    [House Hearing, 108 Congress]
    [From the U.S. Government Publishing Office]

                         YOUTH SMOKING PREVENTION AND
                         STATE REVENUE ENFORCEMENT ACT

    =======================================================================

                                    HEARING

                                   BEFORE THE

                     SUBCOMMITTEE ON COURTS, THE INTERNET,
                           AND INTELLECTUAL PROPERTY

                                     OF THE

                           COMMITTEE ON THE JUDICIARY
                            HOUSE OF REPRESENTATIVES

                          ONE HUNDRED EIGHTH CONGRESS

                                 FIRST SESSION

                                       ON

                                   H.R. 1839

                                   __________

                                  MAY 1, 2003

                                   __________

                                 Serial No. 19

                                   __________

             Printed for the use of the Committee on the Judiciary

        Available via the World Wide Web: http://www.house.gov/judiciary

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                           COMMITTEE ON THE JUDICIARY

                F. JAMES SENSENBRENNER, Jr., Wisconsin, Chairman
    HENRY J. HYDE, Illinois              JOHN CONYERS, Jr., Michigan
    HOWARD COBLE, North Carolina         HOWARD L. BERMAN, California
    LAMAR SMITH, Texas                   RICK BOUCHER, Virginia
    ELTON GALLEGLY, California           JERROLD NADLER, New York
    BOB GOODLATTE, Virginia              ROBERT C. SCOTT, Virginia
    STEVE CHABOT, Ohio                   MELVIN L. WATT, North Carolina
    WILLIAM L. JENKINS, Tennessee        ZOE LOFGREN, California
    CHRIS CANNON, Utah                   SHEILA JACKSON LEE, Texas
    SPENCER BACHUS, Alabama              MAXINE WATERS, California
    JOHN N. HOSTETTLER, Indiana          MARTIN T. MEEHAN, Massachusetts
    MARK GREEN, Wisconsin                WILLIAM D. DELAHUNT, Massachusetts
    RIC KELLER, Florida                  ROBERT WEXLER, Florida
    MELISSA A. HART, Pennsylvania        TAMMY BALDWIN, Wisconsin
    JEFF FLAKE, Arizona                  ANTHONY D. WEINER, New York
    MIKE PENCE, Indiana                  ADAM B. SCHIFF, California
    J. RANDY FORBES, Virginia            LINDA T. SANCHEZ, California
    STEVE KING, Iowa
    JOHN R. CARTER, Texas
    TOM FEENEY, Florida
    MARSHA BLACKBURN, Tennessee

                 Philip G. Kiko, Chief of Staff-General Counsel
                   Perry H. Apelbaum, Minority Chief Counsel
                                     ------

        Subcommittee on Courts, the Internet, and Intellectual Property

                          LAMAR SMITH, Texas, Chairman

    HENRY J. HYDE, Illinois              HOWARD L. BERMAN, California
    ELTON GALLEGLY, California           JOHN CONYERS, Jr., Michigan
    BOB GOODLATTE, Virginia              RICK BOUCHER, Virginia
    WILLIAM L. JENKINS, Tennessee        ZOE LOFGREN, California
    SPENCER BACHUS, Alabama              MAXINE WATERS, California
    MARK GREEN, Wisconsin                MARTIN T. MEEHAN, Massachusetts
    RIC KELLER, Florida                  WILLIAM D. DELAHUNT, Massachusetts
    MELISSA A. HART, Pennsylvania        ROBERT WEXLER, Florida
    MIKE PENCE, Indiana                  TAMMY BALDWIN, Wisconsin
    J. RANDY FORBES, Virginia            ANTHONY D. WEINER, New York
    JOHN R. CARTER, Texas

                         Blaine Merritt, Chief Counsel

                              Debra Rose, Counsel

                             David Whitney, Counsel

                  Melissa L. McDonald, Full Committee Counsel

                         Alec French, Minority Counsel

                                C O N T E N T S

                                  ----------

                                  MAY 1, 2003

                               OPENING STATEMENT

                                                                       Page
    The Honorable Lamar Smith, a Representative in Congress From the
      State of Texas, and Chairman, Subcommittee on Courts, the
      Internet, and Intellectual Property............................     1
    The Honorable Martin T. Meehan, a Representative in Congress From
      the State of Massachusetts.....................................     2
    The Honorable Mark Green, a Representative in Congress From the
      State of Wisconsin.............................................     3

                                   WITNESSES

    Mr. Paul L. Jones, Director, Homeland Security and Justice,
      General Accounting Office
      Oral Testimony.................................................     6
      Prepared Statement.............................................     8
    Mr. Henry ``Hank'' O. Armour, Chairman of the Board, National
      Association of Convenience Stores
      Oral Testimony.................................................    17
      Prepared Statement.............................................    19
    Mr. Matthew Myers, President, National Center for Tobacco-Free
      Kids
      Oral Testimony.................................................    28
      Prepared Statement.............................................    29
    Mr. Patrick Fleenor, Chief Economist, Fiscal Economics
      Oral Testimony.................................................    37
      Prepared Statement.............................................    38

                                    APPENDIX
                   Material Submitted for the Hearing Record

    Letter to Paul L. Jones, Director, Homeland Security and Justice
      from Rep. Lamar Smith..........................................    55
    Letter to Rep. Lamar Smith from Paul L. Jones, Director, Homeland
      Security and Justice...........................................    57
    GAO Report No. GA-02-743, Report to Congressional Requesters,
      August 2002, Internet Cigarette Sales, Giving ATF Investigative
      Authority May Improve Reporting and Enforcement................    59
    Prepared Statement of Ali Davoudi, President, Online Tobacco
      Retailers Association (OLTRA)..................................   118

                         YOUTH SMOKING PREVENTION AND
                         STATE REVENUE ENFORCEMENT ACT

                                  ----------

                             THURSDAY, MAY 1, 2003

                      House of Representatives,
                  Subcommittee on Courts, the Internet,
                             and Intellectual Property,
                                    Committee on the Judiciary,
                                                        Washington, DC.
        The Subcommittee met, pursuant to call, at 10:04 a.m., in
    Room 2141, Rayburn House Office Building, Hon. Lamar Smith
    [Chairman of the Subcommittee] presiding.
        Mr. Smith. The Subcommittee on Courts, the Internet, and
    Intellectual Property will come to order. We have an
    interesting hearing this morning. I will recognize myself and
    the Ranking Member and also Representative Green for our
    opening statements, and the entire opening statements of all
    members will be made a part of the record without objection, as
    well as the entire testimonies of all witnesses today.
        Teenagers who make it through adolescence without having
    smoked are nearly certain not to become regular smokers. Among
    adults who smoke, most report having their first cigarette
    before the age of 13. Governments at all levels have worked
    with those in the public health community to enact policies
    that discourage individuals from smoking cigarettes.
        Two cornerstones of our effort have been, one, strictly
    enforcing minimum age laws and, two, increasing the collection
    of excise, sales and use taxes from consumers in an effort to
    drive the price of smoking up and the demand down.
        Due to their limited incomes, underage smokers are
    especially sensitive to increases in cigarette prices. They are
    also among the most proficient users of the Internet, and they
    have a great incentive to seek anonymity for their purchases.
    Regrettably, a new breed of remote sellers doing business by
    mail order, the telephone, and the Internet now promise
    cigarette consumers both discounted prices and anonymity.
        With names such as zerotaxcigs.com and zerotaxsmokes.com,
    and taxfreecigarettes.com, their activities are raising serious
    questions about the ability of governments at all levels to
    enforce their public health, youth access, and State tax
    policies effectively. These remote sellers have made it easier
    for customers to avoid paying taxes and for teenagers to avoid
    minimum age laws.
        The purpose of our hearing today is to consider H.R. 1839,
    the ``Youth Smoking Prevention and State Revenue Enforcement
    Act,'' which was introduced by Representative Mark Green of
    Wisconsin. Representative Green's bill authorizes State
    attorneys general to bring a civil action seeking injunctive
    relief in an appropriate U.S. district court for violations of
    the Jenkins Act.
        Since enacting the Jenkins Act in 1949, our Federal policy
    has been to support State and local efforts to tax and regulate
    the sale of cigarettes in interstate commerce.
        The Jenkins Act requires any person selling cigarettes for
    profit in interstate commerce to report to State tobacco tax
    administrators the name and address of the persons to whom the
    cigarettes were shipped and the brands and quantities shipped.
        The Act's purpose is to enable State authorities to have an
    effective mechanism for recovering excise, sales and use taxes
    from consumers who seek to avoid paying State taxes by
    purchasing cigarettes from low-tax or no-tax jurisdictions.
        One projection is that U.S. Internet tobacco sales will
    exceed $5 billion in 2005 and that States will lose $1.4
    billion in State tax revenues as a result. Representative
    Green's legislation enables States to enforce compliance with
    their public health, youth access, and cigarette tax policies,
    thus both increasing States' revenue and reducing health care
    risks and costs.
        I would like the record to show and reflect that
    representatives from two online tobacco retailers were asked to
    testify, and it is no surprise perhaps that they declined to do
    so, but we do look forward to hearing from the witnesses who
    are here today.
        I will now recognize the Ranking Member, Mr. Meehan of
    Massachusetts, for his opening statement.
        Mr. Meehan. Thank you, Mr. Chairman, and I want to thank
    you for scheduling these hearings. As you know, I have been
    working on Internet and mail order tobacco sales for 5 years. I
    certainly appreciate the willingness to address this issue. I
    also want to thank Congressman Green for offering to work
    together on this issue. We have had some constructive
    discussions about H.R. 1839, and I am convinced that he
    understands the need for an effective solution to the problem
    of tax avoidance in connection with remote sales of tobacco
    products.
        I would like to be able to support H.R. 1839, but I cannot
    do so in its current form. I have drafted my own version of the
    bill, but I have not introduced it because I didn't want to
    preempt Mr. Green or this hearing. I hope that we will be able
    to reach an agreement on a strong bipartisan bill.
        My basic concern is that H.R. 1839 does not do enough to
    strengthen the Jenkins Act, which already normally requires
    cigarette distributors to comply with the tax laws of the
    States where they send their products. If we don't close the
    loopholes and strengthen the weaknesses that have made the
    Jenkins Act completely ineffective, we will not be
    accomplishing much but simply passing a new version of the law.
        Coalition for Tobacco Free Kids will outline some of the
    specific provisions that need to be addressed to make sure that
    H.R. 1839 gets the job done, but I will highlight a few areas
    that I think are particularly important. The first problem is
    that H.R. 1839 contains no felony provision or increased fines.
    In a report issued last year the GAO noted that prosecutions
    under the Jenkins Act are extremely rare because U.S. attorneys
    have little interest in prosecuting misdemeanors. Retailers who
    rely on the Internet to generate sales are largely fly-by-night
    operations. Injunctive relief is meaningless against these
    sellers because they simply close up shop and then start over
    under a new name. The idea of giving States the ability to
    bring civil claims against other out-of-state sellers in
    Federal court is a step in the right direction, but is unlikely
    to have much practical effect when defendants have nothing at
    risk but the tax money that they should have paid in the first
    place. The credible threat of criminal prosecution, backed up
    by meaningful penalties, including substantial fines and
    imprisonment, is essential in order to make this bill work.
        The second issue I want to point out is that H.R. 1839
    covers only cigarettes. I do not think there is any logical
    reason to leave a loophole for Internet mail order smokeless
    tobacco such as chew and snuff.
        The third concern or set of concerns I want to raise is
    that H.R. 1839 includes a number of drafting problems that
    appear minor and may have unintended consequences. I know that
    Congressman Green has been working diligently to finish his
    draft of the bill in time for this hearing, but these issues
    will also need to be addressed.
        For example, I think H.R. 1839 is intended to establish the
    right of States to sue tobacco sellers and distributors for the
    failure to obey State tax laws, but it is not entirely clear
    from the language whether the States would be entitled to hold
    a seller or distributor responsible for refusing to collect
    taxes that they are owed by consumers, such as excise tax. If
    States are forced to sue individual consumers for tax evasion,
    the bill is simply not going to be effective.
        I hope that we can rework some of these areas and
    provisions in 1839 to make sure that it achieves its intended
    goals. I am optimistic that together we will be able to produce
    a strong bipartisan bill that could pass both Houses of
    Congress and solve the problem.
        Thank you, Mr. Chairman.
        Mr. Smith. Thank you, Mr. Meehan. The gentleman from
    Wisconsin, Mr. Green, is recognized for his opening statement.
        Mr. Green. Thank you, Mr. Chairman. Thanks first for the
    opportunity to have the Subcommittee consider this legislation.
    This legislation addresses a growing problem in this country,
    the largely unregulated sale of cigarettes by mail, telephone,
    and the Internet. As you have already heard, these remote sales
    usually occur across State lines and result in cigarettes being
    delivered directly to someone's door while evading State laws,
    sales to children and sales taxes.
        I want to acknowledge my colleague and friend, Congressman
    Meehan. He has been a leader on this subject and I admire his
    work very much and I do want to work with him. I am hopeful
    that we can produce soon a product that will be effective. My
    bottom line is to get something done that will work.
        This legislation will give State attorneys general the
    tools they need to enforce their laws against habitual evasion
    by remote sellers. My bill will allow attorneys general to
    bring suit in Federal court against all remote sellers.
        This is a problem that is getting out of hand. Anyone today
    can get on the Internet, run a quick search for tax free
    cigarettes or a variation of that phrase and find literally
    hundreds of Web sites offering cigarettes for sale. In fact,
    there is a special Internet search engine set up just for
    Internet tobacco sites. With nothing more than a credit or
    debit card our children can access these sites, buy cigarettes
    and have their cigarettes delivered right to their door without
    an ID. This will only get worse because, as we all know,
    children are among the most frequent and proficient users of
    the Internet.
        States are largely powerless to stop those rampant
    violations of the minimum age laws because the businesses
    selling to their children are outside of their borders or
    otherwise outside the reach of State law. The New York
    Department of Consumer Affairs has managed to get traditional
    retail sellers of cigarettes to an 85 percent compliance rate
    with minimum age laws. But the department has found its efforts
    literally gutted by the proliferation of remote sellers that it
    cannot regulate.
        At the same time, as has been mentioned, States are losing
    taxes on these sales. One of our witnesses today, economist
    Patrick Fleenor, will estimate that State governments will lose
    over $552 million in sales and excise tax revenue this fiscal
    year and this figure will grow to 1.2 billion by fiscal year
    2005. My home State of Wisconsin is expected to lose 9 million
    this year and over $26 million in 2005 at a time when my State,
    like so many others, is suffering and is challenged in trying
    to balance its books.
        The Jenkins Act, which first became law in 1949, requires
    remote sellers of cigarettes to report their sales to the
    States so that States can collect the taxes. This is a great
    idea. The problem is that remote sellers don't comply with the
    law and no one has been able successfully to enforce it.
        The United States General Accounting Office recently
    reviewed 147 Internet sites that sell cigarettes and not a
    single one of those sites complied with the Jenkins Act. In
    fact, many of these sites openly promote their law breaking by
    offering tax free cigarettes and say they, quote, don't report
    sales. The Web addresses, as, Mr. Chairman, have you pointed
    out, clearly reveal the sellers' intentions. These sites
    include notaxcigarettes.com and zerotaxcigarettes among many
    others.
        In light of these open violations of the law, the GAO
    looked at State efforts to enforce the Jenkins Act and they
    didn't find very much. Why? Well, the GAO heard from nine
    States on this and every one of them said that they did not
    have the necessary legal authority. The GAO also looked at
    Federal enforcement efforts and found that, quote, no Internet
    cigarette vendors have been penalized for violating the act nor
    had any penalties been sought for violators. These lost funds
    again loom even larger now that so many States are laboring to
    find ways to cut their budgets to make up for revenue
    shortfalls.
        Obviously the public health consequences are also very
    important. Many States increase cigarette costs through State
    excise taxes for the stated purpose of deterring smoking. We
    lose those benefits of these taxes when we allow large volumes
    of sales to evade those tax schemes.
        Remote sales of cigarettes are also hurting local
    economies. Local small businesses cannot compete with the legal
    tax free sales by remote businesses.
        Mr. Chairman, we should not allow the situation to
    continue. The rampant evasion of State law is precisely the
    type of issue that Congress should address, and the best way
    for to us do this is to give States the tools they need to
    effectively enforce their laws against all remote sellers.
        This legislation will do this and do it the right way. It
    will keep the authority to enforce State and local laws in the
    hands of State law enforcement. It avoids creating an unfunded
    mandate, avoids creating a new Federal bureaucracy and it
    avoids interfering with or outlawing legitimate commerce.
        Mr. Chairman, I hope you will agree with me that this is a
    problem and these illegal cigarette sales to children is an
    issue that we must take up as a Committee. Again, I do want to
    work with some who are currently opposing this legislation. I
    think there are some things that we can do. I think we all
    agree that the bottom line is to pass something that will work
    and work soon.
        Mr. Chairman, thank you again for holding this hearing and
    I appreciate the willingness of our witnesses to come and
    testify today.
        Mr. Smith. Let me thank other members who are here for
    their attendance as well. Mr. Jenkins of Tennessee, Mr. Keller
    of Florida, Mr. Forbes of Virginia and also Mr. Boucher of
    Virginia as well. This Subcommittee consistently has interested
    Members and good attendance. I am very pleased that that
    continues.
        Let me proceed now to introduce our witnesses. And our
    first witness is Paul Jones, the Director of Homeland Security
    and Justice at the U.S. General Accounting Office. Mr. Jones is
    responsible for the management of programs and issues in the
    U.S. Department of Justice and the Department of Homeland
    Security. Mr. Jones graduated with honors from Elizabeth City
    State University with a B.S. in mathematics and earned a
    Master's Degree in public administration from George Washington
    University.
        The next witness is Hank Armour, President and Chief
    Executive Officer of two corporations, West Star and Epoch,
    with convenience stores in the Northwest. Dr. Armour founded
    West Star in 1982 and Epoch in 1988. Mr. Armour earned a B.A.
    and Ph.D. in economics and an MBA from Stanford. He also holds
    a degree from the London School of Economics.
        Our next witness is Matthew Myers, president and CEO of the
    Campaign for Tobacco Free Kids, a non-profit organization
    established to focus attention on reducing tobacco use among
    minors. Mr. Myers formerly represented the Coalition on Smoking
    and Health, which was comprised of the American Cancer Society,
    the American Lung Association, and American Heart Association.
    He holds a B.A. from Tufts and a J.D. from Michigan.
        Our last witness is Patrick Fleenor, a Washington-based
    economic consultant who specializes in taxation. Prior to
    opening his own practice he was a senior economist with the
    Joint Economic Committee. He has also served as Chief Economist
    for the Tax Foundation, one of the nation's oldest think tanks.
    Mr. Fleenor holds a B.A. from Albion College and an M.A. in
    economics from George Mason, and an M.A. in political science
    from American University.
        Welcome to you all. As I mentioned to you a while ago, all
    your complete statements will be made a part of the record, and
    I will remind you that we would like for you to hold your
    opening statements to 5 minutes so that we will have plenty of
    time for questions.
        I should also mention to members that are here that we are
    expecting a vote on the House floor on the rule somewhere
    around 11 to 11:15 and will hope to be finished with the
    hearing by that time.
        Also to the witnesses, I don't know whether to apologize or
    just explain, but what is new to you is new to us as well. This
    is the first time we have seen that screen in the front. Mr.
    Myers, I am sorry that kind of blocks us. I can't see your name
    tag there but we will make do. This is also new up here. I want
    you to know this screen is off but I could be watching a
    basketball game and I am not. And also new is the corner
    arrangement over there. All good reasons for all these new
    arrangements, but nevertheless still may take some getting used
    to.
        Thank you all for being here.
        Mr. Jones, we will start with your testimony.

