In the past few weeks, federal officials have announced guidelines that are very likely to increase cigarette smuggling into the United States and have other unintended consequences.
The 2021 Tobacco Tax Equity Act, introduced in Congress on April 22nd, would both increase the federal excise tax (FET) on every pack of cigarettes and adjust the tax for inflation each year to ensure automatic tax increases. In addition, the Food and Drug Administration has decided to ban menthol-flavored cigarettes, a popular type of smoke. Any proposal on its own would be problematic, but together they could lead to prohibition-style lawlessness with little public health benefit.
The federal excise tax hike is likely to increase the number of cigarette smugglers trafficked into the United States. The Tobacco Tax Equity Act, if passed, would double the FET rate from $ 1.01 per pack to $ 2.02. This would widen the price gap between low-tax countries and the US and make smuggling across our borders more attractive.
National borders are of little concern when massive profits can be made from smuggling a product like cigarettes. A study by the International Monetary Fund from 2016, “How to draft and enforce tobacco taxes”, reports from a consensus estimate from five expert studies that the global illegal cigarette market accounts for 10 percent of global cigarette consumption.
However, this is a global average and in some countries illegal markets account for more than 40 percent of total consumption. In the US, three studies published in 2013, 2015 and 2019 have set the national tax evasion and avoidance rate for cigarettes at up to 21 percent of the market. This is a number that is almost certain to jump with an increase in the FET. Establishing a mechanism to increase the tax based on the rate of inflation almost always makes smuggling more attractive.
I am a co-author of a number of cigarette tax and smuggling studies that seek to measure cigarette smuggling rates in most of the 48 bordering states. We estimate that New York was America's largest smuggled state with 53 percent of total consumption by 2018, and California was number two with 48 percent. Both states, and probably other states as well, are likely to see an enormous influx of internationally smuggled smokers through their seaports.
As part of my research, I have reported on international smuggling busts that have shown how profitable illegal international trade can be. An illegal shipment came to New Jersey from China in 2012 and was eventually delivered to California via roads and highways.
The federal government is aware of the problem. In 2015, the State Department published “Global Tobacco Trafficking: A Threat to National Security,” a paper describing the effects of cross-border cigarette smuggling. It stated: "The trade in illegal tobacco products not only grows criminal networks, but also diversifies their activities."
These activities will only become more profitable if excise taxes are increased, especially if the Food and Drug Administration implements its April proposal to ban menthol-flavored cigarettes. Menthol-flavored smoke makes up a high percentage of the legal market. A total ban would only expand the portfolio of products smuggled into the US by transnational organized crime cells. Such bans have been attempted in Canada and Massachusetts, and early evidence of their success is not positive.
A number of Canadian provinces banned the sale of menthol cigarettes before a national ban came in 2018. In a 2020 working paper entitled “Deliberate and Unintentional Effects of Menthol Cigarette Bans,” university researchers found that menthol bans “significantly increased non-menthol cigarette smoking among adolescents, resulting in no overall net change in Adolescent smoking rates led ”. The Canadian and US researchers also found that menthol cigarette bans shifted smokers' purchases from retail stores to First Nations reserves. Massachusetts banned menthols from June 2020, and early data from there suggests that some purchases in Bay State were simply relocated to other states, particularly New Hampshire.
Federal officials may have the best intentions of US citizens in their hearts as they work to raise taxes or directly ban certain products. However, both will have unintended consequences that can offset much of the good they are trying to achieve.
Michael LaFaive is the Senior Director of Financial Policy at the Mackinac Center for Public Policy, a research and educational institution in Midland, Michigan. Follow him on Twitter @lafaive.