Cigarette Smuggling: Information on Interstate and U.S.-Canadian Activity
(Testimony, 05/04/98, GAO/T-RCED-98-182).

GAO discussed its work on cigarette smuggling, focusing on: (1)
interstate cigarette smuggling in the United States; and (2) Canada's
experience with international smuggling.

GAO noted that: (1) smuggling cigarettes from low- to high-tax states,
or interstate smuggling, prominent in the 1970s, may now be a reemerging
problem; (2) such activity is likely to occur when the differences in
cigarette taxes across the states are significant enough to make it
profitable; (3) recently, many states have opted to sharply increase
their cigarette taxes; (4) yet most low-tax states have not; (5) as a
result, recent studies suggest that the level of interstate smuggling
activity may now be increasing; (6) in fact, recent estimates suggest
that smuggling is responsible for states collectively losing hundreds of
millions of dollars in annual tax revenues; (7) in addition, recent
experiences demonstrate that international smuggling can occur when
cigarette tax differentials are substantial; (8) international smuggling
has occurred recently between Canada and the United States; (9)
according to the Canadian government, sharp increases in Canadian
federal and provincial cigarette taxes in the late 1980s and early 1990s
led to large-scale smuggling between the United States and Canada
conducted almost entirely by organized crime; (10) violence increased,
merchants suffered, and in one year alone, Canada and its provinces lost
over $2 billion (in Canadian dollars) in tax revenues; (11) Canada
responded in 1994 by sharply reducing federal and provincial cigarette
taxes and increasing its enforcement efforts, among other steps; and
(12) since then, smuggling has declined considerably.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-RCED-98-182
     TITLE:  Cigarette Smuggling: Information on Interstate and 
             U.S.-Canadian Activity
      DATE:  05/04/98
   SUBJECT:  Organized crime
             Tobacco taxes
             Tobacco industry
             Contraband
             Foreign governments
             Smuggling
             Tax evasion
IDENTIFIER:  Canada
             Ontario (Canada)
             Quebec (Canada)
             Kentucky
             North Carolina
             Virginia
             New York
             Washington
             
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Cover
================================================================ COVER


Before the Senate Democratic Task Force on Tobacco

For Release
on Delivery
Expected at
1:30 p.m.  EDT
Monday
May 4, 1998

CIGARETTE SMUGGLING - INFORMATION
ON INTERSTATE AND U.S.-CANADIAN
ACTIVITY

Statement of Robert A.  Robinson, Director,
Food and Agriculture Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-98-182

GAO/RCED-98-182T


(150747)


Abbreviations
=============================================================== ABBREV

  ATF -

============================================================ Chapter 0

Mr.  Chairman and Members of the Task Force: 

Thank you for the opportunity to discuss the results of our work on
cigarette smuggling.  As you know, this is part of a larger body of
work we are conducting on issues surrounding the proposed tobacco
settlement.\1 In conducting this work, we are addressing a wide
variety of issues, including the national and regional economic
impacts of the tobacco industry, smoking trends among youths in the
United States and Canada, and the effect of a settlement on state
excise taxes.  As you requested, our statement today focuses on
information concerning cigarette smuggling--in particular, interstate
cigarette smuggling in the United States and Canada's recent
experience with international smuggling.  In summary, we found the
following: 

  -- Smuggling cigarettes from low- to high-tax states, or interstate
     smuggling, prominent in the 1970s, may now be a reemerging
     problem.  Such activity is likely to occur when the differences
     in cigarette taxes across the states are significant enough to
     make it profitable.  Recently, many states have opted to sharply
     increase their cigarette taxes.  Yet most low-tax states have
     not.  As a result, recent studies suggest that the level of
     interstate smuggling activity may now be increasing.  In fact,
     recent estimates suggest that smuggling is responsible for
     states collectively losing hundreds of millions of dollars in
     annual tax revenues. 