      STATEMENT OF PAUL L. JONES, DIRECTOR, HOMELAND SECURITY AND
                   JUSTICE, GENERAL ACCOUNTING OFFICE

        Mr. Jones. Thank you, Mr. Chairman. Mr. Chairman, Members
    of the Subcommittee, I am pleased to be here today to discuss
    our review--I forgot to press the button. New technology. I am
    pleased to be here today to discuss our review of the state of
    compliance by Internet cigarette vendors with the Jenkins Act.
        The Internet offers consumers the option and convenience of
    buying cigarettes from vendors in low tax States without having
    to physically be there. The Jenkins Act requires any person who
    sells and ships cigarettes across a State line to a buyer other
    than a distributor to report the sale to the buyer's State tax
    tobacco administrator. The act establishes misdemeanor
    penalties for violations. Compliance with this Federal law by
    cigarette sellers enables States to collect excise taxes.
        My prepared statement discusses the results of our review
    of Federal efforts to enforce compliance with the Jenkins Act.
    I appreciate having my statement included for the record.
        The results of our review were requested by Congressman
    Meehan and Congressman Conyers. The results of that review was
    reported in August of 2002.
        In my oral statement I would briefly like to make three
    points. First, we determine that most Internet vendors do not
    comply with the Jenkins Act or notify their customers of their
    responsibilities under the act. We identified 147 Web site
    addresses for Internet cigarette vendors based in the United
    States. None of these Web sites displayed information
    suggesting that they comply with the act. Conversely, 78
    percent of these Web sites indicated that the vendors do not
    comply with the act. They posted such statements as we do not
    comply with the Jenkins Act, we do not report sales to State
    tax authority, and we keep customer information private.
    Twenty-two percent provided no indication of whether they
    complied with the act.
        Internet vendors cited the Internet Tax Freedom Act and
    privacy laws among reasons for not reporting cigarette sales to
    State authorities. A number of native Americans claim exemption
    from the act based on sovereign nation status. Our review
    indicated neither the Internet Tax Freedom Act or privacy laws
    exempt cigarette vendors from Jenkins Act compliance.
    Additionally, nothing in the Jenkins Act or its legislative
    history implies that Native American cigarette sales are
    exempt.
        Second, State and Federal officials are concerned that as
    Internet sales continue to grow, particularly as State
    cigarette taxes increase, so will the amount of lost State tax
    revenue due to noncompliance. One research firm estimated that
    Internet tobacco sales in the United States will exceed $5
    billion in 2005 and that States will lose about $1.4 billion in
    tax revenue from these sales. California recently estimated
    that its tax loss revenue due to noncompliance with the Jenkins
    Act is approximately $22 million annually.
        And third, amid these growing concerns the Federal
    Government enforcement of the Jenkins Act has been limited. The
    Attorney General of the United States is responsible for
    supervising the enforcement of Federal laws, including the
    Jenkins Act. However, the Justice Department and the FBI were
    unable to identified any investigations of Internet cigarette
    vendors or other actions to enforce the act. The Bureau of
    Alcohol, Tobacco and Firearms, which enforces Fed excise tax
    and criminal laws and regulation related to tobacco products,
    has ancillary authority to enforce the Jenkins Act. ATF
    officials identified only three investigations since 1997 of
    Internet vendors for cigarette smuggling and violating the
    Jenkins Act.
        States have taken action to promote Jenkins Act compliance
    but results have been limited. We concluded that States are
    hampered in their attempts to promote Jenkins Act compliance
    because they lack authority to enforce the act.
        Congressman Green's bill, H.R. 1839, gives States authority
    to bring civil action against Jenkins Act violators. This could
    lead to greater involvement of States in the enforcement of the
    Jenkins Act. Hence, this could enhance States' effort to
    collect excise taxes.
        To improve the Federal Government's effort in enforcing the
    Jenkins Act and to promote compliance with the act by Internet
    vendors, we suggest in our report that Congress consider
    providing ATF with primary jurisdiction to investigate
    violations of the act. Since our report was issued, ATF was
    transferred to the Department of Justice. Now it may be
    possible for the Attorney General to administratively transfer
    Jenkins Act enforcement authority from the FBI to ATF without
    involving the Congress. We believe that this possibility
    deserves further investigation on the part of the Department of
    Justice.
        This concludes my oral statement. I would be happy to
    respond to questions from the Committee.
        [The prepared statement of Mr. Jones follows:]
                      Prepared Statement of Paul L. Jones
        I am pleased to be here today to discuss our work on the extent of
    compliance by Internet cigarette vendors with the Jenkins Act.\1\ The
    Jenkins Act requires any person who sells and ships cigarettes across a
    state line to a buyer, other than a licensed distributor, to report the
    sale to the buyer's state tobacco tax administrator. The act
    establishes misdemeanor penalties for violating the act. Compliance
    with this federal law by cigarette sellers enables states to collect
    cigarette excise taxes from consumers.
    ---------------------------------------------------------------------------
        \1\ 5 U.S.C. Sec. 375-378.
    ---------------------------------------------------------------------------
        However, some state and federal officials are concerned that as
    Internet cigarette sales continue to grow, particularly as states'
    cigarette taxes increase, so will the amount of lost state tax revenue
    due to noncompliance with the Jenkins Act. One research firm estimated
    that Internet tobacco sales in the United States will exceed $5 billion
    in 2005 and that the states will lose about $1.4 billion in tax revenue
    from these sales.\2\
    ---------------------------------------------------------------------------
        \2\ Online Tobacco Sales Grow, States Lose, Forrester Research,
    Inc. (Apr. 27, 2001). We were unable to assess the reliability of the
    estimates because the methodology used in developing it, including key
    assumptions and data, is proprietary.
    ---------------------------------------------------------------------------
        My testimony today is based on the results of work that we
    completed in August of 2002--namely, our report entitled Internet
    Cigarette Sales: Giving ATF Investigative Authority May Improve
    Reporting and Enforcement (GAO-02-743). Overall, we found that the
    federal government has had limited involvement with the Jenkins Act
    concerning Internet cigarette sales. We also noted that states have
    taken action to promote Jenkins Act compliance by Internet cigarette
    vendors, but results were limited.
        We determined that most Internet cigarette vendors do not comply
    with the Jenkins Act or notify their customers of their
    responsibilities under the act. Vendors cited the Internet Tax Freedom
    Act, privacy laws, and other reasons for noncompliance. A number of
    Native Americans cited sovereign nation status. GAO's review indicated
    that these claims are not valid and vendors are not exempt from the
    Jenkins Act.
        We concluded that states are hampered in attempting to promote
    Jenkins Act compliance because they lack authority to enforce the act.
    We suggested that to improve the federal government's efforts in
    enforcing the Jenkins Act and promoting compliance with the act by
    Internet cigarette vendors, which may lead to increased state tax
    revenues from cigarette sales, the Bureau of Alcohol, Tobacco and
    Firearms (ATF), instead of the Federal Bureau of Investigation (FBI),
    should be provided with primary jurisdiction to investigate violations
    of the act.\3\ We noted that transferring primary investigative
    jurisdiction was particularly appropriate because of the FBI's new
    challenges and priorities related to the threat of terrorism and the
    FBI's increased counterterrorism efforts.
    ---------------------------------------------------------------------------
        \3\ Since our report was issued, ATF was transferred from the
    Department of the Treasury to the Department of Justice and is now
    known as the Bureau of Alcohol, Tobacco, Firearms and Explosives.
    ---------------------------------------------------------------------------
        To perform our work, we obtained information from the Department of
    Justice (DOJ) and ATF headquarters regarding federal Jenkins Act
    enforcement actions with respect to Internet cigarette sales. We
    interviewed officials and obtained documentation from nine selected
    states \4\ regarding states' efforts to promote Jenkins Act compliance
    by Internet cigarette vendors and estimates of the impact of
    noncompliance on tax revenues. In addition, we reviewed 147 Internet
    cigarette vendor Web sites, and we interviewed representatives of five
    Internet vendors.
    ---------------------------------------------------------------------------
        \4\ We contacted tobacco tax officials in 11 states. Officials in 9
    states provided us with information, and officials in 2 states did not
    provide the information we requested in time for it to be included in
    our report. We selected the 10 states with the highest cigarette excise
    tax rates on January 1, 2002, based on the presumption that these
    states would be among those most interested in promoting Jenkins Act
    compliance to collect cigarette taxes. Also, we selected one additional
    state that appeared to have taken action to promote Jenkins Act
    compliance by Internet cigarette vendors.
    ---------------------------------------------------------------------------
                                   background
        Each state, and the District of Columbia, imposes an excise tax on
    the sale of cigarettes, which vary from state to state. As of January
    1, 2003, the state excise tax rates for a pack of 20 cigarettes ranged
    from 2.5 cents in Virginia to $1.51 in Massachusetts (see fig.1). The
    liability for these taxes generally arises once the cigarettes enter
    the jurisdiction of the state.

        Many states have increased their cigarette excise taxes in recent
    years with the intention of increasing tax revenue and discouraging
    people from smoking. As a result, many smokers are seeking less costly
    alternatives for purchasing cigarettes, including buying cigarettes
    while traveling to a neighboring state with a lower cigarette excise
    tax. The Internet is an alternative that offers consumers the option
    and convenience of buying cigarettes from vendors in low-tax states
    without having to physically travel there.
        Consumers who use the Internet to buy cigarettes from vendors in
    other states are liable for their own state's cigarette excise tax and,
    in some cases, sales and/or use taxes. States can learn of such
    purchases and the taxes due when vendors comply with the Jenkins Act.
    Under the act, cigarette vendors who sell and ship cigarettes into
    another state to anyone other than a licensed distributor must report
    (1) the name and address of the person(s) to whom cigarette shipments
    were made, (2) the brands of cigarettes shipped, and (3) the quantities
    of cigarettes shipped. Reports must be filed with a state's tobacco tax
    administrator no later than the 10th day of each calendar month
    covering each and every cigarette shipment made to the state during the
    previous calendar month. The sellers must also file a statement with
    the state's tobacco tax administrator listing the seller's name, trade
    name (if any), and address of all business locations. Failure to comply
    with the Jenkins Act's reporting requirements is a misdemeanor offense,
    and violators are to be fined not more than $1,000, or imprisoned not
    more than 6 months, or both. Although the Jenkins Act, enacted in 1949,
    clearly predates and did not anticipate cigarette sales on the
    Internet, vendors' compliance with the act could result in states
    collecting taxes due on such sales. According to DOJ, the Jenkins Act
    itself does not forbid Internet sales nor does it impose any taxes.
               limited federal involvement with the jenkins act
                          and internet cigarette sales
        The federal government has had limited involvement with the Jenkins
    Act concerning Internet cigarette sales. We identified three federal
    investigations involving such potential violations, and none of these
    had resulted in prosecution (one investigation was still ongoing at the
    time of our work). No Internet cigarette vendors had been penalized for
    violating the act, nor had any penalties been sought for violators.
    FBI Has Primary Investigative Jurisdiction
        The Attorney General of the United States is responsible for
    supervising the enforcement of federal criminal laws, including the
    investigation and prosecution of Jenkins Act violations.\5\ The FBI has
    primary jurisdiction to investigate suspected violations of the Jenkins
    Act. However, DOJ and FBI officials were unable to identify any
    investigations of Internet cigarette vendors or other actions taken to
    enforce the act's provisions regarding Internet cigarette sales.
    According to DOJ, the FBI could not provide information on actions to
    investigate Jenkins Act violations, either by itself or in connection
    with other charges, because the FBI does not have a section or office
    with responsibility for investigating Jenkins Act violations and does
    not track such investigations. Also, DOJ said it does not maintain
    statistical information on resources used to investigate and prosecute
    Jenkins Act offenses.
    ---------------------------------------------------------------------------
        \5\ 28 U.S.C. Sec. 533 provides that the Attorney General of the
    United States may appoint officials ``to detect and prosecute crimes
    against the United States . . .'' except where investigative
    jurisdiction has otherwise been assigned by law.
    ---------------------------------------------------------------------------
        In describing factors affecting the level and extent of FBI and DOJ
    enforcement actions with respect to the Jenkins Act and Internet
    cigarette sales, DOJ noted that the act creates misdemeanor penalties
    for failures to report information to state authorities, and
    appropriate referrals for suspected violations must be considered with
    reference to existing enforcement priorities. Since September 11, 2001,
    it is understood that the FBI's priorities have changed, as
    unprecedented levels of FBI resources have been devoted to
    counterterrorism and intelligence initiatives.
    ATF Has Ancillary Enforcement Authority
        ATF, which enforces federal excise tax and criminal laws and
    regulations related to tobacco products, has ancillary authority to
    enforce the Jenkins Act.\6\ ATF special agents investigate trafficking
    of contraband tobacco products in violation of federal law and sections
    of the Internal Revenue Code. For example, ATF enforces the Contraband
    Cigarette Trafficking Act (CCTA), which makes it unlawful for any
    person to ship, transport, receive, possess, sell, distribute, or
    purchase more than 60,000 cigarettes that bear no evidence of state
    cigarette tax payment in the state in which the cigarettes are found,
    if such state requires a stamp or other indicia to be placed on
    cigarette packages to demonstrate payment of taxes (18 U.S.C. 2342).\7\
    ATF is also responsible for the collection of federal excise taxes on
    tobacco products and the qualification of applicants for permits to
    manufacture tobacco products, operate export warehouses, or import
    tobacco products. ATF inspections verify an applicant's qualification
    information, check the security of the premise, and ensure tax
    compliance.
    ---------------------------------------------------------------------------
        \6\ With ancillary authority to enforce the Jenkins Act, if ATF
    investigates a possible Contraband Cigarette Trafficking Act violation
    (i.e., cigarette smuggling), for which it has primary jurisdiction, and
    determines there is a possible Jenkins Act violation, then ATF may also
    investigate the Jenkins Act violation and refer it to DOJ for
    prosecution or injunctive relief.
        \7\ Certain persons, including permit holders under the Internal
    Revenue Code, common carriers with proper bills of lading, or
    individuals licensed by the state where the cigarettes are found, may
    possess these cigarettes (18 U.S.C. 2341).
    ---------------------------------------------------------------------------
        To enforce the CCTA, ATF investigates cigarette smuggling across
    state borders to evade state cigarette taxes, a felony offense.
    Internet cigarette vendors that violate the CCTA, either directly or by
    aiding and abetting others, can also be charged with violating the
    Jenkins Act if they failed to comply with the act's reporting
    requirements. ATF can refer Jenkins Act matters uncovered while
    investigating CCTA violations to DOJ or the appropriate U.S. Attorney's
    Office for charges to be filed. ATF officials identified three
    investigations since 1997 of Internet vendors for cigarette smuggling
    in violation of the CCTA and violating the Jenkins Act.

