High Taxes Promote Black Market Cigarettes in Bordering State

Cigarettes are legal in the U.S., but a black market is alive and thriving, generating crime and imposing costs on residents and businesses.

To witness this in action one need only cross the state's southern border and see the busy parking lots of Indiana tobacco shops filled with cars from Michigan, whose occupants are stocking up on smokes that cost a dollar less per pack. One South Bend store even offers drive-thru service. “It doesn’t matter to me, just don’t get caught,” said the clerk when asked if she could sell several cartons to a Michigan resident.

“There was always a way to get cigarettes cheaper," says a buyer named Mike, a former smoker who asked that his last name not be used. "Lots of different avenues. I had family in the trucking industry who could stop in a low-tax state and pick up a few cartons."

It is illegal to transport cigarettes from another state into Michigan but cross-border trafficking, or “cigarette smuggling” does happen — not just here but across the nation, as taxes on cigarettes can vary as much as $6 per pack from one jurisdiction to another.

A regularly updated study produced by the Mackinac Center for Public Policy ranks states on cigarette smuggling behavior by comparing cigarette sales to the number of smokers as estimated by U.S. census data.

“In 2008, we used data from 1990 to 2006 to determine statistical averages for states and now we took it to the next step. We look at it every year to see what is happening on the margin, as tax rates and populations change,” said the Mackinac Center’s Morey Fiscal Policy Director and co-author of the study, Michael LaFaive.

In the latest analysis, New York once again tops the list, with 58 percent of the cigarettes consumed there coming from outside the state. Michigan ranks tenth. The largest year-to-year jump in rank occurred in Illinois after taxes went up at state, county and even city levels. Illinois had been 30th in the national rankings. It is now 14th.

Cigarette wholesalers noticed the jump as orders from Illinois and Indiana changed. Indiana retailers started ordering more product while Illinois stores started asking for less, anticipating a change in demand.

“The manufacturers put us on allocation. We are given an allocation based on sales. It created many out-of-stocks for many retailers as well as wholesalers because there wasn’t an adjustment to the allocations to accommodate the movement of product from Illinois into Indiana,” said Gerald Abraham, senior executive vice president of S. Abraham and Sons, which supplies 4,000 convenience stores in 12 states.

Retailers in Illinois didn’t want to be stuck with cigarettes they could not sell while Indiana shops didn’t want to be under-stocked.

The cigarette tax variations also cause an administrative headache. S. Abraham and Sons has four full-time employees who handle nothing but cigarette tax compliance. Each state requires its own tax stamp. Sometimes, there are additional local taxes. (New York City is one notorious example, with taxes that drive the price to $14 per pack and more, sometimes with tragic consequences.)

Large grade commercial smugglers will buy cigarettes in lower tax states and attach counterfeit stamps in the higher tax states where they are trying to sell. Recently, Michigan switched over to digital stamps, which makes stamp counterfeiting more difficult.

The digital systems cost wholesalers $500,000 to install. The state of Michigan subsidized the cost but there is no guarantee that such assistance will be available in the future.

“The costs are getting considerably higher all the time. Overhead and administration of tax policy and processing taxes, processing paperwork, all of that is getting very costly on the wholesale side and it may be too much work for the profit we can make on it,” said Abraham.

When cigarette prices rise, smokers look for options.

“You realize you’re bending the law but there is an addiction you’re dealing with,” said Mike, the former smoker.

Not only did Mike ask friends and family to pick up cheaper smokes in low-tax states, he resorted to cigarillos, mini-cigars that weren’t taxed as highly as cigarettes in Michigan. He believes the cigarillos were worse for his health because they were produced in unregulated markets abroad.

He also tells the story of his sister, a chain smoker who went on the Internet to find cheaper cigarettes. Her tactic ended when federal officers tracked her down after raiding the files of the seller. She was fined $4,000.

Another ex-smoker, Chris Parish, says she didn’t smuggle to help fund her two-pack-a-day habit.

“I just didn’t pay other bills,” she said.

Parish said she spent about $70 a week on cigarettes after Michigan increased its tax to $2 a pack.

“I would have gladly bought more groceries or paid my propane bill on time but unfortunately I had an addiction, and my priority was to smoke,” she added.

Many smokers do resort to the black market, for which cigarettes make the perfect product. They’re lightweight, concealable and can be purchased at a variety of prices because of tax variations. A box of cartons weighing a mere 11 pounds can earn a smuggler thousands of dollars.

The black market for cigarettes makes convenience stores a prime target for thieves.

“We had a few incidents in the past, three or four break-ins,” said Adam Musleh, owner of U.S. 31 Tobacco in South Bend, Indiana. Musleh said the robbers took mostly cigarettes.

“There is a word for it. They call them bricks of gold,” said Musleh.

Musleh has now attached grates on the windows and installed a $25,000 camera system in his shop.

“It doesn’t look too bad but we don’t like to have it,” he added.

Additionally, trucks delivering cigarettes can become a target for hijackers.

“We’ve got some hot areas. Certain areas in Detroit, Cleveland, northwest Indiana where we have to be very careful. We’ve actually had to hire armed guards to follow and drive along with the trucks because it is rampant,” said Abraham.

Cigarettes are an easy target for cash-strapped government trying to raise revenue. Cigarette taxes raise millions of dollars and lawmakers defend the increases in the name of public health.

But both of those arguments, revenue generation and public health, are now under question.

In a study, economists Kevin Callison and Robert Kaestner find that cigarette taxes have minimal effects on smoking behavior.

“Looking at adult smokers, on average, it takes an increase of about 100 percent to reduce smoking in both propensity and in intensity, by about 5 percent,” said Callison, a professor of economics at Grand Valley State University. The researchers are now looking at whether the anticipation of higher taxes can alter behavior. Initial results show that it does not.

The study is no surprise to certified tobacco treatment specialist, Jodie Seese.

“People would draw a line. When they’re $3 a pack, ‘I’m quitting,' they’d say. Four bucks, ‘I’m definitely done,' but the fact is you’re still addicted and you do find a way,” said Seese.

Seese says smokers now favor buying packs rather than cartons because of the upfront costs.

The Mackinac Center’s LaFaive says on the fiscal side, government needs to do a cost-benefit analysis. “It does raise revenue, because people want the product but it also increases a lot of lawlessness. People smuggle, individuals smuggle in groups. We've seen violence against people, against property, against police, all because people are trying to save a few dollars or make a few dollars ... in avoiding an excise tax,” said LaFaive.

Once again, Michigan is considering a bill to lower cigarette taxes. Senate Bill 148 proposes to reduce Michigan’s cigarette tax from $2 to $1 a pack.