sealPurdue News

September 1994

Cigarette tax hike may send state revenues up in smoke

WEST LAFAYETTE, Ind. -- Raising the tax on cigarettes to fund President Clinton's health care plan could substantially increase interstate cigarette smuggling and decrease revenue in some states, say two Purdue University economics professors.

Jerry G. Thursby and Marie C. Thursby, both professors of economics in the Krannert Graduate School of Management, say cigarette smuggling is big business and will get even bigger if the proposed federal excise tax on cigarettes is passed.

"Some government officials have suggested the tax should be as much as $2 a pack," Jerry Thursby says. "Pending legislation calls for 45 cents a pack. Even that amount will result in substantial increases in revenue for cigarette smugglers."

Thursby and his wife, Marie, have done extensive research into the phenomenon of cigarette smuggling and are working on a major study investigating the effects of a higher federal tax on interstate smuggling. Both agree that doubling the tax rate could double the amount of smuggling between states.

"By using some rather sophisticated statistical analysis, we can get a fairly accurate picture of just how much smuggling is taking place," Jerry Thursby says. "Our data have shown that previous increases in smuggling activity coincided with federal tax increases. Our data suggest that doubling the tax could increase smuggling revenues from an estimated $1 billion to well over $2 billion."

Interstate smuggling is a relatively simple process, he says. Smugglers from states with high taxes travel to states with low taxes and purchase truckloads of cigarettes from wholesalers. Washington, D.C., for example, has an excise tax of 65 cents a pack, while Virginia's is 2.5 cents.

The wholesalers pay the tax for their particular state when they purchase the cigarettes from the producer, but do not affix the state stamp to the cigarettes. The paper trail ends there, because once the initial tax is paid, states don't keep track of where the cigarettes go. Smugglers then take the cigarettes back to their home state, counterfeit a stamp and sell the cigarettes to distributors at the higher rate.

The Contraband Cigarette Act of 1978 often is cited as having put an end to cigarette smuggling. Although studies showed a marked decrease in smuggling immediately after enactment of the law, other factors were responsible for the decline, Jerry Thursby says.

"In reality, the decrease in smuggling activity after the contraband act was somewhat of a happy coincidence," he says. "First of all, the average tax rates were falling, so there was no incentive to smuggle. Also, many states lowered the number of law enforcement officers on the road, figuring the federal government would enforce the new law.

"The federal government didn't enforce the law, however, so the decline in smuggling was actually reflecting a decline in enforcement. Because the incidence of smuggling decreased after the act, the federal government decided the problem had disappeared. That's still the government's attitude, as evidenced by the fact that the act is rarely enforced."

Both economists say lowering tax differentials between states is one of the best ways to stop smuggling.

"If we look at this from a strictly economic point of view, lowering tax differentials reduces incentives for smuggling," Marie Thursby says.

The federal government is seeking to raise revenues and decrease tobacco consumption at the same time. While fewer smokers might sound good, she says, Canada is an example of a country where the costs associated with smuggling have been substantial in comparison with the benefits gained from higher taxes.

"Canada's high tax rate apparently has led to a decline in tobacco consumption," she says. "Statistics show that from 1989 to 1992, per capita consumption decreased by about 17.1 percent in Canada compared to 6.8 percent in the United States. But problems associated with smuggling are so serious that the Canadian government has rolled back taxes by nearly 50 percent in some provinces."

Smugglers are enjoying a windfall in Canada, Jerry Thursby says.

"I've seen estimates saying almost 40 percent of Canada's cigarettes are contraband," he says. "In Canada, where a carton of cigarettes is about $37, people are buying U.S. cigarettes on the black market for as little as $14."

A higher tax on cigarettes in the United States not only would increase interstate smuggling, he says, but also would likely cause some states to lose revenues because of the decreased consumption.

"I don't think too much thought has been given to the fact that lowering consumption may decrease valuable revenues for some states," he says. "And, even if those states do manage to increase their revenues, they may find themselves using them up trying to combat an increase in smuggling."

As far as federal revenues are concerned, the Thursbys say the government should see an increase, because that money comes from taxes paid by manufacturers, rather than wholesalers.

Sources: Jerry Thursby, (765) 494-4462; Internet,
Marie C. Thursby, (765) 494-7612; Internet,
Writer: Victor B. Herr, (765) 494-2077; Internet,
Purdue News Service: (765) 494-2096; e-mail,

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