Cigarette Tax Hike: Smuggling Up, Revenue Down

By MICHAEL LAFAIVE & TODD NESBIT. Michael LaFaive is senior director of fiscal policy with the Mackinac Center for Public Policy in Michigan. Todd Nesbit is an assistant professor of economics at Ball State University. Excerpt:

"There is a clear and obvious link between taxes — specifically, tax differentials between states — and illicit behavior, including tax evasion and avoidance, theft, violence and public corruption. These were all hallmarks of the profitable trade in alcohol during Prohibition, and some states are still making similar mistakes with tobacco.

Cigarettes aren't illegal, but governments have artificially raised the price of the product to such a degree that their sale and purchase now is tinged with many of the consequences of full alcohol prohibition. Thanks to "prohibition by price," people commonly smuggle cigarettes across borders, usually illegally, to evade excise taxes.

In writing several academic studies on cigarette taxes, we have built a statistical model to measure cigarette smuggling between states, as well as to and from Mexico and Canada. Through 2015, Connecticut had the 15th highest smuggling rate in the nation at 16.7 percent. That is, of all the cigarettes consumed in Connecticut in 2015, almost 17 percent were transported, sold or bought illegally.

That estimate is from a time when Connecticut's cigarette taxes were only $3.40 per pack. They have since been raised to $4.35, and would jump to $4.60 if the state adopts Malloy's proposed hike. Our model indicates that at that price, Connecticut's smuggling rate would leap to more than 38 percent of the total market. That would rank fifth in the nation in smuggled smokes.

But at the very least, won't the tax revenue help with Connecticut's state budget? Don't count on it.

Officials think they will get as much as $6.6 million in fiscal 2018 from such a tax hike. But the new cigarette tax rate would be so high that our model predicts a very small decline in revenue — 0.8 percent in the first year — as a direct result of tax evasion. The tax increase is unlikely to impact the rate of smoking because, at current tax rates, those who still smoke have a very strong preference for doing so. In other words, the state may harm consumers without solving its budget problems.

We are not the only scholars to recognize America's cigarette smuggling problem. In our 2016 study, titled "Cigarette Taxes and Smuggling," we described more than 20 cigarette smuggling estimates made by professors, consultants and others. Most found the problem of smuggling to be significant, and some estimated smuggling to be an even larger phenomenon than we did.

If more smuggling was the only problem with raising cigarette taxes, it might be tolerable. But it is not. The Massachusetts arrest only happened because police thought they might nab a suspect in an unrelated incident of stolen cigarettes but instead found a cigarette smuggler.

A quick internet search will reveal plenty of odd and sad stories. With high excise taxes, cigarettes have become like little gold bars for criminals everywhere.

Retailers are not the only victims. Wholesalers and warehouses have been robbed, truckloads hijacked and people arrested in murder-for-hire cases involving smuggled cigarettes. Public corruption is also part of the trade. One Maryland police officer was busted for participating in a smuggling ring where he used his official police cruiser to escort contraband to its destination."