Cigarette Smuggling Cost States $79.4 Billion in Forgone Excise Taxes Over 16 Years

TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. avoidance is a natural consequence of tax policy. Illicit market operators have been smuggling cigarettes for about as long as excise taxes have been levied on these easily transportable products. The most recent data show that the combined effect of net smuggling into US states was a loss of more than $4.7 billion in forgone revenue in 2022. The annual effect of cigarette smuggling is significant, but the cumulative impact of annual smuggling across the historical period from 2007 to 2022 demonstrates the severity of the issue when left to fester.

Over this 16-year period, the total loss from net cigarette smuggling exceeded $79.4 billion, amounting to an average annual loss of $4.96 billion.

Tax rate differentials between states are a primary driver of cigarette smuggling. The larger the difference in tax rate, 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" (tax evasion) via a large-scale criminal enterprise that might counterfeit tax stamps, sell counterfeit cigarettes, or deal in prohibited products-often operating out of China. Other policies, like flavor bans, also yield smuggling of the banned products, either from states without a ban or from illicit operators that merely see the ban as a grant of market share to the black market.

States with high cigarette tax rates have experienced the greatest losses from cigarette smuggling. New York has been the biggest loser by far, with accumulated forgone revenues totaling $21.1 billion. The next largest loss of revenue was experienced by California at $12.7 billion-an undeniably significant sum, but barely 60 percent of the losses in New York. Rounding out the biggest loser states are Texas ($7.2 billion), Washington (4.3 billion), and Michigan ($4.3 billion).

In all, 32 states have suffered net inbound smuggling since 2007 for a total loss of $79.43 billion. At least 15 states have missed out on more than $1 billion of excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. revenue.

Conversely, 15 states have experienced net outbound smuggling since 2007, as some businesses have been driven to consistently low-tax states (we don't include Alaska and Hawaii in our analysis, and North Carolina is used as the basis for our smuggling estimates, so we only analyze 47 states). The extra excise revenues generated by these states over this period total only $3.97 billion. The tax gain from lower-tax states is much lower than total forgone revenues, both due to the lower tax rates in these states that make them more attractive to consumers and due to the large number of cigarettes that are not purchased legally at all, instead being counterfeited or smuggled in from foreign countries like China or Mexico.

New Hampshire experienced the biggest gain from net cigarette smuggling, having generated an extra $955 million in revenue from cigarettes purchased in New Hampshire but consumed elsewhere. The next largest gains were experienced by Indiana ($787 million), Virginia ($511 million), and Delaware ($356 million).

Cross-border shopping tends to be a zero-sum economic activity since domestically produced cigarettes are still being purchased legally. While it undermines some of the intended consumption discouragement of high excise taxes by lowering the effective tax rate and disrupts the funding meant to address any externalities from cigarette consumption by decoupling the state generating revenues from the state suffering the effects of consumption, all the gains from trade stay within the US, and the total tax burden on the market is lowered.

Larger problems, both to public health and state revenues, are introduced by international smuggling and counterfeiting. In 2022 alone, more than 369 million packs of cigarettes were estimated to have been smuggled into the US from international sources Counterfeit cigarettes tend to be significantly more dangerous to consumers' health, often containing highly elevated amounts of lead and other heavy metals or even insect eggs and human feces.

The cigarette smuggling distribution networks for these large criminal enterprises have become quite sophisticated, often outmaneuvering or overwhelming state enforcement efforts. While profit margins are high, largely due to the market share bestowed onto the black market from prohibitions and high tax rates, the risk involved is relatively low. Cigarette smuggling generates billions in annual profits, some of which gets funneled to criminal enterprises that also engage in much more dangerous activity, like money laundering and even global terrorism.

Cigarette consumption has been steadily decreasing for decades, which means that state tax revenues tend to decrease if kept at the same rate. This prompts many states to periodically hike their tax rates to make up for the losses from lower consumption. While this often yields a temporary spike in revenues, it tends to primarily push legal consumption down further, not necessarily all consumption, ultimately yielding lower revenues in the long run-both from the naturally discouraging effect that higher taxes have on consumption and by driving more business to black and gray markets. States that have historically tried to chase revenues with large tax increases seem to be the ones that suffer most from cigarette smuggling.

While taxes and flavor bans have been minimally effective at encouraging smokers to quit their habit, one important innovation that has promoted smoking cessation has been the introduction of vaping and alternative tobacco products (ATPs). These products allow users to consume nicotine, but with substantially less harm than combustible cigarettes. As ATPs have gained market share, many states have levied taxes on them. These products, too, are smuggled to avoid those taxes and any prohibitions. The vaping market is an especially striking example of the avoidance of prohibition, with most of the vaping in the US done with illegal products imported from China.

Past experiences with prohibition and smuggling show us that, even with zealous enforcement efforts, the black market will find ways to deliver in-demand products to consumers. Exorbitant taxes on products like cigarettes open the door for illicit market operators. The result has been a predictable shift away from legally sold products. Cigarette tax avoidance costs states billions of dollars in forgone excise tax collections and requires states to spend additional public dollars to enforce these ineffective policies. Policymakers should consider the unintended consequences, both to public health and public coffers, of the excise taxes and regulatory regimes for cigarettes and other nicotine products.