  -- In addition, recent experiences demonstrate that international
     smuggling can occur when cigarette tax differentials are
     substantial.  International smuggling has occurred recently
     between Canada and the United States.  According to the Canadian
     government, sharp increases in Canadian federal and provincial
     cigarette taxes in the late 1980s and early 1990s led to
     large-scale smuggling between the United States and Canada
     conducted almost entirely by organized crime.  Violence
     increased, merchants suffered, and in one year alone, Canada and
     its provinces lost over $2 billion (in Canadian dollars) in tax
     revenues.  Canada responded in 1994 by sharply reducing federal
     and provincial cigarette taxes and increasing its enforcement
     efforts, among other steps.  Since then, smuggling has declined
     considerably. 

To address these issues, we discussed U.S.  interstate cigarette
smuggling and U.S.-Canadian international smuggling with the Bureau
of Alcohol, Tobacco, and Firearms (ATF) officials; reviewed estimates
of interstate cigarette smuggling prepared by the Washington State
Department of Health; and tested the Washington State estimates using
an alternative methodology.  To understand Canada's experience with
international smuggling, we reviewed the Canadian Government Action
Plan on Smuggling, a study conducted for the National Coalition
Against Crime and Tobacco Contraband,\2 and a report by the Canadian
Office of the Auditor General.  Again, we would like to stress that
the information that follows will be included in a more expansive
report scheduled to be released in mid-May 1998. 


--------------------
\1 This body of work will be presented in Tobacco:  Issues
Surrounding a National Tobacco Settlement (GAO/RCED-98-110),
scheduled to be released in mid-May 1998. 

\2 The National Coalition Against Crime and Tobacco Contraband is a
U.S.  coalition composed primarily of retailers, wholesalers, and
tobacco manufacturers.  The coalition's report on smuggling entitled
Cigarette Smuggling in the United States (Aug.  15, 1994) was
prepared by Lindquist Avey Macdonald Baskerville, Inc. 


   INTERSTATE SMUGGLING:  A
   REEMERGING PROBLEM AS
   DIFFERENCES IN STATES' TAXES
   INCREASE
---------------------------------------------------------- Chapter 0:1

According to ATF, cigarettes are currently being smuggled across
state borders to avoid the payment of state excise taxes, and such
smuggling can violate federal and/or state laws.\3 The opportunity
for individuals to profit from interstate smuggling exists because of
the wide disparity in excise taxes across the states.  As of January
1, 1998, state excise taxes on cigarettes ranged from 2.5 cents per
pack to $1.00 per pack (see fig.  1).  According to estimates from
the Washington State Department of Health on the extent of current
smuggling activity, some states are losing nearly $100 million
annually in potential tax revenues.\4

   Figure 1:  State Cigarette Tax
   Rates, in Cents, Per Pack of 20
   Cigarettes, as of January 1,
   1998

   (See figure in printed
   edition.)

Source:  The Tobacco Institute. 

The incentives to smuggle cigarettes into any particular state
obviously depend on the amount that the state's tax rate exceeds that
of neighboring or other states.  Substantial differences in states'
tax rates in the late 1960s and early 1970s encouraged significant
smuggling activity.  By the early 1980s, the nominal value of tax
rate differentials had stabilized, but because of inflation, the
constant dollar value of the differentials--and thus the
profitability from smuggling--had eroded.  For example, a 25-cent
difference in tax rates in 1997 dollars is worth less than a 25-cent
difference in tax rates in 1980 dollars.  In addition, law
enforcement efforts may have added to the risk of smuggling.  As a
result, smuggling declined.  Since the mid-1980s, however, tax rates
have increased substantially in some states.  By 1996, differences in
states' tax rates had returned to mid-1970s levels in constant
dollars--thereby restoring incentives for smuggling.  Consequently,
according to recent studies, the profitability, and therefore the
extent, of interstate smuggling activity is likely to have increased
in recent years. 

In 1997, the state of Washington estimated the extent of interstate
smuggling activity in terms of tax per day by state--which we
converted to the associated loss (or gain) in state tax revenue. 
Washington State's estimates were derived using an approach that
statistically determines how demographic factors, such as income and
religious preferences, and differences in tax rates relative to other
states affect cigarette sales on which state taxes are paid.  The
estimated relationships can then be used to simulate actual
consumption.\5 The amount by which estimates of actual consumption
exceed estimates of taxed sales in a state would then represent the
net cigarettes smuggled into that state.  Using survey data provided
by the Centers for Disease Control and Prevention, we tested the
Washington State estimates and found them to be reasonable. 