              In 1997, a special agent in ATF's Anchorage, Alaska,
            field office noticed an advertisement by a Native American
            tribe in Washington that sold cigarettes on the Internet. ATF
            determined from the Alaska Department of Revenue that the
            vendor was not reporting cigarette sales as required by the
            Jenkins Act, and its investigation with another ATF office
            showed that the vendor was shipping cigarettes into Alaska.
            After ATF discussed potential cigarette smuggling and Jenkins
            Act violations with the U.S. Attorney's Office for the District
            of Alaska, it was determined there was no violation of the
            CCTA.\8\ The U.S. Attorney's Office did not want to pursue only
            a Jenkins Act violation, a misdemeanor offense, and asked ATF
            to determine whether there was evidence that other felony
            offenses had been committed. Subsequently, ATF formed a
            temporary task force with Postal Service inspectors and state
            of Alaska revenue agents, which demonstrated to the
            satisfaction of the U.S. Attorney's Office that the Internet
            cigarette vendor had committed mail fraud. The U.S. Attorney's
            Office agreed to prosecute the case and sought a grand jury
            indictment for mail fraud, but not for violating the Jenkins
            Act. The grand jury denied the indictment. In a letter dated
            September 1998, the U.S. Attorney's Office requested that the
            vendor either cease selling cigarettes in Alaska and file the
            required Jenkins Act reports for previous sales, or come into
            compliance with the act by filing all past and future Jenkins
            Act reports. In another letter dated December 1998, the U.S.
            Attorney's Office instructed the vendor to immediately comply
            with all requirements of the Jenkins Act. However, an official
            at the Alaska Department of Revenue told us that the vendor
            never complied. No further action has been taken.
    ---------------------------------------------------------------------------
        \8\ The U.S. Attorney's Office determined there was no CCTA
    violation because the state of Alaska did not require that tax stamps
    be placed on cigarette packages as evidence that state taxes were paid.

              Another investigation, carried out in 1999, involved
            a Native American tribe selling cigarettes on the Internet
            directly to consumers and other tribes. The tribe was not
            paying state tobacco excise taxes or notifying states of
            cigarette sales to other than wholesalers, as required by the
            Jenkins Act. ATF referred the case to the state of Arizona,
            where it was resolved with no criminal charges filed by
            obtaining the tribe's agreement to comply with Jenkins Act
    ---------------------------------------------------------------------------
            requirements.

              A third ATF investigation of an Internet vendor for
            cigarette smuggling and Jenkins Act violations was ongoing at
            the time of our work.

        ATF officials said that because ATF does not have primary Jenkins
    Act jurisdiction, it has not committed resources to investigating
    violations of the act. However, the officials said strong consideration
    should be given to transferring primary jurisdiction for investigating
    Jenkins Act violations from the FBI to ATF. According to ATF, it is
    responsible for, and has committed resources to, regulating the
    distribution of tobacco products and investigating trafficking in
    contraband tobacco products. A change in Jenkins Act jurisdiction would
    give ATF comprehensive authority at the federal level to assist states
    in preventing the interstate distribution of cigarettes resulting in
    lost state cigarette taxes since ATF already has investigative
    authority over the CCTA, according to the officials. The officials also
    told us ATF has special agents and inspectors that obtain specialized
    training in enforcing tax and criminal laws related to tobacco
    products, and, with primary jurisdiction, ATF would have the
    investigative authority and would use resources to specifically conduct
    investigations to enforce the Jenkins Act, which should result in
    greater enforcement of the act than in the past.
    states have taken action to promote jenkins act compliance by internet
                  cigarette vendors, but results were limited
        Officials in nine states that provided us information all expressed
    concern about Internet cigarette vendors' noncompliance with the
    Jenkins Act and the resulting loss of state tax revenues. For example,
    California officials estimated that the state lost approximately $13
    million in tax revenue from May 1999 through September 2001, due to
    Internet cigarette vendors' noncompliance with the Jenkins Act.
    Overall, the states' efforts to promote compliance with the act by
    Internet vendors produced few results. Officials in the nine states
    said that they lack the legal authority to successfully address this
    problem on their own. They believe greater federal action is needed,
    particularly because of their concern that Internet cigarette sales
    will continue to increase with a growing and substantial negative
    effect on tax revenues.
    States' Efforts Produced Limited Results
        Starting in 1997, seven of the nine states had made some effort to
    promote Jenkins Act compliance by Internet cigarette vendors. These
    efforts involved contacting Internet vendors and U.S. Attorneys'
    Offices. Two states had not made any such efforts.
        Six of the seven states tried to promote Jenkins Act compliance by
    identifying and notifying Internet cigarette vendors that they are
    required to report the sale of cigarettes shipped into those states.
    Generally, officials in the six states learned of Internet vendors by
    searching the Internet, noticing or being told of vendors'
    advertisements, and by state residents or others notifying them. Five
    states sent letters to the identified vendors concerning their Jenkins
    Act reporting responsibilities, and one state made telephone calls to
    the vendors.
        After contacting the Internet vendors, the states generally
    received reports of cigarette sales from a small portion of the vendors
    notified.\9\ The states then contacted the state residents identified
    in the reports, and they collected taxes from most of the residents
    contacted. When residents did not respond and pay the taxes due, the
    states carried out various follow-up efforts, including sending
    additional notices and bills, assessing penalties and interest, and
    deducting amounts due from income tax refunds. Generally, the efforts
    by the six states to promote Jenkins Act compliance were carried out
    periodically and required few resources. For example, a Massachusetts
    official said the state notified Internet cigarette vendors on five
    occasions starting in July 2000, with one employee working a total of
    about 3 months on the various activities involved in the effort.
    ---------------------------------------------------------------------------
        \9\ Cigarette vendors are not required to report to a state unless
    they sell and ship cigarettes into the state. Consequently, the states
    do not know if the Internet vendors that were notified but did not
    respond had any cigarette sales to report.
    ---------------------------------------------------------------------------
        Table 1 summarizes the six states' efforts to identify and notify
    Internet cigarette vendors about the Jenkins Act reporting requirements
    and shows the results that were achieved. There was little response by
    the Internet vendors notified. Some of the officials told us that they
    encountered Internet vendors that refused to comply and report
    cigarette sales after being contacted. For example, several officials
    noted that Native Americans often refused to report cigarette sales,
    with some Native American vendors citing their sovereign nation status
    as exempting them from the Jenkins Act, and others refusing to accept a
    state's certified notification letters. Also, an attorney for one
    vendor informed the state of Washington that the vendor would not
    report sales because the Internet Tax Freedom Act relieved the vendor
    of Jenkins Act reporting requirements.

        Apart from the states' efforts to identify and notify Internet
    cigarette vendors, state officials noted that some Internet vendors
    voluntarily complied with the Jenkins Act and reported cigarette sales
    on their own. The states subsequently contacted the residents
    identified in the reports to collect taxes. For example, a Rhode Island
    official told us there were three or four Internet vendors that
    voluntarily reported cigarette sales to the state. On the basis of
    these reports, Rhode Island notified about 400 residents they must pay
    state taxes on their cigarette purchases and billed these residents
    over $76,000 (the Rhode Island official who provided this information
    did not know the total amount collected). Similarly, Massachusetts
    billed 21 residents for cigarette taxes and collected $2,150 based on
    reports of cigarette sales voluntarily sent to the state.
        Three of the seven states that made an effort to promote Jenkins
    Act compliance by Internet cigarette vendors contacted U.S. Attorneys
    and requested assistance. The U.S. Attorneys, however, did not provide
    the assistance requested. The states' requests and responses by the
    U.S. Attorneys' Offices are summarized below.

              In March 2000, Iowa and Wisconsin officials wrote
            letters to three U.S. Attorneys in their states requesting
            assistance. The state officials asked the U.S. Attorneys to
            send letters to Internet vendors the states had identified,
            informing the vendors of the Jenkins Act and directing them to
            comply by reporting cigarette sales to the states. The state
            officials provided a draft letter and offered to handle all
            aspects of the mailings. The officials noted they were asking
            the U.S. Attorneys to send the letters over their signatures
            because the Jenkins Act is a federal law and a statement from a
            U.S. Attorney would have more impact than from a state
            official. However, the U.S. Attorneys did not provide the
            assistance requested. According to Iowa and Wisconsin
            officials, two U.S. Attorneys' Offices said they were not
            interested in helping, and one did not respond to the state's
            request.\10\
    ---------------------------------------------------------------------------
        \10\ DOJ noted that federal prosecutors generally do not issue
    advisory opinions about prosecutive matters, as they may subsequently
    be presented with the need to make an actual decision based on specific
    facts. The issuance of such an opinion might create the basis for a
    legal dispute if a subsequent prosecution were undertaken.

              After contacting the FBI regarding an Internet vendor
            that refused to report cigarette sales, saying that the
            Internet Tax Freedom Act relieved the vendor of Jenkins Act
            reporting requirements, the state of Washington acted on the
            FBI's recommendation and wrote a letter in April 2001
            requesting that the U.S. Attorney initiate an investigation.
            According to a Washington official, the U.S. Attorney's Office
            did not pursue this matter and noted that a civil remedy (i.e.,
            lawsuit) should be sought by the state before seeking a
            criminal action. At the time of our work, the state was
    ---------------------------------------------------------------------------
            planning to seek a civil remedy.

              In July 2001, the state of Wisconsin wrote a letter
            referring a potential Jenkins Act violation to the U.S.
            Attorney for prosecution. According to a Wisconsin official,
            this case had strong evidence of Jenkins Act noncompliance--
            there were controlled and supervised purchases made on the
            Internet of a small number of cartons of cigarettes, and the
            vendor had not reported the sales to Wisconsin. The U.S.
            Attorney's Office declined to initiate an investigation, saying
            that it appeared this issue would be best handled by the state
            ``administratively.'' The Wisconsin official told us, however,
            that Wisconsin does not have administrative remedies for
            Jenkins Act violations, and, in any case, the state cannot
            reach out across state lines to deal with a vendor in another
            state.
    States Concerned about Internet Vendors' Noncompliance and Believe
            Greater Federal Action Is Needed
        Officials in each of the nine states expressed concern about the
    impact that Internet cigarette vendors' noncompliance with the Jenkins
    Act has on state tax revenues. The officials said that Internet
    cigarette sales will continue to grow in the future and are concerned
    that a much greater and more substantial impact on tax revenues will
    result. One state, California, estimated that its lost tax revenue due
    to noncompliance with the Jenkins Act by Internet cigarette vendors was
    approximately $13 million from May 1999 through September 2001.\11\
    ---------------------------------------------------------------------------
        \11\ The Excise Taxes Division, California State Board of
    Equalization, did not make an official analyses of lost revenue. The
    $13 million estimate is a projection by the division based on the
    amount of state excise and use taxes determined as due from cigarette
    sales reported by out-of-state Internet vendors during the period of
    May 1999 through Sept. 2001.
    ---------------------------------------------------------------------------
        Officials in all nine states said that they are limited in what
    they can accomplish on their own to address this situation and
    successfully promote Jenkins Act compliance by Internet cigarette
    vendors. All of the officials pointed out that their states lack the
    legal authority necessary to enforce the act and penalize the vendors
    who violate it, particularly with the vendors residing in other states.
    Officials in three states told us that efforts to promote Jenkins Act
    compliance are not worthwhile because of such limitations, or are not a
    priority because of limited resources.
        Officials in all nine states said that they believe greater federal
    action is needed to enforce the Jenkins Act and promote compliance by
    Internet cigarette vendors. Four state officials also said they believe
    ATF should have primary jurisdiction to enforce the act. One official
    pointed out that his organization sometimes dealt with ATF on tobacco
    matters, but has never interacted with the FBI. Officials in the other
    five states did not express an opinion regarding which federal agency
    should have primary jurisdiction to enforce the act.
     most internet cigarette vendors do not comply with the jenkins act or
                   notify consumers of their responsibilities
        Through our Internet search efforts, we identified 147 Web site
    addresses for Internet cigarette vendors based in the United States and
    reviewed each website linked to these addresses.\12\ Our review of the
    Web sites found no information suggesting that the vendors comply with
    the Jenkins Act. Some vendors cited reasons for not complying that we
    could not substantiate. A few Web sites specifically mentioned the
    vendors' Jenkins Act reporting responsibilities, but these Web sites
    also indicated that the vendors do not comply with the act. Some Web
    sites provided notice to consumers of their potential state tax
    liability for Internet cigarette purchases.
    ---------------------------------------------------------------------------
        \12\ The 147 Web site addresses appear to represent 122 different
    Internet cigarette vendors. We made this determination by comparing
    information such as vendor names, company names, street addresses, P.O.
    box numbers, and telephone numbers. For example, some Web sites had the
    same mailing address and telephone number, suggesting they were
    separate Web sites being operated by one company.
    ---------------------------------------------------------------------------
    Majority of Web sites Indicate that Vendors Do Not Comply with the
            Jenkins Act
        None of the 147 Web sites we reviewed stated that the vendor
    complies with the Jenkins Act and reports cigarette sales to state
    tobacco tax administrators.\13\ Conversely, as shown in table 2,
    information posted on 114 (78 percent) of the Web sites indicated the
    vendors' noncompliance with the act through a variety of statements
    posted on the sites. Thirty-three Web sites (22 percent) provided no
    indication about whether or not the vendors comply with the act.
    ---------------------------------------------------------------------------
        \13\ Two Web sites posted statements indicating that customer
    information would be released if required; however, both sites also
    stated that the information would not be given out without the
    customers' permission. The Jenkins Act does not require cigarette
    sellers to notify customers regarding whether or not they comply with
    the act's reporting requirements.

    Reasons Cited for Noncompliance with the Jenkins Act
        Some Internet vendors cited specific reasons on their Web sites for
    not reporting cigarette sales to state tax authorities as required by
    the Jenkins Act. Seven of the Web sites reviewed (5 percent) posted
    statements asserting that customer information is protected from
    release to anyone, including state authorities, under privacy laws.
    Seventeen Web sites (12 percent) state that they are not required to
    report information to state tax authorities and/or are not subject to
    the Jenkins Act reporting requirements. Fifteen of these 17 sites are
    Native American, with 7 of the sites specifically indicating that they
    are exempt from reporting to states either because they are Native
    American businesses or because of their sovereign nation status. In
    addition, 35 Native American Web sites (40 percent of all the Native
    American sites we reviewed) indicate that their tobacco products are
    available tax-free because they are Native American businesses.\14\
    ---------------------------------------------------------------------------
        \14\ Fifty-nine percent, or 87, of the 147 Web site addresses
    reviewed are either Native American-owned or located and/or operated on
    Native American lands.
    ---------------------------------------------------------------------------
        To supplement our review of the Web sites, we also attempted to
    contact representatives of 30 Internet cigarette vendors, and we
    successfully interviewed representatives of 5.\15\ One of the 5
    representatives said that the vendor recently started to file Jenkins
    Act sales reports with one state.\16\ However, the other 4 said that
    they do not comply with the act and provided us with additional
    arguments for noncompliance. Their arguments included an opinion that
    the act was not directed at personal use. An additional argument was
    that the Internet Tax Freedom Act \17\ supercedes the obligations laid
    out in the Jenkins Act.
    ---------------------------------------------------------------------------
        \15\ We were either unable to reach representatives of the
    remaining 25 vendors we selected to conduct structured interviews, or
    they declined to answer questions.
        \16\ The vendor who said that he does comply with the Jenkins Act
    told us that he recently started to file reports with the state of
    Washington after receiving a notice from the state's Department of
    Revenue. However, he said Washington is the only state he reports to,
    and he declined to provide us with evidence of his compliance with the
    act.
        \17\ P.L. 105-277, Div. C, Title XI, Oct. 21, 1998.
    ---------------------------------------------------------------------------
        Our review of the applicable statutes indicates that neither the
    Internet Tax Freedom Act nor any privacy laws exempt Internet cigarette
    vendors from Jenkins Act compliance. The Jenkins Act has not been
    amended since minor additions and clarifications were made to its
    provisions in 1953 and 1955; and neither the Internet Tax Freedom Act
    nor any privacy laws amended the Jenkins Act's provisions to expressly
    exempt Internet cigarette vendors from compliance. With regard to the
    Internet Tax Freedom Act, the temporary ban that the act imposed on
    certain types of taxes on e-commerce did not include the collection of
    existing taxes, such as state excise, sales, and use taxes.
        Additionally, nothing in the Jenkins Act or its legislative history
    implies that cigarette sales for personal use, or Native American
    cigarette sales, are exempt. In examining a statute, such as the
    Jenkins Act, that is silent on its applicability to Native American
    Indian tribes, courts have consistently applied a three-part analysis.
    Under this analysis, if the act uses general terms that are broad
    enough to include tribes, the statute will ordinarily apply unless (1)
    the law touches ``exclusive rights of self-governance in purely
    intramural matters;'' (2) the application of the law to the tribe would
    abrogate rights guaranteed by Indian treaties; or (3) there is proof by
    legislative history or some other means that Congress intended the law
    not to apply to Indians on their reservations. Our review of the case
    law did not locate any case law applying this analysis to the Jenkins
    Act. DOJ said that it also could not locate any case law applying the
    analysis to the Jenkins Act, and DOJ generally concluded that an Indian
    tribe may be subject to the act's requirements. DOJ noted, however,
    that considering the lack of case law on this issue, this conclusion is
    somewhat speculative. ATF has stated that sales or shipments of
    cigarettes from Native American reservations are not exempt from the
    requirements of the Jenkins Act.\18\
    ---------------------------------------------------------------------------
        \18\ Industry Circular, No. 99-2, Bureau of Alcohol, Tobacco and
    Firearms, June 6, 1999.
    ---------------------------------------------------------------------------
    Few Web sites Provide Notice of the Vendors' Reporting
            Responsibilities, but Some Provide Notice of Customer Cigarette
            Tax Liability
        Only 8 (5 percent) of the 147 Web sites we reviewed notified
    customers that the Jenkins Act requires the vendor to report cigarette
    sales to state tax authorities, which could result in potential
    customer tax liability. However, in each of these cases, the Web sites
    that provided notices of Jenkins Act responsibilities also followed the
    notice with a statement challenging the applicability of the act and
    indicating that the vendor does not comply. Twenty-eight Web sites (19
    percent) either provided notice of potential customer tax liability for
    Internet cigarette purchases or recommended that customers contact
    their state tax authorities to determine if they are liable for taxes
    on such purchases. Three other sites (2 percent) notified customers
    that they are responsible for complying with cigarette laws in their
    state, but did not specifically mention taxes. Of the 147 Web sites we
    reviewed, 108 (73 percent) did not provide notice of either the
    vendors' Jenkins Act reporting responsibilities or the customers'
    responsibilities, including potential tax liability, with regard to
    their states.
                                  conclusions
        Our report concluded that states are hampered in attempting to
    promote Jenkins Act compliance because they lack authority to enforce
    the act. In addition, violation of the act is a misdemeanor, and U.S.
    Attorneys' reluctance to pursue misdemeanor violations could be
    contributing to limited enforcement. Transferring primary investigative
    jurisdiction from the FBI to ATF would give ATF comprehensive authority
    at the federal level to enforce the Jenkins Act and should result in
    more enforcement. ATF's ability to couple Jenkins Act and CCTA
    enforcement may increase the likelihood it will detect and investigate
    violators and that U.S. Attorneys will prosecute them. This could lead
    to improved reporting of interstate cigarette sales, thereby helping to
    prevent the loss of state cigarette tax revenues. Transferring primary
    investigative jurisdiction is also appropriate at this time because of
    the FBI's new challenges and priorities related to the threat of
    terrorism and the FBI's increased counterterrorism efforts.
        To improve the federal government's efforts in enforcing the
    Jenkins Act and promoting compliance with the act by Internet cigarette
    vendors, which may lead to increased state tax revenues from cigarette
    sales, our report suggested that the Congress should consider providing
    ATF with primary jurisdiction to investigate violations of the Jenkins
    Act (15 U.S.C. Sec. 375-378). In view of the fact that ATF was recently
    transferred from the Treasury Department to DOJ, it may now be possible
    for the Attorney General to administratively transfer primary Jenkins
    Act enforcement authority from the FBI to ATF without involving the
    Congress in the matter. We believe that this possibility deserves
    further investigation on the part of DOJ.

