Cigarette Taxes Are Costing States Billions in Lost Revenue
Punitive levies drive black markets, fuel criminal enterprises, and—perhaps counterintuitively—help people evade the tax man.
In May of this year, Customs and Border Protection (CBP) officers seized 150,000 cigarettes from two women disembarking a cruise ship in Los Angeles. The women had 10 pieces of luggage filled with smokes they'd apparently purchased in Mexico for which they had no import paperwork. Why would anybody try to bring over 700 cartons of cigarettes back from a Pacific cruise? Because the haul was worth an estimated $60,000, and the two would have had no problem selling their cargo to smokers desperate to beat California's high taxes. Those stiff levies drive buyers and money to the black market.
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High Taxes Invite Smuggling
"Selling illegally imported cigarettes could yield high profits for underground vendors," commented Africa R. Bell, CBP Port Director of Los Angeles/Long Beach Seaport, "due to the low cost of cigarettes when purchased overseas and the evasion of taxes owed upon import."
California charges $2.87 per pack in taxes, which rubs many state residents the wrong way. Over half (52.54 percent) of cigarettes sold in the state are smuggled from elsewhere. That makes California the leading destination for smuggled cigarettes in the U.S., bumping New York from its long position at the top of the list. In neighboring Arizona ($2.00 per pack) and Oregon ($3.33 per pack), over a quarter of all cigarettes sold are smuggled, while Nevada ($1.80 per pack) is a source of cigarettes sold out of state.
State governments don't make money on cigarettes smuggled in from elsewhere, which is what got the CBP port director so hot and bothered. When even vacationers see business opportunity in filling suitcases with cigarettes, it doesn't take long for the numbers to add up.
$83.8 Billion in Lost Revenue
"The cumulative impact of annual smuggling since 2007, the first year for which we have historical data, demonstrates the severity of the issue," excise-tax policy expert Jacob Macumber-Rosin wrote this week for the Tax Foundation. "Over this 17-year period from 2007 to 2023, the total loss from net cigarette smuggling exceeded $83.8 billion, which amounts to an annual average loss of $4.93 billion."
Over that 17-year period, the biggest hit in foregone revenue has been to New York state, which recently increased taxes to $5.35 per pack, with another $1.50 added by New York City, and spent many years at or near the top of the list for smuggling destinations. "New York has been the biggest loser by far, forgoing $21.95 billion in revenue," comments Macumber-Rosin. California comes next, at $14.27 billion. Texas, which levies $1.41 per pack, ranks third with $7.50 billion.
It stands to reason, though, that if people are smuggling cigarettes from low-tax jurisdictions to those with high taxes, sales and revenue collections must be booming for places with less burdensome taxes. We don't really know how much is raked in by Mexico (where about half of the cigarette market is off the books). But New Hampshire ($1.78 in taxes per pack) "experienced the biggest gain from net cigarette smuggling, generating more than $1 billion in revenue from cigarettes purchased there but consumed elsewhere," according to the Tax Foundation. Indiana (recently hiked to $2.99 per pack from $0.99) took in $848 million, and Virginia ($0.60 per pack) reaped $574 million.
As the numbers show, "high tax" and "low tax" are relative terms. New Hampshire is a net supplier of cigarettes, with about a third of those sold in the state transported elsewhere; this despite the state having higher taxes than Texas, a net recipient of smuggled cigarettes which account for one-fifth of its market. It's all about your advantage or disadvantage relative to your neighbors, and almost everybody has an advantage if they're reasonably close to the ravenous revenue appetites of New York or Massachusetts ($3.51 per pack).
Illicit Cigarette Production Helps Evade the Tax Man
Smuggling across state lines isn't the only way to beat the tax man. Illicit factories, often producing counterfeit cigarettes sold under major brand names, offer a more sophisticated way to beat taxes. In April, CBP officers in Laredo, Texas, seized a cargo of counterfeit cigarettes loaded in Vietnam that was estimated to be worth $700,000. That pales in comparison to a $2.3 million haul in 2020.
Taking a different tack, the Mohawk tribe claims exemption from taxes in the U.S. and Canada (those countries' governments don't agree) and produces cigarettes under house brands sold in a gray market.
The connecting thread is the widespread desire among consumers to escape draconian taxes imposed by government officials who see smokers simultaneously as moral lepers to be punished and cash cows to be milked. The twin goals of suppressing tobacco consumption and collecting revenue are mutually exclusive, but logic has never been the strong point of those drawn to government office. Besides, motivations are irrelevant when the end point is the same: business opportunities for those willing to evade the law to connect eager sellers with willing buyers.
"Tax rate differentials between states are a primary driver of cigarette smuggling," Macumber-Rosin notes for the Tax Foundation. "The larger the difference in tax rates, the more money that can be saved by driving across state lines to purchase products in lower-tax jurisdictions. Sometimes this happens 'casually,' with individuals cross-border shopping for cigarettes for personal consumption in nearby low-tax states (tax avoidance), while other times this happens 'commercially' via a large-scale criminal enterprise (tax evasion). These organized criminal enterprises, often operating out of China, may counterfeit tax stamps, sell counterfeit cigarettes, or deal in prohibited products."
Age restrictions, bans on flavored products, and restrictive laws that seek to limit or prohibit consumers' access to goods that run afoul of officials' disapproval also fuel black market activity. Ultimately, less revenue is collected than might be gained with lower taxes, and activities the government dislikes continue with the assistance of black-market suppliers. Prohibition offered a huge lesson in the inevitable limits of restrictive policies that government officials refused to learn, leaving them frustrated over their failures when it comes to tobacco—or other goods, like marijuana and vapes.
High Taxes Are Good for Criminals
Obviously, consumers are the beneficiaries of black markets that help them evade high taxes and other legal hurdles. But so are criminals, whose enterprises are funded and empowered by restrictive policies.
"Cigarette smuggling is a highly profitable, but comparatively low-risk, criminal enterprise that generates billions in profits," adds Macumber-Rosin. "Sometimes, these profits are funneled to more dangerous activities, like global terrorism."
Smoking rates have declined for decades in a trend unaffected by tax rates. Government officials can't accelerate that process with punitive policies—they can only hurt themselves and empower criminals. As in all things, the best policy for government is to stay out of the way and leave smokers alone.
