Tobacco Road

There's a giant sucking sound in the United States--and you don't need to be Ross Perot to hear it. It's the sound of hundreds of thousands of Americans smoking cigarettes smuggled from Mexico and other points of entry. And it's growing louder every day.

Over the past 15 years, the average state and federal tax on a pack of cigarettes has gone up 152 percent--from 21 cents to 53 cents. And some states are way above the average. Michigan, for instance, raised its state cigarette tax 200 percent in May 1994, from 25 cents a pack to a national high of 75 cents.

With politicians hot for tax revenue and cigarette prohibitionists on the march, the trend can only continue. Indeed, one of the few things Congress seemed to agree on during the health-care debate was the easiest way to get money to pay for national health care: Raise cigarette taxes. The Senate Finance Committee's bill proposed an increase in the federal cigarette tax of more than 900 percent.

The effects of such prohibition-by-taxation are as predictable as they are usually ignored. Cigarette smuggling is well on its way to becoming a major problem in the United States. Raising cigarette taxes any further risks repeating Canada's recent disastrous experience with cigarette smuggling, which threatened "the very fabric of Canadian society," according to Canadian Prime Minister Jean Chretien, when he announced deep cuts in cigarette taxes a year ago.

Contraband cigarettes held no more than 2 percent of the total cigarette market in Canada until 1991, when the government imposed a value-added tax and increased the federal cigarette tax by 146 percent. After the tax increase, however, the price differential between cigarettes sold in Canada and those in the United States soared to more than CDN$35 a carton. More and more smokers refused to pay as much as CDN$50 for a fully taxed carton of cigarettes when they could buy the same brand on the black market for CDN$20-40.

The result was an invitation to organized crime. Mohawk Indians from tribes along the U.S.-Canada border, biker gangs, and Asian Triads smuggled cigarettes across the border in boats, airplanes, trucks, vans, legitimate courier companies, and snowmobiles.

Ironically, most of the smuggled cigarettes were made in Canada. Canadian tobacco companies exported 15.6 billion cigarettes to the United States in 1993, up more than 830 percent from 1990. Because there was no apparent increased U.S. demand for Canadian cigarettes, it's widely accepted that almost all of the exported cigarettes, on which no Canadian taxes were paid, were smuggled back into Canada.

These cigarettes were sold by street vendors, out of the backs of cars, at flea markets, at restaurants, at bars, at convenience stores, and at high schools. When one smoker hooked up with a dealer, all of his or her friends and co-workers were connected as well. The October 20, 1992 Globe and Mail of Toronto reported that a 77-year-old woman was buying "hot smokes" for members of her bridge club and that a surgeon became the black market supplier for his co-workers at a Montreal hospital. Many of the smokers who were uneasy about breaking the law decided it was OK when they saw that "everybody's doing it."

Not everybody, but it started getting close. Before the tax hike, one in 50 cigarettes smoked in Canada had evaded taxes, estimates the forensic and investigative accounting firm of Lindquist Avey Macdonald Baskerville in a study sponsored by the Canadian tobacco industry. By the end of 1993, nearly one in three cigarettes was contraband. An August 1994 report by the Non-Smokers' Rights Association (Canada) disputes those figures. But it concedes that one in four cigarettes may have been contraband in 1993.

Smuggling particularly hurt "mom and pop" convenience stores, which rely heavily on cigarette sales. Rob Stamler, a partner with Lindquist Avey and a former assistant commissioner of the Royal Canadian Mounted Police, says that many retailers began carrying "dual inventory" --legal cigarettes over the counter, illegal smokes below. Retailers also were victims of a crime wave, as it became more lucrative for thieves to skip the cash register and head straight for the cigarettes.

The government tried cracking down on cigarette smuggling, but the police didn't get much support. "Everyone thinks the taxes on cigarettes are too high, so it's not a crime to buy them [illegally]," Staff Sergeant Walter Wafer, head of the Mounties' customs-and-excise section in Montreal, told the Toronto Globe and Mail.

The government's inability to enforce an unpopular law only emboldened Canadians to become more defiant. On January 24, 1994, 75 store owners in St. Eustache, Quebec, rebelled by openly selling contraband cigarettes. Hundreds of Canadians waited hours to buy cigarettes for less than half the legal price. The police, perhaps deciding in this instance that it was better to be loved than feared, made no arrests.

Such upfront defiance of the law alarmed Canadian politicians. Even more disturbing to them were signs that cigarette tax evasion was having spill-over effects on other taxes. To stop the fiscal, political, and social hemorrhaging, in February the federal and five provincial governments made deep cuts in cigarette taxes, which essentially eliminated cigarette smuggling in Canada.

Tax rates are still much lower in the United States than they were in Canada, but signs of rebellion are already apparent. Contraband cigarettes evading federal taxes made up 6 percent of the total U.S. cigarette market in 1994, up from a negligible level in 1991, according to a preliminary estimate in a new study by Lindquist Avey.

The study suggests that the United States is now at the same stage that Canada was in early 1991, the time at which cigarette smuggling there began to spin out of control. The United States may need just one more significant tax increase to unleash a full-scale revolt.