggests as much as 85 percent of the legal paid sales response to cigarette excise tax increases is a result of tax avoidance and not of quitting. More people are simply getting their nicotine through other — and sometimes more dangerous — sources than are kicking the habit.

Maintaining the automatic accelerator all but guarantees that smuggling and other intended consequences will continue to rise.

Thank you for your time.

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