On a national level, the Washington State study indicated substantial
smuggling from states with low tax rates to states with high tax
rates.  For example, the estimates of tax revenue losses in the
states with the highest tax rates at the time the Washington State
study was done--Washington and Massachusetts--were $52 million and
$61 million annually, respectively.\6

Similarly, the estimates of tax revenues lost for New York, a state
with a slightly lower tax rate but which has a large population,
exceeded $90 million annually.  Exporting states, such as Kentucky,
North Carolina, and Virginia, showed only modest revenue gains
because their tax rates are so low that extra sales to buyers in the
high-tax states do not generate significant tax revenue.\7

The results of the Washington State study and other similar studies
should be viewed as providing ball-park estimates.  The estimates may
be imprecise for a number of reasons.  Estimates of revenues lost may
be (1) overstated because they do not account for the fact that
smokers would buy fewer cigarettes if they were unable to avoid the
state cigarette tax (and therefore pay more for their cigarettes on
average) or (2) understated because they do not account for federal
and state tax revenues avoided because of international smuggling.\8


--------------------
\3 It is unlawful for any person to ship, transport, receive, sell,
distribute, or purchase 60,000 cigarettes or more that bear no
evidence of state tax payment in the state in which the cigarettes
are found, if such state requires a stamp to demonstrate payment of
taxes (18 U.S.C.  2342).  States may also have stricter laws related
to cigarette smuggling.  For example, in Maryland, it is generally
illegal for a consumer to bring into the state more than two packs of
cigarettes on which Maryland taxes have not been paid. 

\4 These estimates treat all forms of tax avoidance--both large and
small--as "smuggling," even though some actions, such as local
cross-border purchases in small quantities, may not be illegal. 

\5 This approach was pioneered by the Advisory Commission on
Intergovernmental Relations in Cigarette Tax Evasion:  A Second Look,
ACIR, Washington, D.C., March 1985, and recently updated in A Tax
Study:  Cigarette Consumption in Washington State, Washington State
Department of Health, January 1997. 

\6 At the time of the Washington State study, Washington, with a
cigarette tax rate of 82.5 cents per pack, and Massachusetts, with a
rate of 76 cents per pack, had the two highest tax rates in the
United States.  Since then, however, Alaska has raised its tax rate
to $1.00 per pack, and Hawaii has raised its rate to 80 cents per
pack. 

\7 The state cigarette tax rates for New York, Kentucky, North
Carolina, and Virginia have all remained unchanged since the
Washington State study was done. 

\8 For some states, revenue from state sales taxes, in addition to
cigarette taxes, may also decline because of cross-border purchases
and contraband sales. 


   LARGE INCREASES IN CANADIAN
   CIGARETTE TAXES LED TO
   WIDESPREAD SMUGGLING INTO
   CANADA
---------------------------------------------------------- Chapter 0:2

According to the Canadian government, for several years Canada
increased the price of cigarettes through federal and provincial
excise taxes, which resulted in a steady decline in the number of
Canadians who smoke.  However, these efforts had an unintended
consequence--a sharp increase in smuggling activity resulting in
revenue losses exceeding $2 billion (in Canadian dollars) for the
federal and provincial governments in 1993 alone, according to the
Canadian government.  From 1984 through 1993, federal taxes on a pack
of 20 cigarettes increased from 42 cents to $1.93 in Canadian
dollars.  Provincial taxes, levied in addition to the federal taxes,
increased significantly as well.  For example, from 1984 through
1993, Quï¿½bec's cigarette taxes rose from 46 cents to $1.78 per pack,
and Ontario's rose from 63 cents to $1.66 per pack (in Canadian
dollars).  As a result, the average real price of a pack of
cigarettes in Canada--in 1994 Canadian dollars--increased from $2.64
in 1984 to $5.65 in 1993. 