        Mr. Smith. Thank you, Mr. Jones. Without objection, we will
    also make the entire GAO report a part of the record as well.
        Mr. Armour.

     STATEMENT OF HENRY ``HANK'' O. ARMOUR, CHAIRMAN OF THE BOARD,
               NATIONAL ASSOCIATION OF CONVENIENCE STORES

        Mr. Armour. Good morning, Mr. Chairman. My name is Hank
    Armour and I am a small businessman from Olympia, Washington.
    As President and CEO of West Star Corporation, I own and
    operate 24 retail facilities in Washington State and
    California.
        I would first like to thank Representative Green for
    tackling such an important issue in this legislation, the Youth
    Smoking Prevention and State Revenue Enforcement Act. I also
    would like to thank Members of the Subcommittee for inviting me
    to testify regarding this very important issue facing
    retailers, States and children across this country. I am
    testifying today on behalf of the National Association of
    Convenience Stores, NACS, where I sit as chairman of the board.
    I am a past president of the Washington Association of
    Neighborhood Stores and currently serve on its executive
    committee.
        There are over 134,000 convenience stores operating in the
    United States and the District of Columbia, and they employ
    over 1.5 million Americans. Tobacco sales are highly important
    components of the convenience store industry, and while
    controversial tobacco is a legal product and one that is very
    important to our economic viability.
        The convenience store industry's position is that minors
    should not consume tobacco and that no retailer should sell
    tobacco to minors. That is why the convenience store operators
    across the country have spent time and money trying to prevent
    these illegal sales. My company has instituted strict measures
    to ensure that no minor can purchase an age restricted product.
    A detailed list is included in my submitted testimony, but I
    want to take just a few minutes to review some of the measures
    that we have instituted.
        They include training sales associates in the ``We Card''
    program on the very first day of employment. We recertify every
    sales associate every 6 months. We prominently post ``We Card''
    signs and decals in all of our stores. We conduct monthly
    internal sting operations to ensure compliance with our age
    restricted product sales policies. We have reprogrammed our
    cash registers to prompt sales associates to check for ID every
    time an age restricted product is scanned. And finally we have
    a zero tolerance policy in which we immediately terminate a
    sales associate if the sales associate sells cigarettes to a
    minor.
        As you can see, we take our responsibility very seriously.
    While no system is perfect, through these training efforts
    retailers have been able to significantly increase their
    compliance rate with regard to age verification at point of
    sale.
        Brick and mortar retailers such as myself who have spent
    time and money on these responsible tobacco retailing efforts
    are at an unfair disadvantage to Internet, mail order, and
    other remote retailers. I am not asking for a weakening of our
    enforcement obligation, I am asking for our obligation to apply
    equally to all tobacco retailers. In my view, these remote
    retailers are frankly irresponsible. For many of these remote
    sellers, especially Internet retailers, age verification is
    simply a joke. As you can see from the Web sites I have
    submitted with my testimony, all a child has to do is click on
    a link verifying that he or she is over 18 years old, and the
    child can buy cigarettes. This lackadaisical age verification
    wouldn't fly in Washington State and I don't think any other
    State would allow a convenience store owner to place a sign in
    the store that says by asking for cigarettes you are verifying
    that you are 18 years old.
        According to Clara York, an employee of cigarette retailers
    Seneca Cigarettes, the ultimate responsibility for making sure
    teenagers do not purchase cigarettes lies with parents, who
    should make an effort to police the Web sites their children
    are visiting. Unlike Clara York, as a responsible tobacco
    retailer I believe it is my responsibility and the
    responsibility of my sales associates to ensure that kids don't
    purchase cigarettes at my retail locations.
        Beyond age verification remote sellers are evading tax
    obligations. I operate stores in Washington State and
    California. Both States have high excise taxes. Washington has
    an excise tax of $14.25 per carton. Because they don't collect
    State taxes remote sellers can offer their cigarettes for
    almost $15 less per carton than what I can. When you add in
    sales tax that amount approaches $20 per carton. And like many
    other States, Washington is currently considering another $5
    per carton increase in State excise taxes. As more and more
    States raise their State excise taxes, smokers will be driven
    to these remote sellers for cheaper cigarettes.
        Mr. Green. [Presiding.] If you could summarize your
    testimony. I know your light isn't operating there.
        Mr. Armour. While the legislation being considered today
    will not address every problem relating to cigarette sales, it
    is a good place to start. We can make a big difference by
    addressing the egregious violations committed every day by
    Internet and other remote retailers. All tobacco retailers
    should have to play by the same rules. And Mr. Green, your
    legislation will accomplish this goal. This is a fair and
    balanced approach to a growing problem in our society. I thank
    you, Mr. Green, for introducing the Youth Smoking Prevention
    and State Revenue Enforcement Act and would be happy to answer
    any questions.
        [The prepared statement of Mr. Armour follows:]
                     Prepared Statement of Henry O. Armour
        Good morning, Mr. Chairman. My name is Hank Armour, and I am a
    small businessman from Olympia, Washington. As president and CEO of
    West Star Corporation, I own and operate twenty-four retail facilities
    in Washington State and California.
        I would first like to thank Representative Green for tackling such
    an important issue in his legislation, the Youth Smoking Prevention and
    State Revenue Enforcement Act. I also would like to thank members of
    the subcommittee for inviting me to testify regarding this very
    important issue facing retailers, states and children across this
    country.
        I am testifying today on behalf of the National Association of
    Convenience Stores (``NACS''), where I sit as Chairman of the Board. I
    am a Past President of the Washington Association of Neighborhood
    Stores and currently serves on its Executive Committee.
        There are over 134,000 convenience stores operating in the United
    States and the District of Columbia that employ over 1.5 million
    Americans. Tobacco sales are a highly important component of the
    convenience store industry. Convenience stores sell more than half of
    the single packs of tobacco sold in the United States in more than 20
    million transactions per day. Such sales, on average, constituted
    nearly 40 percent of the in-store sales at retail locations in 2001.
    While controversial, tobacco is a legal product and one that is
    important to the economic viability of the convenience store industry.
        The convenience store industry's position is that minors should not
    consume tobacco and that no retailer should sell tobacco to minors.
    That is why convenience store operators across the country have spent
    time and money trying to prevent tobacco these illegal sales. These
    prevention efforts include employee training, signage, company-operated
    stings, incentives for employees, and enforcement of company policies.
    Some retailers have even installed electronic age verification (EAV)
    devices to help eliminate these sales. My company has instituted the
    following measures to ensure that no minor can purchase an age-
    restricted product from my stores:

              On the first day of employment a sales associate is
            trained in the We Card program and is fully informed of our
            zero tolerance policy towards the sale of cigarettes to minors.

              Throughout the first two weeks of employment sales
            associates complete computer based training modules on a daily
            basis including one on the sales of age-restricted products.

              Every six months sales associates complete a re-
            certification computer based training module dealing with the
            sales of age-restricted products.

              We Card signs and decals are prominently posted in
            all of our stores.

              We conduct on a monthly basis internal sting
            operations to insure that sales of age-restricted products are
            been made appropriately.

              We publicize appropriate ID checking during sting
            operations in our monthly newsletter.

              We have programmed our cash registered to prompt the
            sales associate to check for ID every time an age restricted
            product is scanned for sale.

              And finally, as I mentioned earlier, we have a zero
            tolerance policy towards the sale of age-restricted products to
            minor in which we immediately terminate a sales associate if
            they sell such products to a minor.

        As you can see, we take our responsibility very seriously.
        In order to assist in the elimination of tobacco sales to minors,
    retailers, wholesalers and manufacturers formed in 1996 the Coalition
    for Responsible Tobacco Retailing. This Coalition developed the ``We
    Card'' training program, which provides education and training to help
    retailers prevent underage tobacco sales. The program includes
    development and disseminations of retailer best practices to tobacco
    retailers across the country. The ``We Card'' training materials
    include signage, training videos, training guides, posters, interactive
    on-line training, and daily reminder calendars. Nearly 800,000 ``We
    Card'' kits were distributed to retailers nationwide between 1996 and
    2001. ``We Card'' offers on average 200 classroom training sessions
    that train almost 10,000 retailers annually. From 1996 to 2001, nearly
    60,000 retailers underwent ``We Card'' classroom training and they, in
    turn, trained more than 700,000 employees. While no system is perfect
    through these training efforts, retailers have been able to
    significantly increase their compliance rates with regards to age
    verification at point of sale.
        Brick-and-mortar retailers, such as myself, who have spent time and
    money on these responsible tobacco-retailing efforts are at an unfair
    disadvantage to Internet, Mail order and other remote retailers. We pay
    to train our employees, we get stung and have to pay fines if an
    illegal sale is made, and these remote sellers have none of these
    obligations. I am not asking for a weakening of our enforcement
    obligation, I am asking for our obligations to apply equally to all
    tobacco retailers. In my view, these remote retailers are frankly
    irresponsible. A good majority do not have a consistent or reliable age
    verification processes and should be made to conform with state tobacco
    retailing regulations. For many of these remote sellers, especially
    those Internet retailers, age verification is a joke. As you can see
    from the websites I've submitted with my testimony, all a child has to
    do is click on a link verifying and that he/she is over 18 years old
    and the child can buy cigarettes. This lackadaisical age verification
    wouldn't fly in Washington State, and I don't think any other state
    would allow a convenience store owner to place a sign in the store that
    states, ``By asking for cigarettes you are verifying that you are 18
    years old.'' According to Clara York, an employee of cigarette e-tailer
    Seneca Cigarettes, ``the ultimate responsibility for making sure
    teenagers do not purchase cigarettes, lies with parents who should make
    an effort to police the Web sites their children are visiting.'' As a
    responsible tobacco retailer I believe it is my responsibility and the
    responsibility of my sales associates to ensure kids don't purchase
    cigarettes at my retail locations.
        Beyond age verification, remote sellers are evading their tax
    obligations. I operate stores in Washington State and California - two
    states that have high excise taxes. Both states have excise taxes that
    are close to $1.50 per pack. Because they don't collect states taxes,
    remote sellers can offer their cigarettes for $15 less per carton than
    I can. When you add in sales taxes that such sellers do not collect,
    the amount approaches $20/carton. And Washington State, as are many
    other states across the nation, is currently considering another $5/
    carton increase in the state excise tax. As more and more states raise
    their state excise taxes, smokers will be driven to these remote
    sellers for cheaper cigarettes.
        Retailers in the convenience store industry cannot compete with
    remote sellers who are not complying with their tax obligations--many
    of which flaunt their ``so called'' tax-free status. It simply is not a
    level playing field. On its home page, Seneca Smokes states that it
    does not report to any state taxation or tobacco department. Brand Name
    Cigarettes' advertising tells smokers to stop paying high taxes and
    start saving money today by purchasing tobacco products securely
    online. Just look at some of the website names: NoCigaretteTaxes.com,
    taxfreecigarettes.com, Cheapsmokesbymail.com, Cigs4free.com,
    dirtcheapcig.com, and notaxsmokes.com. The problem is not solely with
    Internet retailers, Big Indian Smoke Shop is buying advertisements in
    papers highlighting their tax-free cigarettes - the one attached to my
    testimony ran in a New York City paper right after the tobacco excise
    tax was increased.
        While the legislation being considered today will not address every
    problem relating to cigarettes sales, it is a good place to start. We
    can make a big difference by addressing the egregious violations
    committed everyday by Internet and other remote retailers.
        The convenience store industry is not asking for special treatment.
    We want all tobacco retailers to have to play by the same rules, and
    Mr. Green's legislation will help accomplish this goal. We want a level
    playing field. This bill will allow attorneys general to go after those
    remote sellers, including those that are out-of- state or run by Native
    Americans, who are violating the law. This is a fair and balanced
    approach to a growing problem in our society.
        I thank Mr. Green for introducing the Youth Smoking Prevention and
    State Revenue Enforcement Act, and would be happy to answer any
    questions.

                                   ATTACHMENT

        Mr. Green. Thank you, Mr. Armour, for your testimony.
        Mr. Myers, President for the National Center for Tobacco-
    Free Kids. Welcome.

