Increased North Dakota Tobacco Taxes Could Lead to Rampant Smuggling

Two proposals to hike the state excise tax on cigarettes in Bismarck between $1.10 and $1.56 may very well yield the state more revenue, but it will also assuredly yield greater lawlessness: rampant smuggling; theft; violence against people, police and property; the sale of adulterated products and corruption of public officials are patterns we have seen in states that practice what we call “Prohibition by Price.”

We have created a statistical model that attempts to measure the degree to which cigarettes are smuggled around the continental United States. We find that North Dakota is a net exporter of cigarettes through 2013. Specifically, for every 100 cigarettes consumed in the Peace Garden State nearly 3.8 are smuggled out to other states and Canada. That will change dramatically if either tax hike proposal is adopted. It is easy to see why.

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Currently, North Dakota has a relatively low tax rate and proximity to high tax Minnesota and Canada. In addition, it imposes no tax stamps on its smokes. The low taxes draw both “casual” and “commercial” smugglers to the state, and the lack of a tax stamp makes North Dakota an additional big draw for the latter group.

Casual smuggling occurs when individuals cross a legal jurisdiction — such as a state line or Indian reservation — to buy lower cost cigarettes for personal consumption. Commercial smuggling involves long haul and large shipments for wider distribution.

We used our statistical model to estimate what would happen if the bill to raise excise taxes by $1.56 (SB 2322) was adopted. Smuggling into the state would leap to 21.4 percent of the total market. That is, of all the cigarettes consumed in North Dakota in the following year, more than 21 percent would be illegal.

Of that total, smuggling splits almost evenly between casual and commercial smuggling at 11.8 percent and 11 percent, respectively. The total smuggling rate would be larger if we did not subtract out continuing exports to Canada.

It is worth noting Indian reservations in North Dakota will quickly become source locations for smuggled cigarettes, if only for casual smugglers. State law allows the sale of untaxed cigarettes to non-tribal members at three of the four reservations.

The state has a tobacco tax compact with the Standing Rock Sioux Tribe to impose taxes on non-tribal members and other compacts with different tribes are possible. On the smuggling front, however, that may be cold comfort. Removing the incentive for non-tribal members to smuggle just increases the likelihood of tribal members doing so. History tells us that that is no small thing.

New York state tribes jealously guard their non-tax status and have become major sources for illicit tobacco there and in Canada. According to the International Consortium of Investigative Journalists, “smugglers moved some 6 billion cigarettes off New York Indian reservations in 2007” alone. Their report on reservation-related illicit cigarette trafficking work is must viewing for anyone concerned about this trade in North Dakota.

North Dakota need not look as far as New York to recognize the smuggling problem that will increase along with higher taxes. Just look to Minnesota, which hiked its excise taxes in 2013.

The Minnesota governor’s most recent proposed budget includes a line to fund a new “Stop Cigarette Smugglers” program which may include more cops, higher smuggling penalties and new licenses and related fees on businesses to fund them. Page 11 reads, “In 2014, 40 percent of retail inspections resulted in either a seizure or assessment related to the discovery of untaxed tobacco products.” According to one published report retail sales of cigarettes on the Minnesota border dropped 50 percent after Minnesota hiked its excise tax.

The parallels between cigarette trafficking today and the era of Prohibition are striking. Cigarettes remain legal today but their prices are often so high due to excise tax rates that their trade has taken on all the characteristics of real Prohibition. That is why we refer to this era of illicit cigarette trafficking as “Prohibition by Price.”

In addition to rampant smuggling (including those with Canada) we have witnessed violence against people caught in the illicit trade cross-fire, such as the death of an innocent American couple hit in a police chase while visiting Canada.

We have witnessed violence against police trying to thwart cigarette thefts. In Michigan in 2013, police were forced to shoot at cigarette thieves who drove their getaway van directly at them. Also in Michigan cigarette truck hijackings have left pistol-whipped drivers dazed and in fear of their lives.

Our modern era of cigarette smuggling also has a Prohibition era bath-tub gin parallel in counterfeit cigarettes. Fake cigarettes are passed off as legitimate but are often adulterated with such things as sawdust, which is used as filler. Officials have also found heavier concentrations of unsafe chemicals.

The sale of “loosies” is a major concern on big city streets too. During Prohibition, men used to sell single shots of whiskey to workers leaving factories. Public officials today as during Prohibition have also been corrupted by the trade. In 2012 a police officer in Prince George’s County, Maryland,  was sent to prison for helping move contraband smokes while using his patrol vehicle, uniform and firearm. Prison guards have been caught smuggling smokes into prisons.

We don’t doubt that many of those advocating for a tax hike are sincere. There are some positive attributes from a tax hike, such as slightly fewer tobacco users. But even then such pluses come with costs that are often overlooked. Namely, rampant smuggling and other illicit activity. Worse, not as many people quit smoking after tax hikes as people believe.

Two studies we have sourced before indicate that as much as 80 percent to 85 percent of the after tax hike change in legal paid sales is a function of tax avoidance and not of kicking the habit. People quit, but more are likely just to get their smokes from alternative, and not necessarily safer, outlets.

A better solution is for states to maintain far more rational taxing policies. The residents of North Dakota would therefore benefit from a much smaller tax increase or none at all.