According to a 1994 study for the National Coalition Against Crime
and Tobacco Contraband, because of these price increases, Canadians
found lower-priced alternatives on the black market.  During most of
this period, cigarettes made in Canada were exported tax-free to the
United States.  Organized criminal groups purchased Canadian
cigarettes that had been exported to the United States and smuggled
them back into Canada.  This resulted in more than an 11-fold
increase in U.S.  cigarette imports from Canada from 1990 to 1993
(see fig.  2).  The 1994 study found that an Indian reserve that
straddles the U.S.-Canadian border between Cornwall, Ontario, and
Massena, New York, had become the primary conduit for smuggling
cigarettes into Canada.  Once in Canada, the cigarettes were passed
through elaborate networks for distribution to vendors throughout the
country.  By evading the Canadian federal and provincial taxes,
smugglers were able to earn huge profits from contraband cigarettes. 
According to the Canadian government, profits for smuggled cigarettes
were an estimated $500 per case,\9 or $500,000 per truckload, in
Canadian dollars.\10

   Figure 2:  U.S.  Cigarette
   Imports From Canada, 1984
   Through 1996

   (See figure in printed
   edition.)

Source:  GAO's analysis of U.S.  Department of Agriculture's data. 

In 1993, approximately 2.1 million Canadians consumed an estimated 90
million to 100 million cartons of contraband cigarettes with a legal
retail value of about $4.5 billion in Canadian dollars.  That year,
the problem was greatest in the province of Quï¿½bec, where, the
Canadian government estimated, contraband cigarettes made up over 60
percent of the market.  In other parts of the country, according to
the government, between 15 and 40 percent of the cigarettes sold were
contraband. 

While citing the effectiveness of past efforts to reduce smoking by
increasing cigarette taxes, Prime Minister Chrï¿½tien stated in
February 1994 that the widespread availability of relatively
inexpensive contraband cigarettes was negating government controls on
the distribution, sale, and consumption of cigarettes.  According to
the Canadian Prime Minister, as the portion of the Canadian market
supplied by smuggled tobacco increased, the average price paid for
cigarettes dropped.  Access to cheap contraband tobacco undermined
the government's health policy objectives of reducing tobacco
consumption, particularly among youths.  He added that he believed
that Canadian tobacco manufacturers were aware that tobacco exports
to the United States had been reentering Canada illegally and that
these manufacturers benefited directly from this illegal activity. 

In February 1994, Prime Minister Chrï¿½tien addressed the smuggling
problem by proposing, among other actions,

  -- strengthening enforcement at targeted smuggling areas,
     particularly along the U.S.-Canadian border;

  -- reducing the federal cigarette tax by $5 per carton in all
     provinces, effective February 9, 1994, and matching any
     provincial tax reduction over $5 to a maximum federal reduction
     of $10 (in Canadian dollars);

  -- imposing an export tax of $8 per carton (in Canadian dollars) to
     be paid by tobacco manufacturers;

  -- imposing a 3-year federal surtax on tobacco manufacturers'
     profits to fund a major public education program and other
     health measures;

  -- requiring manufacturers to clearly mark individual cigarettes to
     differentiate cigarettes manufactured for domestic and export
     use; and

  -- further restricting access to cigarettes by minors. 

From February 9 through April 15, 1994, federal and provincial taxes
were significantly lowered in the five provinces where international
smuggling was particularly troublesome, including Quï¿½bec and Ontario. 
For example, combined taxes in Quï¿½bec fell by $2.10 per pack, and
taxes in Ontario fell by $1.92 per pack in Canadian dollars.\11
Although taxes in these provinces have increased slightly since, once
the initial tax cuts took effect, the U.S.-Canadian contraband
cigarette market dried up, according to the 1994 study for the
National Coalition Against Crime and Tobacco Contraband.  Consistent
with the study's findings, U.S.  cigarette imports from Canada
dropped about 96 percent from 1993 through 1996 (see fig.  2). 


--------------------
\9 A case of Canadian cigarettes contains 50 cartons. 

\10 Prime Minister Jean Chrï¿½tien, Government Action Plan on
Smuggling, House of Commons, February 8, 1994. 

\11 Based on 20 cigarettes per pack. 


-------------------------------------------------------- Chapter 0:2.1

Thank you again for the opportunity to appear before you today.  We
would be pleased to respond to any questions you may have. 


*** End of document. ***