                STATEMENT OF MATTHEW MYERS, PRESIDENT,
                 NATIONAL CENTER FOR TOBACCO-FREE KIDS

        Mr. Myers. Thank you. I want to start out by thanking
    Congressman Green for introducing this legislation and
    prompting this important dialogue. I also want to thank
    Congressman Meehan for his long time leadership on these issues
    and his effort to find realistic solutions to a serious
    problem. I am hoping that today's hearing can in fact be the
    kickoff to a dialogue that will lead to the enactment of
    legislation that will make a real difference. We ought to be
    able to get there.
        It is clear from the discussion this morning that we agree
    on goals, that we need to do more to prevent youth access to
    tobacco products over the Internet and that we need to do
    something to give the State officials the tools to make sure
    that State taxes on tobacco products are in fact collected,
    both because if we fail to do so it undercuts efforts to reduce
    youth tobacco use and at this time more than any time in our
    recent past States need the funds if they are going to succeed.
        That is critically important.
        We agree on the problem.
        We agree that State taxes are currently being evaded on a
    rampant basis and that unless State officials are given new
    tools that nothing they can do will make a significant
    difference.
        We agree on the need for action.
        We agree that the twin problems of youth access and tax
    evasion need to be addressed, preferably in one bill, but if
    not in one bill, then in two bills with realistic solutions.
        We agree that the Jenkins Act has been a failure, not that
    it was not well intended, but it simply didn't give the Federal
    and State officials the tools they need.
        We agree that there is a desire not to create a new
    bureaucracy, unfunded mandates or unnecessary burdensome
    provisions.
        We also agree that if we are going to pass legislation we
    must give the State attorneys general the tools they actually
    need to make a real difference.
        In that area, our testimony is designed to focus on what we
    think needs to be added to this bill so that the State
    attorneys general will be able to do the jobs, so they will be
    able to stop the hemorrhaging of State revenues.
        Let me tick off in the limited time available the key areas
    that we think need to be addressed.
        First, it is essential that this bill deal with all tobacco
    products. By leaving out some tobacco products we
    unintentionally encourage the sale over the Internet of others.
        We should create an even playing field. We are not talking
    about adding new taxes, we are only talking about making sure
    that people who sell tobacco products comply with the tax laws
    that are already in existence.
        Second, it is absolutely clear talking to law enforcement
    officials around the country that unless the bill clearly and
    unambiguously makes it the responsibility of the seller to
    collect and pay the taxes, then enforcement efforts will
    inevitably fail. We cannot go after every kid or person who
    purchases a tobacco product. No law enforcement official in the
    Nation has those kinds of resources. I believe it is the intent
    of this bill to do so. But when you compare the provisions of
    this bill with what is needed it is clear that there needs to
    be an amendment. It is a simple process to make explicit that
    it is the obligation of the seller to collect and remit those
    taxes to the State officials prior to shipping the tobacco
    products into the State if we are going to succeed. If we don't
    include that kind of explicit language, everything else we do
    is doomed to failure.
        Third, we have to make sure that the State officials are
    given the tools they need to enforce those provisions. What do
    we mean? Record keeping provisions on the part of sellers, the
    kind of things that the people in state, the bricks and mortar
    people have to comply with. The authority of State officials to
    block the shipment of cigarettes in from repeat offenders. It
    won't be enough if you simply go after the taxes time and time
    again. Just as you would with a repeat seller who violates the
    law, you need the authority to prohibit those people from
    selling tobacco products. And third, this bill already contains
    a notice provision. What it needs to make clear is that out of
    State sellers shouldn't be allowed to sell in State until they
    have filed with the State, so that the State officials don't
    have to go on a search for a needle in a haystack to figure out
    who is violating the law.
        Next, the enforcement provisions have to be adequate.
    Otherwise State officials won't have the incentive to do so.
    What that means is significant enough minimum penalties just as
    retailers face so that people will have an incentive both to
    obey the law and the law enforcement officials will have the
    incentive to enforce the law. The bill I think unintentionally
    strips the Federal officials of its Federal authority. We
    should be adding to those.
        Last, let me just add something that Congressman Meehan
    said. We need to make sure that the criminal penalties here are
    real and that they can be enforced both by Federal and State
    officials. If we do those things, this is a law enforcement
    bill that can have a significant public health impact on our
    children and can help States prevent the continued hemorrhage
    from the illegal sale of tobacco products.
        Thank you. Congressman Green, we are very sincere in our
    offer that we would like to work with you to have a bill that
    can pass this Congress with bipartisan support in an
    overwhelming vote.
        [The prepared statement of Mr. Myers follows:]
                      Prepared Statement of Matthew Myers
        Good morning Mr. Chairman, and members of the Committee. My name is
    Matthew Myers. I am the President of the National Center for Tobacco-
    Free Kids, a national organization created to protect children from
    tobacco by raising awareness that tobacco use is a pediatric disease,
    by changing public policies, and by actively countering the special
    interest influence of the tobacco industry.
        Mr. Chairman, I want to thank you for inviting me to testify on
    draft legislation by Congressman Green. While we support the concept of
    providing the State Attorneys General with authority to enforce
    violations of this Act, regrettably, we must oppose the legislation as
    drafted.
        Current Internet sales of tobacco raise two serious issues:
    uncontrolled sales to youth and evasion of state sales and tobacco
    related excise taxes. The twin problems of youth access and tax evasion
    need to both be addressed, preferably in one bill, but if not in one
    bill in two bills that contain adequate provisions to make a real
    difference. This bill as currently drafted does not deal with the
    problem of sales to young people at all; and it is our assessment that
    its limited proposal to address the problem of the evasion of state
    sales and tobacco related excise taxes will be ineffective. If its
    enactment prevents or forestalls the passage of legislation that
    effectively addresses these problems, it will do more harm than good.
    Even worse, it would undermine the longstanding, bipartisan efforts of
    Congressman Meehan, former Congressman Hansen and others to enact a
    comprehensive solution by giving the false impression that the problems
    had been effectively addressed.
        There are currently about 200 U.S. websites and 200 foreign-based
    websites that sell cigarettes to U.S. smokers. Effective safeguards
    against kids being able to purchase cigarettes via the Internet are
    almost non-existent. While many Internet websites post notices that
    sales to persons under 18 are illegal or not allowed, very few do
    anything at all to make sure such sales do not occur.
        Tax evasion via Internet sales of tobacco products is rampant.
    Internet tobacco prices are much lower than those in regular bricks-
    and-mortar retail outlets because Internet prices almost never include
    the taxes charged by retail stores. These low prices make Internet
    tobacco products attractive to both adult and underage smokers, and
    help to boost overall smoking levels. In addition, states lose millions
    of dollars each year in uncollected tax revenues. All of these problems
    have been compounded by the inadequacy of the enforcement tools
    available, the most serious of which is caused by the fact that under
    current law responsibility for paying the state taxes is normally the
    responsibility of the purchaser rather than the Internet seller.
        We have been skeptical about whether these problems can be fully
    resolved by any action short of a ban such as that imposed recently by
    the State of New York, but we have endorsed H.R. 5724, the Meehan/
    Hansen bill introduced in the last Congress. The Meehan/Hansen bill
    offered a comprehensive solution to the problems arising from Internet
    sales of tobacco products by addressing both parts of the problem:
    youth access and tax evasion. The American Cancer Society, the American
    Heart Association and the American Lung Association also endorsed H.R.
    5724. To protect against Internet sales to youth, H.R. 5724 would have
    required the verification of age and identity both at the time of sale
    and the time and place of delivery.
        We understand that this Committee wants to focus exclusively on
    legislation within its jurisdiction that addresses the fact that states
    are illegally losing millions of tax dollars. To accommodate that
    desire, we undertook to provide Congressmen Green and Meehan with a
    draft of such legislation. We strongly urge the Committee to adopt its
    provisions.
        I would now like to outline the seven specific areas in which the
    legislation offered by Congressman Green fails to meet what we believe
    are the minimum standards necessary for any effective legislation
    dealing with Internet tobacco sales.
    1.  The legislation should apply to all tobacco products, not just
            cigarettes.
        If the legislation applies only to cigarettes it will do nothing to
    reduce illegal sales and tax evasion over the Internet or through mail
    order on other tobacco products. By focusing only on cigarettes, the
    legislation could have the unintended consequence of encouraging use of
    other tobacco products such as smokeless tobacco. There can be no
    justification for the different treatment of different tobacco
    products.
    2.  The legislation should explicitly impose the burden of either
            paying or insuring that applicable state taxes are paid on the
            Internet seller rather than on the purchaser.
        State tobacco taxes on tobacco products sold at retail are
    collected at the distributor level. The products arrive at the retail
    outlet with a tax stamp already on them and the applicable tobacco
    related taxes already paid. This enables law enforcement officials to
    easily monitor compliance and insures that violations will involve a
    sufficient amount of money to warrant enforcement.
        At present Internet sellers based outside the United States and/or
    on Indian lands pay no state taxes and Internet sellers based in low
    tax states only pay the tax from the state in which they are based. The
    responsibility for paying the tax on the tobacco products they sell
    then falls to the individual consumer/purchaser, making enforcement
    difficult and costly. Unless the responsibility for paying the tax is
    clearly and unquestionably switched to the Internet seller, it doesn't
    matter who is given the authority to enforce the law--it will not
    happen.
        Despite our requests that a provision be added that explicitly
    switches the responsibility to the Internet seller, the bill before the
    Committee does not do so. As written, the draft legislation offered by
    Congressman Green in Sec. 2(a) only requires that the Internet seller
    ``comply with all the sales tax and use tax and other laws, applicable
    to the distribution and sale of cigarettes.'' This could be interpreted
    to give states only a federal right of action to enforce existing state
    laws that apply to Internet sellers. Very few states have laws that
    explicitly apply to Internet sellers.
        Even a broader interpretation would be difficult to implement
    because states have numerous ``sales and use tax and other laws
    applicable to the sale of cigarettes.'' Some apply to manufacturers,
    distributors, and wholesalers; others apply to retailers, vending
    machine operators, etc. In most states, state laws place no tobacco tax
    collection or payment obligations on retailers because these
    responsibilities are placed on others. If the goal is to require the
    Internet seller to pay the tax or to insure that it is paid, then the
    legislation should be explicit on this point. If legislation is
    ambiguous as to whether the burden to pay the tax falls on the Internet
    seller or purchaser or some third party, then it will be wholly
    ineffective in curtailing tax evasion.
    3.  The legislation should apply to all remote sales of tobacco
            products.
        As written, the legislation exempts sales that are not ``outside
    the State or Indian lands where the order is processed.'' While the
    impact is probably unintended, this could be read to exempt sales from
    Indian lands to consumers outside the Indian reservation but within the
    same state. This could be a substantial loophole in states with large
    populations with in-state tribal Internet sellers.
    4.  The legislation should include an enforcement mechanism that will
            assure that the states can actually enforce the legislation and
            block Internet and mail-order sales of tobacco products for
            which state taxes have not been paid.
        Internet sellers are often based out of state, on Tribal lands, or
    even offshore or overseas. Some are fly-by-night operations. Even if
    this legislation gives states authority to bring civil actions against
    any person who violates the Act, bringing state lawsuits against
    distant vendors is an inevitably costly, cumbersome, complicated, and
    ultimately uncertain enforcement procedure.
        To be effective, legislation must require that Internet sellers
    maintain records of their sales for several years, prohibit anyone from
    shipping tobacco products into the state who has not registered and
    give the state the authority to block the delivery of tobacco products
    who have not complied with the law. The current draft does not
    adequately include any of these tools.
    5.  The Civil Action section of the legislation should provide for
            civil fines and give the federal government the right to seek
            civil fines and civil damages.
        As drafted, Sec. 3. entitled ``Civil Action'' says that a State
    Attorney General may ``obtain appropriate relief, including money
    damages,'' but does not provide for any specific or minimum penalties
    or fines for violating the provisions of this Act, nor does it include
    the authority to withdraw a repeat violator's right to sell tobacco
    products into the state in the future.
        We support the proposal to provide state Attorneys General with the
    authority to bring civil actions to enforce violations of the law, but
    it should not at the same time strip the federal government of
    authority to bring a civil enforcement action and allow the federal
    government only to seek criminal penalties. As drafted, the federal
    government would not be allowed to seek any civil or monetary damages
    or fines from Internet or mail order sellers who break the law. Federal
    authorities have not to date exercised their current enforcement
    authority, in part, because individual enforcement cases were deemed to
    be too small to warrant the effort. If the law imposed the burden to
    pay the taxes on the Internet seller, rather than the purchaser,
    federal enforcement could potentially become an important complement to
    any state enforcement prompted by the Act.
    6.  The criminal penalties should be increased beyond the inadequate
            penalties established in the original Jenkins Act in 1949.
        This legislation provides only a misdemeanor penalty with no
    minimum fine and a maximum fine too small to have a deterrent effect,
    along with up to 6 months in jail, or both. These penalties are
    inadequate. The penalties in the original Jenkins Act failed to deter
    violators or to encourage federal enforcement of the law and the
    provisions in the bill now before the Committee will not correct this
    problem. To be effective, the criminal penalty provisions should make
    violations of the act a felony, provide for significant, minimum
    criminal fines, and provide for larger criminal fines and possible
    imprisonment for flagrant and repeated violations.
    7.  The legislation does not require Internet and mail-order sellers to
            keep any records of their sales and deliveries into a state.
        While the legislation, like the original Jenkin's Act, requires
    Internet and mail-order sellers to register with state tax
    administrators and make monthly sales reports to those officials, it
    does not require them to keep their own records of these sales and
    deliveries over time. This omission could be a major impediment to
    enforcement efforts and to the calculation of monetary damages, such as
    unpaid taxes. A provision should be added to the legislation requiring
    sellers to maintain specific records for not less than five years.
                                     ______

        In sum, this bill addresses a legitimate problem, but does not do
    so effectively. If the goal is to insure that state tobacco taxes are
    collected on Internet tobacco sales, the bill as drafted will not
    accomplish its purpose. We in the public health community are prepared
    to and would welcome the opportunity to work with the Committee to
    produce effective legislation that would make a reality of our common
    goal to reduce tax evasion and eliminate youth access to tobacco
    products in remote sales of tobacco products.

                                   ATTACHMENT

        Mr. Green. I look forward to it. Thank you for your
    testimony. The final witness today is Mr. Patrick Fleenor,
    Chief Economist with Fiscal Economics. Welcome.

    STATEMENT OF PATRICK FLEENOR, CHIEF ECONOMIST, FISCAL ECONOMICS

        Mr. Fleenor. Mr. Chairman, Members of the Committee, as you
    know, over the last 5 years the retail price of cigarettes in
    the United States has soared. Buoyed by the rash of recent
    State and local excise tax hikes as well as the implicit taxes
    which were part of the Master Settlement Agreement, the average
    retail price of cigarettes has risen nearly $4 per pack, almost
    twice the level of just 5 years ago. In high tax jurisdictions
    such as New York City cigarettes can cost more than $7.50 a
    pack. Consumers have responded to the rising prices by
    increasingly searching out low cost sources of cigarettes.
        One source that has experienced considerable growth over
    the last several years has been online tobacco retailers who
    sell cigarettes acquired from low-tax jurisdictions. In the
    year 2000 it was estimated that there were roughly 40 U.S.
    based Web sites selling cigarettes. Today this figure has risen
    to nearly 200. An equal number of foreign sites also sell
    cigarettes into the U.S. market.
        A September 2002 study by Prudential Securities estimated
    that 2 percent of the cigarettes consumed in the United States,
    or more than 400 million packs were purchased online. The
    report projected this figure would triple by 2005. Another
    study by Forrester Research forecast that Internet sales would
    claim 14 percent of the market by 2005.
        With State and local governments frequently collecting more
    than $1 in excise and sales tax revenue on each pack of
    cigarettes sold, Internet cigarette sales can have significant
    fiscal effects. I estimated--using a sophisticated economic
    model which first allocates Internet sales to the States and
    then estimates their effect on State and local revenue. The
    model basically applies State and local excise taxes as well as
    sales taxes to the number of packs sold, during the current
    fiscal year under the assumption that Internet sales would
    supply about 2 percent of the market I estimated that Internet
    sales would collectively cost State and local governments about
    $552 million in excise and sales tax revenue. This impact,
    however, will vary significantly by State. In New York, home of
    the Nation's highest cigarette taxes, Internet sales will cost
    State and local governments more than $150 million. It will
    also be high in California and New Jersey and Michigan.
        On the flip side, some States will experience very little
    losses. Montana, for example, will lose about $41,000 this year
    in sales tax as well as cigarette excise taxes. Losses will
    also be relatively light in Wyoming, Delaware, and Colorado.
        Even in the absence of additional State and local excise
    tax hikes, many observers feel that the share of the U.S.
    cigarette market supplied by Internet retailers will continue
    to expand over the next several years unless the tax advantage
    that online retailers enjoy over traditional brick and mortar
    retailers is significantly narrowed.
        Estimates of market penetration vary significantly, so I
    estimated State and local revenue losses under two scenarios.
    The first assumed the Internet retailers would capture about 6
    percent of the market by 2005. In that scenario I estimated
    that total excise and sales tax revenue losses by the States
    would equal around $1.7 billion, again the impact varying
    significantly by State. New York, I estimated would lose about
    $435 million while other States would lose as little as about
    $115,000.
        In the second scenario I assumed Internet retailers would
    capture about 14 percent of the market by 2005. In that case
    you have losses of about $4 billion, again significant
    variation among the States in terms of revenue loss. Some
    States like New York will lose as much as a billion, others
    will lose around $268,000.
        Proponents of a larger role for State governments in the
    enforcement of tobacco statutes, as we are talking about today,
    frequently argue that in addition to the fact that State and
    local governments have a greater incentive to collect their tax
    revenue than do Federal authorities, the widely varying impact
    that avoidance causes on the States calls for something more
    than a one-size-fits-all approach. Therefore my research tends
    to support the bill.
        Thank you, Mr. Chairman and Members of the Committee, for
    the opportunity to testify this morning. I will submit a copy
    of my full statement for the record and be happy to take any
    questions.
        [The prepared statement of Mr. Fleenor follows:]
                     Prepared Statement of Patrick Fleenor
        Mr. Chairman and Members of the Committee, my name is Patrick
    Fleenor. I am the chief economist of Fiscal Economics, a consulting
    firm specializing in the economic analysis of fiscal policy. Prior to
    my current position I was a senior economist with the Joint Economic
    Committee of the United States Congress. I have also served as chief
    economist of the Tax Foundation, one of the nation's oldest and most
    respected think tanks. It is an honor for me to appear before you today
    to discuss the impact of Internet cigarette sales on state and local
    government budgets.
                                  introduction
        Over the last 5 years, the retail price of cigarettes has soared.
    Buoyed by the rash of recent state and local excise tax hikes as well
    as the implicit tax hikes which are part of the Master Settlement
    Agreement, the average retail price of a pack of cigarettes has risen
    to nearly $4.00 per pack, almost twice the level just 5 years ago. In
    high-tax jurisdictions such as New York City, cigarettes can cost as
    much as $7.50 per pack.
        Consumers have responded to these rising prices by increasingly
    searching out low-cost sources of cigarettes. One source that has
    experienced considerable growth over the last several years has been
    online tobacco retailers who sell cigarettes acquired from low-tax
    jurisdictions.
        In 2000, it was estimated that there were roughly 40 U.S.-based
    websites selling cigarettes on the Internet. Today, this figure has
    risen to more than 200 with an equal number of foreign sites also
    selling cigarettes in the U.S. market. A September 2002 study by
    Prudential Securities estimated that 2 percent of the cigarettes
    consumed in the U.S.--more than 400 million packs annually--were
    purchased online.\1\ The report projected that this figure would triple
    by 2005. Another study by Forrester Research forecast that Internet
    cigarette sales would claim 14 percent of the U.S. market by 2005.\2\
    ---------------------------------------------------------------------------
        \1\ Prudential Financial, Buying Cigarettes Over the Internet,
    September 24, 2002.
        \2\ Robert Rubin, Chris Charron, and Moria Doesey, Online Tobacco
    Sales Grow, States Lose, Forrester Research, Inc., April 27, 2001.
    ---------------------------------------------------------------------------
      estimating the effect of internet cigarette sales on state & local
                     sales and excise tax revenues by state
        With state and local governments frequently collecting more than
    $1.00 in excise and sales tax revenue on each pack of cigarettes sold,
    Internet cigarette sales can have significant fiscal effects. It is
    possible to calculate these effects by employing an economic model that
    apportions Internet cigarette sales by state and then uses information
    on sales and excise taxes as well as average price data to calculate
    revenue losses by jurisdiction.
        This type of analysis was used to prepare the estimates presented
    in Table 1. Here it was assumed that Internet purchases accounted for
    2.0 percent of total cigarette sales in FY 2003. Under this assumption,
    which is generally consistent with the estimate made in the Prudential
    Securities report, 413.9 million packs of cigarettes will be sold over
    the Internet during the 2003 fiscal year.
        The allocation module of the model uses population data, smoking
    rates, sales and excise tax levels, and other information to calculate
    the demand for cigarettes as well as incentive to purchase cigarettes
    online. Consequently, states with similar populations can have widely
    differing levels of Internet sales. Total Internet sales in New York,
    for example, are estimated to be more than three times the level in
    Texas even though smoking rates in the two states are similar. This
    occurred in large part because the incentive to purchase cigarettes
    online--i.e. sales and excise taxes levied on cigarettes--were, on
    average, more than 3 times higher per pack in New York.
        Once total Internet sales have been apportioned among the states
    the model calculates state and local excise and sales tax revenue lost
    as a result of Internet cigarette sales. The model estimates that in FY
    2003 state and local governments in the U.S. will lose $552.4 million
    due to online cigarette sales. The bulk of these funds, $399.4 million
    or 72.3 percent of the total, will be due to lost excise tax
    collections. The balance will result from lost sales taxes.
        Tables 2 and 3 present projections of state and local government
    revenue losses under current law for FY 2005 under two scenarios. The
    analysis underlying Table 2 assumes that Internet sales will capture 6
    percent of the U.S. cigarette market by FY 2005, a forecast similar to
    that made by Prudential Securities. Under this scenario state and local
    governments will lose $1.7 billion in excise and sales tax revenue
    during that fiscal year.
        The results of the analysis presented in Table 3 assume that
    Internet cigarette sales climb to 14 percent of the market by FY 2005,
    a forecast generally consistent with that made by Forrester Research.
    Under this assumption, state and local governments would lose roughly
    $4.0 billion in excise and sales tax revenue during FY 2005.
                                   conclusion
        The ability of Internet retailers to sell low-tax cigarettes at a
    time of rapidly rising cigarette taxes has resulted in that sector
    supplying an ever increasing share of the nation's cigarette market in
    recent years. This has cost state and local governments billions of
    dollars in lost excise and sales tax revenue at a time of widening
    budget gaps. Even in the absence of additional tax hikes, many industry
    observers feel that the Internet sector will continue to expand over
    the next several years, with commensurate revenue losses for state and
    local governments, unless the tax advantage Internet retailers
    currently enjoy over traditional brick-and-mortar retailers is
    significantly narrowed.

