Smoking: Tobacco Road

Cigarette smuggling threatens to become a major problem.

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.

The study was commissioned by the National Coalition Against Crime and Tobacco Contraband, which is financially backed by R.J. Reynolds Tobacco Co. The coalition also includes other tobacco companies, wholesalers, distributors, and retailers.

Anti-smoking forces dismiss the coalition as a tobacco-industry front group and say its warnings are scare tactics. John Bloom, who works on tobacco-tax issues for the American Cancer Society, says the Lindquist Avey estimate "is just about as believable as the tobacco industry's claim that nicotine isn't addictive." In fact, he argues that "a major federal tax increase would not cause a significant international smuggling problem and would actually reduce what little interstate smuggling that is going on," by reducing the price differential percentage between states.

Nonetheless, international cigarette smuggling appears to be on the rise in the United States. Perhaps the most visible tip-off is what's going on at the Mexican border. The Department of Agriculture estimates that U.S. tobacco companies exported 148.3 million packs to Mexico in 1994, an increase of 2,424 percent from 1990. As with Canada's exports, it's assumed that the vast majority of these untaxed cigarettes are smuggled back into the United States.

The volume of traffic at border crossings, which has increased since the passage of NAFTA, makes it difficult for U.S. Customs officials to detect smuggled goods–and even then they are looking primarily for illicit drugs, not untaxed cigarettes. Individuals buy untaxed cigarettes at duty-free shops, drive into Mexico, and cross back into the United States. Illegal immigrants commuting to work in Texas sometimes smuggle cigarettes in backpacks, says Kevin Koch, vice president of McLane Company, a cigarette distributor.

But as was the case in Canada, most international cigarette smuggling appears to be controlled by organized crime. Couriers, or "mules," were used by one Los Angeles organization to transport cigarettes from Mexico into California. Until it was raided in July 1994, the ring reportedly was smuggling 7,000 cartons every week.

Organized crime groups have been involved in interstate smuggling for years, but because smokers can easily cross state lines, crime groups account for only a small portion. However, the experience and criminal infrastructure that these groups have developed to evade state taxes is helping them adapt to evading federal cigarette taxes.

The Mafia's smuggling competitors include the increasingly powerful Russian mafia, Mexican rings, and various American Indian organizations.

Cross-border smuggling is especially acute in California. Monte Williams, administrator of the excise tax division of the State Board of Equalization, says smuggling in California "keeps getting worse every month." He estimates that up to 7 percent of the state tobacco market was illegal in 1994 and that the state treasury could lose $50 million as a result.

Many of the for-export-only cigarettes intended for Mexico never make it across the border. Organized crime groups illegally obtain cigarettes from free trade export warehouses along the border, and then forge the paperwork to make it appear that the untaxed cigarettes had been exported.

In the New York City area, for-export cigarettes housed in bonded warehouses or officially loaded onto ships destined
for Europe, Asia, or the Middle East have been found in Brooklyn warehouses, according to Paul Rickard of the New York state tax and finance department. Lindquist Avey's Stamler says that it often is less risky for organized crime to divert untaxed cigarettes into New York City from a New Jersey free-trade zone warehouse or other nearby points of entry than to truck cigarettes all the way from North Carolina.

"[Cigarette] smuggling is more profitable than narcotics and less risky," says Det. Lieut. Robert Manes, who heads Michigan's state police Treasury Enforcement Team. With its high cigarette tax and recent history of smuggling cigarettes to Canada, his state appears ripe for a major increase in contraband sales. Right now, says Manes, his team is primarily "trying to gather intelligence."

But early indications suggest that cigarette smuggling in Michigan is growing substantially. Preliminary state treasury figures indicate that cigarette sales have dropped significantly since the tax increase.

Manes says that some of this drop may be due to retailers who stockpiled cigarettes before the tax went into effect. But interstate tax-dodging also seems to be a factor: Ohio and Indiana both report increases in their cigarette sales, especially near the Michigan border. And in Kentucky, where cigarette taxes are $7.20 a carton less than Michigan's, statewide cigarette sales were up 5.7 percent following Michigan's tax increase.

Bill Zeiler of Zeiler's Farm Market in Temperance, Michigan, says that cigarettes used to account for 20 percent to 33 percent of total sales at the store, which is located just across the border from Toledo, Ohio. Since the tax increase, he says, cigarette sales have fallen almost 85 percent.

Zeiler also says that the store is losing more than just cigarette sales: "People would buy [cigarettes] every day or every couple of days, and they'd usually buy something else. Now they're going to Ohio stores to buy those things."

Other Michigan stores are reporting a surge in cigarette-related theft. Jim Garmo, who has run the Galaxy Superstore in Ypsilanti for about 10 years, says he had never suffered any break-ins until the tax increase. Since then, however, Garmo says that his store was burglarized nine times for cigarettes between June and October. And sales have dropped from 1,300 cartons a week to 350 cartons.

One reason why cigarette smuggling in the United States is almost certain to keep expanding is that even politicians with reputations as tax-cutters often rely on cigarette tax hikes. Michigan's recent voter-approved increase was part of Republican Gov. John Engler's plan to cut property taxes (see "Engler's Angle," August/September, 1994).

The Republican-controlled Congress is unlikely to increase the federal cigarette tax in the near future, but state taxes continue to rise. Arizona voters narrowly approved a 40-cent-per-pack increase last November to fund indigent health expenses.

Higher cigarette taxes will not only be a disappointment for prohibitionists and tax-starved politicians. If a large increase goes forward in the United States, cigarette smuggling "will make the illicit drug trade look like peanuts by comparison," warns Stamler. With 45 million smokers in the United States, there is a huge potential black market. Organized crime will enter its second golden age.

But more important, Americans will become comfortable with routinely breaking the law and evading taxes. Repeating Canada's experiment in excessive cigarette taxes may well threaten the very fabric of American society.

Ed Carson is a staff reporter for REASON.