On Cigarette Tax Evasion, I Told You So

Additional four million packs to be smuggled into Minnesota next year

In 2015 I was graciously invited to testify before a Minnesota state committee on taxes regarding an automatic tax inflator for cigarettes. The invitation was a result of my decade long investigation — in partnership with professor and economist Todd Nesbit — of cigarette excise taxes and their impact on illicit activity, most notably tax evasion. I told the committee what it apparently did not want to hear: that their recent tax increase and associated tax inflator would lead to rampant smuggling.

In my testimony I outlined the mountain of research showing a causal link between smuggling, high excise rates and tax differentials on cigarettes between states. At the time I could only report that the North Star State had the 16th highest smuggling rate in the nation. The data was not yet available to measure the impact of the 130 percent excise tax increase imposed in 2013. Using our statistical model we forecasted that smuggling would leap to 32.9 percent of the overall market from just 18 percent.

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Most Minnesota lawmakers were completely dismissive of my concerns and perhaps even more so when I asserted that smuggling would only get worse as the state’s tax inflator raised the overall price of cigarettes. Since that February day the evidence has borne out my forecast and more. The implicit admission by the state of smuggling trouble came that same winter when the governor’s proposed budget said that 40 percent of inspections of Minnesota retailers “resulted in either a seizure or assessment related to the discovery of untaxed tobacco products.”

Using our statistical model with data from 2015, we estimate that Minnesota’s smuggling rate will increase to 37.4 percent of the total market over the next year, or almost 1.5 percent points above our last estimate.

This should surprise no one. The state currently imposes a combined excise and in lieu sales tax of $3.59 per pack. Its neighbor, North Dakota, charges just 44 cents per pack. One doesn’t need a doctorate in economics to recognize that both consumers and criminals are going to take advantage of the tax-induced price differentials to save a buck transiting state borders near and far.

Two men from Illinois recently pled guilty to charges in Minnesota for running a truckload of illegal smokes with a retail value of $78,000 over from Wisconsin last year. It was a record bust in the state but puny compared to those in other states. States with higher excise tax rates have seen arrests that discovered millions of dollars of smuggled cigarettes. On June 8, three Canadian citizens plead guilty to moving $17 million in illicit smokes from Kansas to New York, as one example.

Minnesota will probably see similar large-scale smuggling efforts in the near future, if they aren’t already. After all, the state has guaranteed smugglers a high pay out with its high excise tax rate and automatic (upward) adjustments. We estimate that four million cigarettes will be trafficked into the state by casual users and by organized crime in the next year. The sources will range from North Dakota to North Carolina and even overseas, via mail and shipping containers. Illicit smokes acquired in Virginia have been found as far away as California.

Regrettably, cigarette smuggling isn’t the only unintended consequence of the practice. Indeed, we’ve seen cigarette tax-related thefts of wholesalers and retailers, hijackings of cigarette laden trucks, counterfeiting of legitimate products (which are often adulterated like the Bath Tub Gin of the Prohibition Era), corruption of public officials and even murder-for-hire schemes. Most if not all of this behavior can be laid at the feet of high cigarette excise taxes.

The first step in addressing the problems I cite above is to repeal the automatic inflator on cigarette taxes. As I predicted years ago for Minnesota, automatic tax hikes will lead to automatic increases in tax-related lawlessness.


Related Articles:

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LaFaive and Nesbit Op-ed Published in Lincoln Journal Star

West Virginia Excise Tax Hike Proposal Invites Smugglers

Maryland Cigarette Excise Tax Hike Proposal Irresponsible

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