        Mr. Green. Thank you for your testimony. I thank again all
    the witnesses for testifying. I will begin with questions.
        Mr. Jones, in your research you came across a large number
    of Web sites that sell so-called tax free cigarettes. Did your
    research show who the operators of those Web sites are?
        Mr. Jones. For the most part it had indications of the
    owners. We identified, as I say, 147 sites. The majority of
    those sites were Native American sites, 87 out of the 147 were
    Native Americans. Some of the others listed addresses and
    names. It was for the most part Native Americans, 87 out of
    147.
        Mr. Green. Okay. Thank you. And if you will take a look, I
    hope you have had a chance, as all the witnesses I know have
    had a chance, to take a look at this color handout that we have
    given here which shows just some of the Web sites that are
    there. Mr. Jones, can you tell me as you look at those, was
    that sort of characteristic of the Web sites that you
    researched?
        Mr. Jones. Yes. We searched terms such as cheap cigarettes,
    free taxes, and so forth. And we also came up with a set of
    Internet sites similar to the ones shown here. I think the
    interesting thing is that when you search on these sites it
    becomes very obvious that the selling point is the lack of
    taxes and that is what draws the seller to those sites. I
    think, too, that in some cases that the site also will lure you
    on with buying one cigarette and then talk you into buying one
    that they can make more money on such as a generic brand versus
    premium brand. We found some of those cases also.
        While we didn't specifically look at this in terms of the
    issue of youth smoking, our review didn't specifically look at
    that issue, but looking at some of the sites in terms of how
    you would order cigarettes there were some indications that
    youth could buy cigarettes with very little identification.
    Although they asked for verification of age it would just
    require certification in the statement that I am of age. And of
    course if you want to buy a cigarette, you certify.
        Mr. Green. Every high school student's dream.
        Mr. Jones. My son had an ID card that had a false age, too.
    So I think it is very easy if a youth wanted to falsify his age
    via the Internet because as I said in my statement the Internet
    is anonymous, you can use the Internet without being physically
    there. So to an extent it is anonymous, it also makes it very
    easy for people who might be ashamed to go to stores to buy
    cigarettes because of the social issues, they also find its
    another avenue to procure cigarettes over the Internet.
        Mr. Green. Interesting. Mr. Armour, could you comment on or
    expound upon the threat that these remote sellers present to
    brick and mortar stores?
        Mr. Armour. I think the largest one, going back to what I
    said in my testimony, you look at Washington State. By not
    collecting State excise and sales taxes it is $20 a carton.
    That is an enormous price advantage. And while in Washington
    State I can't quantify the instances of Internet or mail order
    sales into the State because we have so many Indian
    reservations in urban areas that already are siphoning off a
    great deal of excise taxes, our State Department of Revenue
    estimated 3 years ago that the loss of State excise taxes in
    Washington State due to Indian reservation sales exceeded $130
    million a year.
        So I think that is indicative of the wide discrepancy in
    prices that retailers that don't collect taxes have.
        Mr. Green. Interesting.
        Mr. Myers, what do you think is the best way that Internet
    sales can verify age, Internet sellers can verify age? Do you
    have any suggestions on how that might be accomplished?
        Mr. Myers. We do. And Congressman Meehan's bill that he
    introduced previously represents our thinking as well on that.
    What you need to do is require a Government database checked
    photo ID both at the time of the initial transaction over the
    Internet and then second at the point of delivery. If you don't
    do both, then you have opened up a path either way. If you do
    do both, then you can get a real clamp on these issues.
        We would be happy to work on the specific detailed
    provisions about how to do that. But I think it is essential if
    we are going to really put a clamp on illegal sales to children
    all across the country.
        Mr. Green. Thank you. Now the Chair recognizes Mr. Meehan
    for his questions.
        Mr. Meehan. Thank you, Mr. Chairman. Mr. Jones, thank you
    for appearing at this hearing and also for an excellent GAO
    report that both Congressman Conyers and I had requested. I may
    be going over some of your testimony you have already
    presented, but I want to make the Subcommittee record clear on
    some points.
        Mr. Jones, both the Department of Justice and the Bureau of
    Alcohol, Tobacco and Firearms commented on your draft report,
    is that correct?
        Mr. Jones. That is correct.
        Mr. Meehan. What did the Department of Justice state in
    regards to the fact that the Jenkins Act only contained
    misdemeanor penalties in terms of the U.S. attorney's
    willingness to prosecute cases?
        Mr. Jones. Both the Justice Department and the Treasury
    Department commented on the draft report, suggested that felony
    as a penalty would increased compliance with the Jenkins Act.
    They also made some other suggestions in terms of getting more
    enforcement by States, allowing States more authority to take
    Jenkins Act enforcement to State courts and Federal district
    courts. The concern with the----
        Mr. Meehan. So that was the input that you got from the
    Justice Department?
        Mr. Jones. Yes. The concern was that by making it a felony
    you would get more U.S. attorneys to take the cases to Federal
    court. As you know, U.S. attorneys have a limited staff and
    they can't take every Federal case to Federal court. They have
    a certain--I guess it is pretty well known they have thresholds
    that they use to take cases to Federal court, and they very
    rarely take misdemeanors to a Federal court. And because these
    are misdemeanors, very little attention is given to these cases
    because Federal law enforcement knows that they won't be able
    to get U.S. attorneys to take these cases to Federal court.
        So I think the reason that the Federal Government doesn't
    enforce the law; that is, the FBI and the ATF, is because they
    can't get U.S. attorneys to take the cases to court.
        Mr. Meehan. It is your testimony as well, you mention the
    Treasury Department, the ATF, the agency that you recommend to
    have jurisdiction over this matter, that now potentially we
    could accomplish administratively. They made the same
    representations in the comments?
        Mr. Jones. Yes. And they went--ATF when a step further and
    offered to take over the responsibility of enforcement. As you
    know, ATF now enforces the Cigarette Contraband Trafficking
    Act, which is a smuggling act, and it also carries a felony
    penalty. So they feel by having the comprehensive authority to
    enforce the Jenkins Act and CTA act that they will have the
    whole issue in one court. And since ATF has been transferred
    now from Treasury to the Justice Department, we think that
    Justice can handle that issue and Congress doesn't need to
    worry about that right now.
        Mr. Meehan. Excellent.
        Mr. Myers, your testimony mentioned the growing problem of
    kids buying cigarettes over the Internet in the absence of
    safeguards to prevent these types of sales. Massachusetts
    Attorney General Tom Reilly and I actually conducted our own
    sting operation on two separate occasions and we were astounded
    at how easily it was for young children who participated in the
    sting, how easy it was for them to buy cigarettes over the
    Internet with the click of the mouse.
        Do you think this new legislation addresses the growing
    problem with youth access to tobacco over the Internet, and how
    specifically can we better address this problem that I think it
    is clear that we all agree it is, certainly Congressman Green
    and I are in strong agreement on?
        Mr. Myers. It is a vitally important problem. And State
    attorney generals have done more to stop illegal sales at the
    brick and mortar retailers. Then it becomes even more important
    to address the issue here. There are a number of things we have
    to do. First, strong enforcement of tax evasion is a component
    of the issue. If the cigarettes aren't cheaper kids will be
    less likely to buy them. But, second, we have to have a
    meaningful set of provisions for age verification, as
    Congressman Green and I discussed earlier. We need to make sure
    it hits both at the point of sale and at the point of delivery.
    We need to hold the people in that line of process accountable
    for it. That includes adequate record keeping. So this bill by
    itself does not solve that problem.
        Mr. Meehan. Will giving States attorneys general the right
    to bring a case to Federal court help reduce the problem with
    youth access?
        Mr. Myers. Giving State attorneys general the right to sue
    along with the tools they need to do so will make a difference.
    This bill needs to be beefed up to accomplish it. Unless it is
    clear that it is the out-of-state sellers who have the
    obligation to collect and pay the tax, unless the State
    attorneys general have the authority to actually block sales by
    a seller who is not living up to the law and to ban future
    sales, and unless you have penalties that include felony
    penalties, then you will not accomplish the goal that I think
    we all agree upon.
        Mr. Meehan. Thank you.
        Mr. Green. I thank the gentleman. The Chair recognize Mr.
    Keller, the gentleman from Florida.
        Mr. Keller. Thank you very much, Mr. Green. Mr. Myers, let
    me begin with you. And I want to thank you so much for coming
    before our Committee today and taking time to educate us on
    your issues. I know all of us share your concern about underage
    children smoking. Let me just tell you one thing in the
    interest of States, if I had somebody from the National Center
    for Tougher Sentences for Child Abusers here before us and we
    had a bill to make dramatically tougher sentences for child
    abusers and they were saying they weren't supportive of it, I
    would think to myself what in the hell are these people
    thinking. I would think that they would be almost marginalizing
    themselves by saying we are not going to support it unless you
    make different changes that we uniquely would do.
        So my question is now, faced with the situation where we
    have a very real problem with underage children smoking because
    these remote Web sites are failing to do adequate age
    verifications and they are making it easier and cheaper for
    kids to buy cigarettes and this bill would in fact ensure that
    the age verification and tax collection would take place for
    remote sales of cigarettes at least better than it is now, why
    are you not supporting this legislation as written?
        Mr. Myers. I am glad you asked that question. Because the
    answer is straightforward. The Jenkins Act was passed with the
    best of intentions and failed because it didn't have adequate
    teeth. It doesn't have adequate enforcement provisions. Our
    goal, like yours, is to come up with a piece of legislation
    that will actually make a difference. We don't move our ball
    forward if we don't give the State attorneys general the actual
    tools they need. Based on a lot of conversations with a lot of
    law enforcement officials, it has been our conclusion that
    without making the changes we suggest, none of which are
    radical, none of which are extraordinary, that you won't in
    fact make the difference that both you and I want to see made.
        This isn't a matter of the perfect being the enemy of the
    good. It is a matter of making sure that you pass a piece of
    legislation that will actually do what you and I want. As
    drafted, we have been told by lots of people this bill won't
    get us there. I am convinced that working with Congressman
    Green and Congressman Meehan we can get there with a reasonable
    bill.
        Mr. Keller. Thank you for that. That is fair. I want to
    give you your side of that. I would encourage reasonableness on
    both sides.
        Mr. Myers. That is why one of the things we first did was
    in fact go out to the people who have to enforce the law and
    ask them about the adequacy of these provisions. Will it make a
    real difference because I know that is what you want? What we
    were told is that unless you take a number of the steps that we
    have described here, that all we are doing is kidding ourselves
    and no one here intends to do that.
        Mr. Keller. Mr. Jones, turning to you, does Native American
    status as far as you know serve as a valid defense for
    noncompliance with State laws regulating the sale and
    distribution or possession of cigarettes? In other words, can
    an Indian tribe by virtue of their own sovereignty say if I
    want to sell to a 12-year-old I can sell to a 12-year-old; is
    that legal on their part?
        Mr. Jones. Our legal staff has found that is not true, that
    Native Americans do not have automatic exemption from the
    Jenkins Act. In fact, a search of the Jenkins Act itself and
    its legislative history does not provide an exemption to Native
    American sales of cigarettes.
        Mr. Keller. It hasn't been raised in this hearing but I
    read some people may take the opinion that the Internet Tax
    Freedom Act provides some sort of legitimate basis for
    noncompliance with the Jenkins Act or State laws relating to
    the sale of cigarettes. Do you have a thought on that?
        Mr. Jones. Yes. The Internet Tax Freedom Act was designed
    to exempt new businesses from adding tax for operating over the
    Internet. It did not exempt taxes that are already in effect.
    So the Internet Tax Freedom Act was to prohibit taxes on new
    products or new uses of the Internet, not for current.
        Mr. Keller. It is a separate issue. What procedures do
    remote sellers now employ, if any, to ensure compliance with
    the Federal and State laws restricting cigarettes to underage
    minors?
        Mr. Jones. We found that some, as I said earlier, do have a
    certification statement that the buyer has to certify that he
    is of age to buy cigarettes. But that is a matter of just a
    certification. And the certification is worth as much as
    signing the note. Some also post you must be of age to purchase
    cigarettes but they don't necessarily enforce those ads.
        Mr. Keller. So some of them ask you how old you are and
    some don't?
        Mr. Jones. That is true.
        Mr. Keller. Okay. Mr. Chairman, I will yield back the
    balance of my time.
        Mr. Smith. [Presiding.] Thank you, Mr. Keller. Let me
    apologize to the witnesses. I had a vote come up in another
    Committee. It was a close vote and I needed to excuse myself.
    Mr. Myers, I am sorry that was in the middle of your testimony,
    but I hope to catch up with you all now.
        The gentleman from Virginia, Mr. Boucher, is recognized for
    his questions.
        Mr. Boucher. Thank you very much, Mr. Chairman. I want to
    begin by commending our colleague Mr. Green for bringing this
    matter before the Committee. I am sorry he is not here to hear
    me say that.
        Mr. Smith. He had to be on the House floor to speak on the
    rule.
        Mr. Boucher. That is an understandable need. So I do want
    to commend him for bringing this matter before the Committee. I
    find myself in basic agreement with his approach that the sales
    and use taxes of the State of residence of the purchaser should
    be honored with respect to interstate transactions in
    cigarettes. But I note that the bill really is limited just to
    cigarettes. Of course we know that there are other tobacco
    products.
        I would like to ask you, Mr. Jones, and you, Mr. Fleenor,
    if in the course of your research with respect to the volume of
    interstate sales of cigarettes you encountered data that would
    reveal to you a comparison in terms of volume of cigarette
    sales on the one hand and sales of other tobacco products,
    smokeless and cigars and other kinds of things, on the other
    hand.
        Give us a sense, if you have this information, of the
    volume of cigarette sales on an interstate basis as compared to
    sales of these other products.
        Mr. Fleenor. Well, I looked at it a bit, and the sales of
    smokeless tobacco, chew, snuff, et cetera are relatively small
    in comparison to cigarettes, about probably--only about four or
    5 percent of--in terms of revenue that--I guess compared to
    cigarettes.
        Mr. Boucher. Of the total sales, cigarettes would be 96
    percent, and other products would be about 4 percent?
        Mr. Fleenor. Exactly.
        Mr. Boucher. Mr. Jones, have you looked at that issue and
    do you agree with those numbers?
        Mr. Jones. Our review didn't focus on that but we did
    notice a majority of the sales were cigarettes.
        Mr. Boucher. I am sure that is true. Does anyone on the
    program have a comment with respect to why this bill should be
    limited just to cigarettes? I know Mr. Myers has advocated that
    the other products be included. Does anyone have a view that is
    contrary to that of Mr. Myers, or would anyone like to defend
    the position of the bill that basically limits its application
    just to cigarette sales? Let the record show there was silence.
        Let me ask another question. Some have suggested that
