Cigarette Smuggling: Interstate and U.S.-Canadian Experience (Testimony,
12/09/97, GAO/T-RCED-98-50).
GAO discussed: (1) information developed concerning interstate cigarette
smuggling in the United States; and (2) Canada's recent 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, yet most low tax states have not; (4) as a
result, studies suggest that the level of interstate smuggling activity
may now be increasing; (5) recent estimates suggest that smuggling is
responsible for states collectively losing hundreds of millions of
dollars in annual tax revenue; (6) recent experiences demonstrate that
international smuggling can occur when cigarette tax rates are
substantial; (7) international smuggling has occurred recently between
Canada and the United States; (8) 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;
(9) violence increased, merchants suffered, and in one year alone,
Canada and its provinces lost over $2 billion (in Canadian dollars) in
tax revenues; (10) Canada responded in 1994 by sharply reducing federal
and provincial cigarette taxes and increasing its enforcement efforts,
among other steps; and (11) since then, smuggling has declined
considerably.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: T-RCED-98-50
TITLE: Cigarette Smuggling: Interstate and U.S.-Canadian Experience
DATE: 12/09/97
SUBJECT: Smuggling
Smoking
Tobacco taxes
Tax evasion
Organized crime
Contraband
State taxes
IDENTIFIER: Canada
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Cover
================================================================ COVER
Before the Subcommittee on Health and Environment, Committee on
Commerce, House of Representatives
For Release
on Delivery
Expected at
10:00 a.m. EST
Tuesday
December 9, 1997
CIGARETTE SMUGGLING - INTERSTATE
AND U.S.-CANADIAN EXPERIENCE
Statement of Robert A. Robinson, Director
Food and Agriculture Issues,
Resources, Community, and Economic
Development Division
GAO/T-RCED-98-50
GAO/RCED-98-50T
(150738)
Abbreviations
=============================================================== ABBREV
ATF -
============================================================ Chapter 0
Mr. Chairman and Members of the Subcommittee:
Thank you for the opportunity to discuss the preliminary 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. 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 youth 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 developed to date 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, 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 rates 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 a study
conducted by the Washington State Department of Health; and developed
our own economic model to estimate the level of interstate cigarette
smuggling in the United States. To understand Canada's experience
with international smuggling, we also reviewed the Canadian
Government Action Plan on Smuggling, a study conducted for the
National Coalition Against Crime and Tobacco Contraband,\1 and a
report by the Canadian Office of the Auditor General. Again, we
would like to stress that the information that follows is preliminary
and will be part of a larger effort that we plan to complete in April
1998.
--------------------
\1 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 payment of state excise taxes, which can
violate federal and/or state laws.\2 The opportunity for individuals
to profit from interstate smuggling exists because of the wide
disparity in excise taxes across states. Currently, state excise
taxes on cigarettes range from more than 70 cents a pack to less than
10 cents a pack. (See attachment 1 for a listing of state excise tax
rates.) According to estimates that we and the Washington State
Department of Health developed on the extent of current smuggling
activity, some states are losing as much as $100 million or more
annually in potential tax revenues.\3
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) of state tax revenue. The
Washington State 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 were paid. The
estimated relationships can then be used to simulate actual
consumption.\4 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. In addition to examining
the Washington State results, we developed another set of estimates
by using survey data provided by the Centers for Disease Control and
Prevention. Using survey data at the state level on the prevalence
of smoking and cigarettes smoked per day, we developed estimates of
actual taxable consumption in each state.\5 Then, for each state, we
compared the estimates of taxable actual consumption to reported
taxed sales to arrive at estimates of cigarette smuggling.
On a national level, both the Washington State study and our analysis
produced roughly similar results, suggesting substantial smuggling
from states with low tax rates to states with high tax rates. For
example, from both studies, the estimates of tax revenue losses in
states with the highest tax rates such as Massachusetts and
Washington ranged between $52 million and $115 million annually.
Similarly, estimates of tax revenues lost for New York, a state with
slightly lower tax rates but which has a large population, still
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.
Because there are disadvantages with each estimation method, the
results of the studies should be viewed as providing ball-park
estimates. The estimates may also be imprecise for a number of other
reasons. Estimates of revenues lost\6 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.
--------------------
\2 Under the Trafficking in Contraband Cigarettes Act, 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. States may also
have stricter laws related to cigarette smuggling. For example, in
Maryland, it is generally illegal for a consumer to bring more than
two packs of cigarettes into the state for which Maryland taxes have
not been paid.
\3 Both 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.
\4 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.
\5 Our estimates of actual taxable consumption exclude smokers on
military bases and Indian reservations, where purchases of cigarettes
are exempt from state excise taxes. Also, this approach requires
adjusting the survey on the basis of estimates of actual consumption
in order to correct somewhat for the known bias in the survey data
toward underreporting consumption.
\6 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, Qu�bec'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 United States cigarette imports from Canada from 1990 to
1993 (see fig. 1). 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,\7 or $500,000 per truckload, in
Canadian dollars.\8
Figure 1: U.S. Cigarette
Imports From Canada, 1984
Through 1996
(See figure in printed
edition.)
Source: GAO 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 Qu�bec, 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 Chr�tien 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 youth.
In February 1994, Prime Minister Chr�tien 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 Qu�bec and Ontario.
For example, combined taxes in Qu�bec fell by $2.10 per pack, and
taxes in Ontario fell by $1.92 per pack in Canadian dollars.\9
Although taxes in these provinces have increased slightly since, once
the initial tax cuts took effect, the 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. 1).
--------------------
\7 A case of Canadian cigarettes contains 50 cartons.
\8 Prime Minister Jean Chr�tien, Government Action Plan on Smuggling,
House of Commons, February 8, 1994.
\9 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.
Table 1
State Cigarette Tax Rates Per Pack of 20
Cigarettes, as of July 1, 1997 (In
cents)
State State cigarette tax rate
---------------------------------- ----------------------------------
Alabama 16.5
Alaska 29.0
Arizona 58.0
Arkansas 31.5
California 37.0
Colorado 20.0
Connecticut 50.0
Delaware 24.0
District of Columbia 65.0
Florida 33.9
Georgia 12.0
Hawaii 60.0
Idaho 28.0
Illinois 44.0
Indiana 15.5
Iowa 36.0
Kansas 24.0
Kentucky 3.0
Louisiana 20.0
Maine 37.0
Maryland 36.0
Massachusetts 76.0
Michigan 75.0
Minnesota 48.0
Mississippi 18.0
Missouri 17.0
Montana 18.0
Nebraska 34.0
Nevada 35.0
New Hampshire 37.0
New Jersey 40.0
New Mexico 21.0
New York 56.0
North Carolina 5.0
North Dakota 44.0
Ohio 24.0
Oklahoma 23.0
Oregon 68.0
Pennsylvania 31.0
Rhode Island 71.0
South Carolina 7.0
South Dakota 33.0
Tennessee 13.0
Texas 41.0
Utah 51.5
Vermont 44.0
Virginia 2.5
Washington 82.5
West Virginia 17.0
Wisconsin 44.0
Wyoming 12.0
----------------------------------------------------------------------
Source: ATF.
*** End of document. ***