    this----
        Mr. Armour. Just on that, a thought I have is, in many
    States, cigarettes are tax stamped. Like in Washington State,
    the cigarettes are tax stamped. So it is very easy for the
    Liquor Control Board, who has enforcement, to identify that
    this is a contraband product in our State by looking at it.
    None of the other tobacco products in our State are required to
    be tax stamped. So there may be some kind of enforcement issue
    related----
        Mr. Boucher. With respect to cigarettes. Well, I think the
    Committee will need to consider this question as we give
    further consideration to the bill.
        Mr. Myers, you noted in your testimony, and perhaps in
    answering one or more of the questions, that you questioned the
    effectiveness of the provision which is found on Page 2
    beginning at Line 9 of the bill, that basically says that the
    sales and use taxes of the State of the residence of the
    purchaser would have to be honored in the case of interstate
    transactions.
        This language looks pretty straightforward to me. I am
    wondering what weakness you see in it, and why you think the
    language, as it appears in the bill itself, is not effective in
    terms of making sure that the residence--that the taxes of the
    State of the residence of the purchaser be paid.
        Mr. Myers. Let me answer that for you in two ways.
        First, is what we have done is look at some of the State
    laws, and some of them are very unclear as to their
    applicability to out-of-State sellers. In fact, some of them,
    because the States didn't think they had the authority here,
    say that--actually provide an option, for either the out-of-
    State seller to pay or for the purchaser to pay, and simply
    applying those laws that were passed in a different
    circumstance could lead to a situation where it is the
    purchaser, not the seller, who is responsible. I don't think
    that is the intention, which is why it has been our view that
    we ought to be explicit about that.
        Mr. Boucher. I am sorry. Let me just ask you.
        This clearly says, each person who engages in the
    interstate, sale or distribution. Now, that clearly would be
    the seller. This is the person engaging in the interstate sale
    or distribution, or at a minimum it is the seller. You might
    also suggest that it is the purchaser, but it is clearly at
    least the seller, shall comply with all of the sales and use
    tax and other laws of the State in which the cigarettes are
    delivered. I don't see how that----
        Mr. Myers. Those laws don't apply, A, either to a
    retailer--and often it is the wholesaler distributor further up
    the line who does it in a normal in-state situation, and that
    wouldn't be the case for the out of State seller, and it
    certainly would be the case for an Indian reservation or
    outside our borders--then you would have an open and ambiguous
    question. Some of those people have been challenged before and
    said those laws don't apply to them.
        Second, the question I would pose back, since I think
    everyone's intention is the same here, and that is to have
    those sellers pay, and I think that is your intention as well.
    Then there is really no down side to being explicit about it,
    so that we don't force the State Attorney Generals to have to
    go through 5, 10 years of litigation based on the vagaries of
    State laws that were written for a different purpose. It is an
    easy enough thing to insert, eliminate the ambiguity and then
    allow the State Attorney Generals to have the tool to begin to
    enforce it right away.
        Mr. Boucher. Okay. Mr. Myers, thank you very much.
        Thank you, Mr. Chairman. My time is up.
        Mr. Smith. Thank you, Mr. Boucher. The gentleman from
    Indiana, Mr. Pence is recognized for his questions.
        Mr. Pence. Thank you, Mr. Chairman.
        And I want to associate myself with comments on both sides
    today, expressing appreciation for Mr. Green's leadership on
    this legislation. I also want to associate myself a bit with
    Mr. Keller's comments concerning a bit of befuddlement about
    opposition from an organization dedicated to protecting
    children from tobacco, finding itself as an opponent of
    legislation that would make laws tougher, and I do--I don't
    necessarily come to these hearings to put witnesses on the
    spot, unless I am in an especially bad mood. So I will accept,
    Mr. Myers, your comments and your testimony and your responses
    to Mr. Keller about the sincerity of your purpose in coming
    here and wanting to improve a piece of legislation, because
    when I heard of the National Center for Tobacco-Free Kids'
    opposition to Mr. Green's legislation, I was confused. You have
    abated that a bit, but----
        Mr. Myers. Congressman, could I just respond briefly?
        Mr. Pence. I would welcome that.
        Mr. Myers. We know we always take a risk when we take a
    piece of legislation that is well-intended, whose goals we both
    share, and then say it doesn't simply give enough tools to
    actually accomplish its goal. That decision was not taken
    lightly. It was based upon multiple conversations, frankly over
    several years, where we have been working with State officials
    about the kinds of tools they need to really make a difference.
    And we have just been told by too many law enforcement
    officials, that if you are going to give us this
    responsibility, you have got to give us the tools. Otherwise,
    we may file a lawsuit, but given the hundreds and hundreds of
    Internet sellers out there, the fly-by-night of them, the cost
    of enforcement is too great. We are not going to be able to do
    the job.
        All we are trying to say is, if we really want to take this
    problem up and solve the problem that you and I agree on, then
    we need to do it. So our goal is very simple, and that is to
    make sure law enforcement officials have the tools to help
    reduce tobacco use.
        Mr. Pence. Reclaiming my time, then, I would like to then
    give Mr. Jones an opportunity to speak from a GAO perspective.
        There has been an assertion on the panel today that
    essentially the Green legislation will not make a difference.
    Your report states that jurisdictions, particularly State
    jurisdictions, don't have sufficient legal authority today to
    enforce the Jenkins Act. Is it accurate to say that the Green
    legislation, as drafted, would help States better enforce the
    law, Mr. Jones?
        Mr. Jones. Mr. Congressman, you are correct.
        Our report does state that States had a problem because
    they lack enforcement authority in terms of the Jenkins Act,
    and I think that Congressman Green's bill does provide some
    support to States in terms of pursuing those violations of the
    Jenkins Act that they can take to court, either at a State
    level or in Federal district court. So it does provide some
    remedy for them.
        Mr. Pence. So it will improve the law?
        Mr. Jones. It will improve States' involvement in enforcing
    the law.
        Mr. Pence. One question--pardon me, Mr. Jones.
        Mr. Jones. As I understand. As I read the bill----
        Mr. Pence. Mr. Armour, I wanted to thank you for your
    testimony today. I grew up in the gas station business in
    southern Indiana. It is called convenience stores now, but we
    used to just sell food inside gas stations.
        Your testimony indicated that your company particularly has
    instituted tobacco retailing practices to ensure that minors
    don't purchase tobacco products in your stores. How have your
    compliance rates with State laws changed since instituting
    these policies?
        Mr. Armour. We have always taken our responsibility
    seriously before there were the level of mandates today, but
    just to give you an order of magnitude, last year we--in our
    company we had over 2.6 million transactions that involved
    cigarettes. There were two Liquor Control Board sting
    operations in which sales associates of ours sold to minors,
    and there were two internal sting operations that we performed,
    as I said in my testimony, in which sales associates sold to
    minors. So four out of 2.6 million transactions, I think with
    appropriate steps and procedures that we have implemented
    have--that is not zero. I am not happy that four took place,
    but I think they can be very, very effective when implemented.
        Mr. Pence. Well, I thank you for your testimony, and as a
    parent, I thank you for your leadership.
        As I do, Mr. Myers, and the leadership for the National
    Center for Tobacco-Free Kids. I place myself, Mr. Chairman, to
    be a constructive part of moving this legislation forward and
    yield back.
        Mr. Smith. Thank you, Mr. Pence.
        The sometimes Ranking Member of the Subcommittee, Mr.
    Berman of California, is recognized for his questions. If he
    yields to the gentlelady from California, Ms. Waters for her
    questions, okay.
        The gentlelady is recognized.
        Ms. Waters. Thank you very much, Mr. Chairman, and members.
        It seems to me we have two distinct issues here. One that
    has to do with the sale of cigarettes to minors on the Internet
    and a failure to have any means by which to do age
    verification, and, of course, the tax issue with the concerns,
    I am sure raised by the brick and mortar retailers, and the
    fact that they have to pay their taxes and others don't.
        It is very difficult for me to understand, as you deal with
    the Internet, how you single out any one product. It seems to
    me that just as many of us are concerned about sale to youth of
    cigarettes, aren't we concerned about the sale of youth--to
    youth of alcohol products and other kinds of things? Is this an
    isolated issue, or should we be looking at this issue in terms
    of all of those laws that may be violated relative to age
    verification, in particular maybe some other things. I don't
    know. I don't know if there is any effective way to do age
    verification. Maybe there is and I haven't heard it, and I will
    ask Mr. Myers or any of the other--who are present here today,
    is there--has anyone discovered any way to do age verification
    on the Internet?
        Mr. Myers. Well, the simplest way, of course, would be not
    to permit sale of tobacco products over the Internet, and,
    ultimately, that may be the best solution. We do think based
    upon examining this, talking with a number of responsible
    retailers and others, that by requiring the production of
    Government-issued Ids at the critical junctures, holding the
    people who deliver the product responsible, ensuring that it is
    only delivered to an adult, that you can do a number of steps
    that would dramatically cut down on youth sales under these
    circumstances.
        We also think that if you have effective tools to make sure
    that State taxes are paid, you decrease the incentive. So there
    is much that we can do. Can we solve it fully without a total
    ban? Probably not, but there is much to be----
        Ms. Waters. You know, I am not an attorney, but it seems to
    me you could raise some equal protection questions about
    banning one particular item on the Internet and not others
    where age verification also is the law. How do you deal with
    that?
        Mr. Myers. There is more than a rational basis for
    addressing that issue. That is not before the Committee today,
    and Congressman Meehan's bill that seeks to both address youth
    access and tax evasion issues steps well short of a total ban
    and just ensures adequate age verification.
        Congressman Meehan's bill might well be a good model for
    other products. I have no expertise in those, so I don't want
    to speak about it, but there is something we can do about this
    product that would make a difference.
        Mr. Watt. Mr. Myers, I am quite aware of what is before the
    Committee. I thought because you were here with your expertise,
    you may have given some creative thought to an issue that is so
    dear to you, but thank you for your response.
        Mr. Myers. Well, we have, and Congressman Meehan's original
    bill, that deals with both youth access and tax evasion issues
    is a solution that we think is both workable, complies with the
    law, and would make a real difference.
        Mr. Smith. The gentlewoman yields back her time. The
    gentleman from California, Mr. Berman, is recognized for his
    questions.
        Mr. Berman. Thank you, Mr. Chairman, and I would like to
    yield my time to Mr. Meehan.
        Mr. Smith. Okay. The gentleman from Massachusetts is
    recognized.
        Mr. Meehan. Thank you, Mr. Berman. I want to clear up one
    subject that my friend from Indiana had raised, and it is a
    question of what the language of the bill ought to be.
        From my perspective, I have been working with my staff the
    last couple of days to try to have language that will
    effectively result in States' Attorney Generals being able to
    have not--as a practical matter being able to move against
    these companies on the Internet that don't pay State taxes and
    who sell to minors.
        Specifically, yesterday I got on a plane after the last
    vote, and I went up and had dinner with the Attorney General of
    Massachusetts and the chief of his Public Protection Bureau,
    and I talked about language. I talked about the issue, because
    the Attorney General is nationally recognized for his efforts
    regarding cigarettes and tobacco products. And what he
    indicated to me was, if you just have civil penalties, it will
    make it more difficult. I discussed language with him.
        So what we are trying to do here is actually pass a law
    that will have the intended effect, because oftentimes we pass
    legislation around here, and also in legislatures across the
    country that have unintended consequences. And it is not a
    reflection on how someone feels about who drafted a bill or how
    the bill was drafted, it simply has unintended consequences. It
    doesn't do what the legislation intended it to do or the
    authors of the legislation intended it to do. So what do you
    do? You talk to law enforcement officials that have the
    authority to actually enforce the law.
        So I think that is what we are trying to do, get the best
    possible language, and I know Congressman Green is committed to
    doing that, because I have been working with him for the last
    few days.
        Mr. Myers, do you think that this bill gives the States the
    incentive and support that they need to crack down on Internet
    tobacco sellers that violate State law restrictions on
    cigarette sales? And you have indicated specific language to
    get the--to make sure the AGs have the tools that they need to
    effectively crack down and prosecute these instances?
        Mr. Myers. Not as currently drafted. I don't think the bill
    will accomplish the goal that Congressman Meehan needs. The
    criminal penalties are not sufficient. They need to be made
    more severe. The civil penalties need to be made clearer and
    more severe and include the right to block sellers who violate
    the law.
        Third, it needs to be made clear that you can go against
    the seller, not just the consumer. Otherwise, you will never--
    the State Attorney Generals will never be able to get a grip on
    this problem or have the economic incentive to do so.
        Mr. Meehan. The final point I wanted to make was relative
    to my friend from California's comments relative--why this
    product--this product is the leading preventable cause of death
    in the United States of America. It is the only product on the
    market if you use specifically as directed, it will kill you.
        Two days ago, I had the unfortunate experience to be in a
    hospital in Hathorne, Massachusetts where my wife's aunt is
    dying and died at six o'clock this morning from lung cancer.
    She smoked for 40 years. She started smoking when she was 14.
    She had quit for the last 20 years or so, but the damage had
    already been done. Over 450,000 people die in this country each
    year because of tobacco use, and 90 percent of the people who
    smoke in America, start smoking when they are children. This is
    serious business. It affects the public health of this entire
    country.
        So why this product? There are a lot of damn good reasons
    why this product. We need to make a commitment, and we are
    making a bipartisan commitment today, I believe, with this
    legislation to find a way to crack down on people that sell on
    the Internet and don't verify the ages and don't pay State
    taxes. And that is what we are about to do, and I hope that we
    are able to work out what I consider to be minor differences on
    language, and I know that Congressman Green is committed to
    this. But this is important work, and it is important work for
    the Congress.
        Thank you, Mr. Chairman.
        Mr. Smith. Thank you, Mr. Meehan, for a very good
    statement, and I hope, as you do, that you and Mr. Green will
    be able to resolve any differences and be able to produce a
    bill that we all can support. Clearly there was bipartisan--
    more than bipartisan. There was consensus this morning on the
    need for such legislation.
        We had a lot of good questions and a lot of good answers
    today, and for that I thank the witnesses who are here. We may
    have some additional questions to submit to you in writing. We
    hope that you will be able to respond to those within 10 days,
    but thank you for being a part of a very important hearing and
    very constructive approach to trying to solve a very critical
    problem. With that, the Subcommittee is adjourned.
        [Whereupon, at 11:20 a.m., the Subcommittee was adjourned.]
                                A P P E N D I X

                                  ----------

                   Material Submitted for the Hearing Record

                       Prepared Statement of Ali Davoudi
        Thank you, Mr. Chairman for providing me with an opportunity to
    respond to the testimony presented at the Subcommittee hearing held
    last Thursday, May 1, 2003, on HR 1839, the Youth Smoking Prevention
    and State Revenue Enforcement Act.
        I would like to thank Representative Green and Representative Pence
    for taking the lead on this important issue, and the Subcommittee on
    beginning the debate on the important issues of preventing sales of
    tobacco products to minors and assuring that applicable taxes are paid
    to the states on tobacco sales.
        My statements are submitted for the record as the President of
    OLTRA, Inc., the Online Tobacco Retailers Association. In 2001, OLTRA
    was founded by a small, concerned group of Internet tobacco retailers
    to bring standards of service through self-regulation to the domestic
    Internet tobacco industry. Over the past two years, OLTRA has grown in
    membership and implemented a number of policies designed to prevent the
    sale of tobacco products to minors through online retailers. OLTRA is
    committed to these measures, and to legal age verification. While OLTRA
    members are, for the most part, small they are not ``fly-by night''
    operations, as asserted by the Campaign For Tobacco Free Kids.
        OLTRA members sell goods, including non-tobacco products, to over
    one million consumers nationwide. OLTRA members actively market their
    products to the estimated 20% of the U.S. adult population considered
    to be regular smokers. We agree with NACS, that while controversial,
    tobacco is a legal product that is important to the economic viability
    of a large number of communities in the United States. OLTRA members
    sell tobacco products solely to adults for personal use. To this end,
    we employ the same precautions that are used for other age-restricted
    products, such as wine and beer, sold directly to consumers over the
    Internet.
        OLTRA members are truly small businesses, embracing the
    entrepreneurial spirit characteristic of the United States since its
    foundation. OLTRA members, some of which also own local convenience
    stores, employ approximately 1,500 people in ten states. A significant
    number of OLTRA member Internet tobacco companies are businesses
    operated by Native American tribes in New York State and New Mexico,
    supporting communities on tribal land and providing jobs in communities
    traditionally facing high levels of unemployment. Internet tobacco
    retailers are also located in important tobacco-growing states such as
    Virginia, Tennessee, Kentucky, and North Carolina.
        The online tobacco industry realizes that a perception exists that
    it sells tobacco to minors, fails to pay taxes, and sells contraband
    and counterfeit cigarettes. This perception is not true of OLTRA's
    members. In fact, OLTRA has worked to adopt responsible business
    practices, including: secure online ordering, a clearly stated refund/
    exchange policy, accurate product identification, clearly stated
    company contact information, live customer support, posted business
    hours, forbidding purchases made with the intent of resale, prohibiting
    language on websites about cigarettes being tax free or duty free,
    mandating a strict age verification system and imposing a requirement
    of sale only to adults 21 years of age and older (imposing an
    additional three years above the age of 18).
        Because local convenience stores are bound by exclusive contracts
    with ``Big Tobacco'' manufacturers, they cannot offer consumers the
    same access to brands as can Internet tobacco retailers. OLTRA member
    retailers provide consumers with access to a wide variety of products,
    including those not available in local convenience stores. This gives
    consumers greater choice among tobacco brands, including specialty and
    boutique brands of tobacco products. Internet retailers also carry
    other consumer goods, such as rolling papers, lighters, candles, air
    filters, filter tips, fruit and candy, and dental products.
        Internet tobacco retailers sell to a growing market of adult
    consumers who seek greater choice, better customer service, the
    convenience of direct delivery and lower prices.
                     the business model of online retailers
        Like other Internet retailers, OLTRA's members have adopted a
    business model in line with the U.S. Supreme Court's landmark decision
    Quill v. North Dakota, 504 U.S. 298 (1992). Quill held that an out-of-
    state seller of goods, whose only contacts with a state are by mail or
    common carrier, lacks the physical presence required by the Commerce
    Clause for the state to impose sales and use taxes upon the seller's
    transactions with citizens of their states. The state's imposition of
    such a use tax would place an unconstitutional burden on interstate
    commerce.
        Following the lead of other retailers of age-restricted products,
    such as wine, and Internet businesses, like Amazon.com, eBay and
    Yahoo!, OLTRA members pay applicable federal and state taxes in the
    states in which they have a physical presence.
        With over 7,600 individual taxing jurisdictions in existence, the
    cost of complying with each jurisdiction's tax laws would put most
    Internet retailers out of business. Quill's bright line rule allows
    Internet retailers to remain in business and pay taxes to those states
    in which they have a physical nexus. Excise taxes are included in this
    bright-line rule. OLTRA members pay all federal excise taxes and
    applicable taxes in the states in which they are located or have a
    physical presence. Until the states are able to agree to simplify sales
    and use taxes and ease the collection and remission of sales taxes by
    out-of-state retailers, the rule set forth in Quill applies.
        Requiring the retailers to collect and remit taxes to the states
    would change the Quill standard for one particular type of product--
    cigarettes. No other product, age-restricted or non-age-restricted,
    would face the same change. Cigarettes should be treated like all other
    products. Congress should not change the Quill standard for cigarettes
    unless it also changes the standard for books, music, clothing, wine
    and other legal products.
        OLTRA members support a uniform nationwide system for all Internet,
    telephone, and mail order retailers to collect and remit applicable
    taxes directly to state taxing authorities. Such a uniform system,
    currently being addressed by the Streamlined Sales Tax Project, would
    be vastly more efficient as a means of tax collection than an ad hoc,
    piecemeal approach targeting a single type of consumer product.
        HR 1839 would not be uniform, efficient, or effective. It is not
    uniform because it would exacerbate the disparate treatment of Internet
    tobacco retailers. It would compel them, unlike all other interstate
    retailers, to participate in the tax collection process. Giving
    individual states the authority to bring actions against retailers
    would lead to a patchwork of different enforcement decisions in each
    state. There is no rational basis for this unequal treatment.
        It would impose upon them the duplicative burden of filing reports
    under the Jenkins Act, and would do so upon the heightened threat of
    felony penalties. Such penalties are not imposed on other retailers.
    The imposition of criminal penalties would be excessive, and sanctions
    should be no greater than penalties for violation of FTC regulations
    governing the sale of consumer goods.
        It is difficult to conceive of a less efficient means of tax
    collection than reporting sales in the hope that sums can later be
    collected from consumers. Such an approach increases the costs of
    collection, as each state, no matter how strained its budget, would
    have to invest in person-by-person collection of taxes on a few cartons
    of cigarettes at a time. Moreover, since no other sales of products
    across state lines are subject to this reporting and collection
    process, each state will have to hire ad hoc tax collectors to carry
    out this cumbersome program. The efficiencies that come from point-of-
    sale tax collection, and the attendant benefits to the States, would be
    lost.
        Turning over personal information to the states would raise
    significant privacy concerns. The states do not store consumer
    information in a secure or adequate manner. According to an article
    published in the March 26, 2003 edition of The Washington Post, ``only
    14 states, including Virginia, comply with federal mandates to help
    ensure the protection of computer systems that hold confidential
    information about millions of people.''
        The penalties proposed by groups such as the Campaign for Tobacco
    Free Kids would not stop the sale of tobacco products over the
    Internet. It would end the sale of these products by responsible
    retailers, like OLTRA's members, and leave the door open to ``fly-by
    night Internet retailers,'' smuggling operations, foreign retailers and
    organized crime. It should be apparent that a uniform nationwide system
    for point-of-sale tax collection is a far better and more efficient
    means of collecting taxes.
        HR 1839 as drafted is also ineffective because it will not have the
    effect of collecting more tax revenues for the states. The Act does
    nothing to overcome the problems inherent in the outdated process of
    reporting and collecting in each state. Increasing the penalties would
    in fact be counterproductive, because it will have the effect of
    banning the sale of tobacco products to adult consumers over the
    Internet. In fact, it would drive consumers to seek out contraband and
    illegitimate tobacco products, once responsible retailers are put out
    of business. See Patrick Fleenor's Cato Institute Policy Analysis No.
    468, ``Cigarette Taxes, Black Markets and Crime: Lessons From New
    York's 50 Year Losing Battle,'' published February 6, 2003. Another
    recent study, published by the Beacon Hill Institute at Suffolk
    University, states clearly that New York City's tobacco tax increase
    ``will generate less than half the revenue projected by New York City
    and will result in a net loss approaching $217 million.''
        Therefore, considerations of equality, efficiency and effectiveness
    warrant study and implementation of a point-of-sale means of tax
    collection, applicable to all retailers under a uniform national system
    mandated by Congress. Any effort to address this issue should be
    consistent with such an approach.
                       efforts to prevent sales to minors
        OLTRA agrees with NACS that minors should not have access to
    tobacco and that no retailer should sell tobacco products to minors.
    OLTRA believes, however, that it is much further along in its efforts
    to prevent tobacco sales to minors than efforts by local convenience
    stores. While Mr. Armour's stores may have adopted measures to prevent
    sales to minors, there are 133,976 other convenience stores across the
    country (and probably a large number of other stores that sell tobacco
    products). A large percentage of these stores employ workers who more
    often than not do not verify that a tobacco purchaser is at least 18
    years of age.
        One recent example of the ease with which minors can purchase
    tobacco products from convenience stores occurred in Massachusetts. As
    reported in the Boston Globe on May 1, 2003, ``the number of stores
    illegally selling cigarettes to teenagers in Massachusetts more than
    tripled in the past year, after budget cuts forced health boards across
    the state to abandon their local inspection programs.''
        The Massachusetts Association of Health Boards (www.mahb.org)
    conducted an elaborate sting operation where minors, under adult
    supervision, attempted to purchase cigarettes in local stores in 68
    Massachusetts cities and towns. In 2002, the average rate of illegal
    sales to minors in these towns was 9.3%. When these same locations were
    checked in February-April 2003, the average rate of illegal sales more
    than tripled to 29%. Teens visited 221 stores, and were able to
    purchase a pack of Marlboros from 64 of those retailers. According to
    Cheryl Sbarra, Director of the Tobacco Control Program for MAHB,
    ``Massachusetts has not seen the illegal sales to minors rate this high
    since 1995. It is more than twice the national average.''
        While Mr. Armour's stores may have only had 4 instances of sales to
    minors out of several million transactions last year, these figures do
    not demonstrate the number of minors that did not participate in a
    sting sale or were not caught. His figures do not demonstrate that
    local convenience stores are preventing the sale of tobacco products to
    minors at a higher rate than OLTRA's members.
        In contrast with the frequency of cigarette sales to minors by
    local convenience stores, minors face a number of barriers if they make
    similar attempts to purchase tobacco products from Internet retailers.
        The effectiveness of such measures can be empirically demonstrated.
    There is little evidence of minors purchasing tobacco products on the
    Internet. This is due to cost of the product, the cost of shipping, the
    required use of credit cards, the time taken for delivery, and the risk
    of parental detection, all of which discourages minors from purchasing
    from online sources. Minors tend to purchase tobacco products from
    social sources or in local convenience stores in pack form, and not in
    cartons from Internet retailers, who have minimum sale requirements of
    one carton or more.
        OLTRA has instituted a policy mandating that its members only sell
    tobacco products to individuals 21 years of age or older, and that its
    customers receive the products they purchase through either the United
    Parcel Service age verification system or United States Postal Service
    restricted delivery system.
        Under the UPS system, a package cannot be delivered to a consumer
    until an adult signature is received by a UPS driver. When this method
    of shipment is used, UPS will not leave the package at the customer's
    doorstep or with a neighbor. The UPS driver cannot release the package
    or clear the delivery from his handheld monitor until he has verified
    that the recipient is an adult. The UPS driver will ask to see a
    government issued photo identification card, verifying that the
    recipient is at least 21 years of age. UPS will not deliver a package
    to anyone under the age of 21. Once the package is delivered, a
    confirmation of delivery is sent to the retailer. This is the same
    system used successfully by the Wine Industry.
        When USPS Restricted Delivery is used, Postal delivery drivers must
    check the recipient's identification before a package is tendered to a
    recipient. The Postal delivery driver cannot leave the package at the
    door of the customer or with a neighbor. A package sent by Restricted
    Delivery can only be delivered to the customer whose name is on file
    with the local Post Office (if a spouse is on file with the Post
    Office, the spouse can sign for the package).
        The Postal delivery driver must collect the signature of the
    recipient. Once the package has been delivered, a confirmation is sent
    to the retailer containing the name of the recipient. A retailer can
    also request that a copy of the recipient's signature be sent to the
    retailer by facsimile or e-mail.
        While packages sent USPS Restricted Delivery can be delivered to
    business addresses, packages can only be delivered and signed for by
    the recipient or his authorized agent (described above). USPS will not
    deliver a package to an individual who is not authorized to receive it.
    This is done so that the Postal delivery driver can check the age and
    identity of the recipient and verify that the recipient is of legal
    age.
        OLTRA has adopted the following measures to prevent the sale of
    tobacco products to minors from member websites:

              Requiring each purchaser to create an account to
            purchase tobacco products.

              On all new accounts, consumers must submit accurate
            name, age, address, credit card, and billing information, along
            with a copy of a government-issued photo ID.

              Checking credit card information against an address
            verification system to prevent fraud.

              Publishing clear statements that the sale of tobacco
            products to individuals 21 years of age or under is prohibited.

              Selling only to adults 21 years of age or older.

              Notifying purchasers that it is a crime for
            individuals under the age of 18 to purchase cigarettes.

              Notifying purchasers that their tobacco products are
            for personal use only and not for resale.

              Refusing to sell tobacco products to any purchaser
            who does not provide accurate information.

              Using the UPS Age Verification System for all first-
            time deliveries on new accounts (or USPS restricted delivery).
            UPS drivers must obtain an adult signature and the recipient
            must present a photo ID to the driver proving that the
            recipient is of legal age to accept tobacco products, if the
            recipient appears to be under the age of 27. This is the same
            system used to deliver other age-restricted products, including
            wine.

              Placing prominent disclaimers on all websites stating
            that OLTRA members do not sell to minors.

              Placing all required Federal warnings on member
            websites.

        Members have taken individual steps to employ further verification
    tools through third-party software, which checks consumer information
    against a variety of government, credit reporting, DMV and other
    databases. Several members have also registered with NetNanny and
    similar services, companies that produce software allowing parents to
    select which websites should be blocked from the view of their minor
    children on their own home computers.
        There are retailers, both online and brick and mortar, that do not
    verify the age of their purchasers. These retailers are not OLTRA
    members. OLTRA reviews the websites of its members, and if a website is
    not in compliance with the OLTRA standards, it will be removed from the
    organization.
        OLTRA believes that the only way to resolve age verification issues
    on Internet sales of tobacco products is through the adoption of
    national standards through federal legislation, not through a patchwork
    of regulations by the individual states. OLTRA would support a federal
    standard on age verification, similar to those currently utilized by
    OLTRA members, to minimize the sale of tobacco products to minors, as
    long as those procedures are economically viable and do not interfere
    with the significant benefits of purchasing over the Internet (secure
    ordering, better customer service, convenient and fast delivery and
    greater consumer choice).
                     enforcement by state attorneys general
        OLTRA opposes the provision in HR 1839 which would grant to State
    Attorneys General the authority to bring actions against Internet
    retailers in federal court for violations of state and federal law.
    OLTRA is in favor of national standards and national enforcement.
    Retaining enforcement with the federal government and not the states
    ensures a consistent body of law. Enforcement authority should remain
    with the federal government, rather than permit a variety of results
    based on the application of conflicting laws that vary from state to
    state.
                    application to native american retailers
        A number of OLTRA members are Native American retailers located on
    tribal land. These retailers provide jobs in their communities,
    employing Native Americans, adding a technological infrastructure in
    areas previously burdened with high unemployment and lacking in high
    tech jobs.
        Native American retailers make up the largest percentage of
    Internet tobacco businesses. This statistic was evident in the GAO
    Report, which listed 87 of the 147 Internet tobacco websites as being
    on Native American land.
        HR 1839 would end the sale of cigarettes from Native American
    retailers to non-tribe members and the passage of HR 1839 would expose
    Native American retailers to individual state laws, laws that do not
    now apply to Native American retailers because they would violate their
    sovereign rights, the Indian Commerce Clause and the Supremacy Clause
    of the United States Constitution.
        For example, as a sovereign Native American nation, the Seneca
    Nation and its members are immune from suits brought by any state. New
    York State has recognized that the Seneca Nation and its members have
    sovereign immunity. In 1997, Governor Pataki stated, ``we respect your
    sovereignty and, if the Legislature acts as I am requesting, you will
    have the right to sell tax-free gasoline and cigarettes free from
    interference from New York State'' (emphasis added). See Santa Fe
    Natural Tobacco Co., Inc. v. Spitzer, Nos. 00 Civ. 7274 (LAP), 00 Civ.
    7750 (LAP), 2001 U.S. Dist. LEXIS 7548, 2001 WL 636441 (S.D.N.Y. June
    8, 2001). This is particularly troubling in New York State, where the
    price of cigarettes has risen dramatically over the past year. As
    recently as May 3, 2003, New York Governor George Pataki stated that
    imposing state taxes on Native American retailers ``would be extremely
    unrealistic.''
        This Subcommittee should work closely with OLTRA to ensure that
    tribal groups are able to have input into consideration of this bill,
    which will have a significant impact on the economies of Native
    American tribes that sell tobacco products over the Internet.
                           conflicts with other bills
        HR 1839, and other bills that may be introduced to regulate the
    sale of tobacco products over the Internet, may conflict with
    legislation currently under consideration.
        Four bills have been introduced on Internet tax issues, three would
    make permanent the Internet Tax Freedom Act (``ITFA'') first passed in
    1998 and extended in 2001. The IFTA expires on November 1, 2003.

              HR 49, introduced by Representative Chris Cox, has
            112 co-sponsors. On April 1, 2003, the House Subcommittee on
            Commercial and Administrative Law held a hearing on the bill.
            Testifying in support were: Hon. James Gilmore III, former
            Governor of Virginia, former Senator Jack Kemp (Director of
            Empower America), and Harris Miller, President of the
            Information Technology Association of America (ITAA).
                 Gilmore, a supporter of the original Internet Tax
            Moratorium passed in 1998, testified in support of federal
            codification of a ``bright-line'' nexus standard in line with
            the U.S. Supreme Court's Quill decision. According to Gilmore,

                   The cyber economy has blurred the application of many
            legal nexus rules. American businesses need clear and uniform
            tax rules. Therefore, Congress should codify nexus standards
            for sales taxes in a way that adapts the law of nexus to the
            New Economy and the new ``dot com'' business model.
            Codification of nexus would serve several important policy
            objectives: (1) provide businesses ``bright line'' rules in an
            otherwise confusing system of state-by-state nexus rules; (2)
            protect businesses, especially small businesses, from onerous
            tax collection burdens; (3) reduce the amount of costly
            litigation spurred by confusing nexus rules; (4) nurture the
            full growth and development of electronic commerce; and (5)
            give consumers and individual taxpayers who participate in
            Internet commerce a tax break.
                 Kemp agreed with Gilmore, and also cited to the Quill
            decision in his testimony before the House Subcommittee. Kemp
            stated that ``The central issue in the Internet tax debate is
            not `fairness' as the NGA and some others would have us
            believe; it is taxation without representation. States have
            been trying for more than three decades to tax people and
            businesses that are located out-of-state because politicians
            are acutely aware non-residents can't vote them out of
            office.''
                 The final speaker, Harris Miller, testifed that ``The
            Internet does not deserve carve outs or special treatment.
            Neither does it deserve to become the tax pinata of 2003, hit
            by every revenue starved taxing jurisdiction in the country.''
            Miller discussed his support for the Quill decision, stating
            that the ``ITAA believes that the states must simplify their
            tax systems and provide bright line business activity tax nexus
            standards before seeking the authority to require remote
            sellers to collect sales tax on their behalf.''

              S. 150, introduced by Senator George Allen of
            Virginia and seven other co-sponsors. Senator Allen has been a
            strong supporter of efforts to remove barriers to free trade
            over the Internet.

              S. 52, introduced by Senator Ron Wyden of Oregon and
            two other co-sponsors. Senator Wyden was an original sponsor of
            the Internet Tax Freedom Act in 1998.

              HR 1481, introduced by Representative Zoe Lofgren of
            California. This bill would extend the Internet tax moratorium
            to 2008.

        These bills, and their wide support in the House and Senate,
    demonstrate that the jurisdictional issue should be addressed for the
    sale of all products, not only tobacco.
        HR 945, introduced by Representative Cliff Stearns, and four co-
    sponsors, would exercise authority under the Commerce Clause to clearly
    establish jurisdictional boundaries over the commercial transactions of
    digital goods and services conducted through the Internet, and to
    foster stability and certainty over the treatment of such transactions.
    HR 945 would give the federal government, not the states, authority to
    regulate commerce in digital goods and services. If the federal
    government can assert authority over digital goods and services, why
    not apply this same standard equally to all goods?
        Finally, HR 1636, introduced by Representative Cliff Stearns and
    twenty-two other co-sponsors, would protect and enhance consumer
    privacy over the Internet. The bill would preempt ``any statutory law,
    common law, rule, or regulation of a State, or a political subdivision
    of a State, to the extent such law, rule, or regulation relates to or
    affects the collection, use, sale, disclosure, retention, or
    dissemination of personally identifiable information in commerce. No
    State, or political subdivision of a State, may take any action to
    enforce this title.'' This legislation could be interpreted as
    superseding state laws calling for the submission of confidential
    customer data to state taxing authorities.
                                    summary
        I look forward to working with the Subcommittee to craft a bill
    that will deal reasonably with these vital issues.
        OLTRA has adopted strict age verification policies and business
    standards for its members. It supports efforts to prevent the sale of
    tobacco products to minors. OLTRA supports the uniform enforcement of
    federal law by federal agencies, rather than giving State Attorneys
    General the power to bring an action in federal courts.
        OLTRA's members in starting their businesses adopted a business
    model in line with the Quill decision, paying all federal excise taxes
    and applicable state taxes in the states in which member retailers are
    located or have a presence. OLTRA's members, except for some of its
    Native American members, support efforts that would establish uniform
    standards for the collection and remission of applicable taxes to the
    states on all products, not just tobacco.
        I hope that these statements are helpful to the Subcommittee and I
    stand ready to testify before the Committee if asked.

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