Freeman

ARTICLE

Smuggled Cigarettes, Unteachable Politicians

High Cigarette Taxes Have Predictable Consequences

SEPTEMBER 01, 1998 by JOHN ATTARIAN

John Attarian is an adjunct scholar with the Midland, Michigan-based Mackinac Center for Public Policy, and a nonsmoker.

“Only one thing in history is certain: that mankind is unteachable,” Winston Churchill told his dinner guests one night in January 1941.[1] He was discussing international relations, but it goes for politicians’ economic blunders, too. Indeed, Churchill’s words of wisdom should be carved on the walls of the Michigan State Capitol in Lansing.

The state of Michigan is wrestling with a huge, stubborn cigarette-smuggling problem. Smuggling and related crimes are bad and getting worse.

The state government has only itself to blame. Michigan created its own smuggling problem in 1994 when it raised its cigarette tax from 25 cents to 75 cents a pack—an increase of 200 percent.[2] The increase was intended to make up the revenue lost from a cut in the state’s property taxes and to discourage smoking. (There is obvious tension between those two objectives.)

The tax doesn’t even raise the money it was expected to raise.[3] But the tax hike did create an incentive to smuggle cigarettes. By leading to an increase in the retail price, it made cigarettes in Michigan more expensive than in states with a lower tax. The bigger the price differential, the greater the incentive to buy where they are cheap, transport them to where they are more expensive, and sell them without paying the tax. As long as the smuggler’s price is lower than the legal (tax-augmented) retail price, he’ll have buyers. When the excise tax is small, so is the smuggler’s profit, and it isn’t worth the effort. But the bigger the excise tax, the bigger the price differential between locations. It follows that the way to stop smuggling is to undo the tax that encouraged it in the first place.

History’s Warning

That’s all there is to it. One wonders why the engineers of the tax increase didn’t realize it. But what makes Michigan’s woes truly exasperating is that history has given numerous warnings of exactly what would happen if the state put a high excise tax on cigarettes.

Two centuries ago, Great Britain had no income tax. Instead, besides a land tax and protective tariffs, the British levied customs and excise taxes on numerous commodities, including liquor, wine, beer, boots, building materials, windows, newspapers, candles, sugar, salt, soap, tobacco, silk, spices, and tea.[4] Contributing heavily to Britons’ cost of living, the taxes were bitterly resented; Samuel Johnson’s famous dictionary defined excise as “a hateful tax on commodities.”[5] The need for revenue to finance the Georgian era’s frequent wars drove the excise taxes and tariffs higher and higher; the standard rate of tariffs, for example, went from 10 percent in 1698 to 25 percent in 1759, with further increases during the American Revolution.[6]

Unsurprisingly, writes historian T.S. Ashton, “high duties gave rise to smuggling. The profits of the clandestine trade depended on the existence of a marked difference between prices in England and those abroad.”[7] Smuggling pervaded Britain; well-organized smuggling rings operated fleets of boats and wagon trains. The rampant smuggling spawned much violence and corruption. Government officials connived at smuggling, or even participated themselves—including a secretary of the admiralty and a chancellor of the exchequer. Grateful for cheaper goods, the British people winked at smuggling and eagerly bought contraband merchandise. About three million pounds’ worth of contraband came in every year by the 1780s, versus about 12 million pounds’ worth of legal imports.[8]

Tea smuggling was horrendous. Once drunk by only a few Britons, tea became the national drink in the eighteenth century. But it had to be imported, and the tax rate on tea was an incredible 119 percent. The combination of a huge market and a very high tax made the incentive to smuggle extremely powerful. The consequences were disastrous for the British treasury, which lost huge sums, and for the East India Company, which held a government-granted monopoly on legal tea imports but was undersold by smugglers and almost ruined. In 1784, the company’s accountant estimated that roughly two-thirds of the tea drunk in Britain was contraband.[9]

Adam Smith recognized the connection between high duties and smuggling. Moreover, he pointed out something perverse about punishing smugglers: “The law,” he wrote, “contrary to all the ordinary principles of justice, first creates the temptation, and then punishes those who yield to it; and it commonly enhances the punishment too in proportion to the very circumstance which ought certainly to alleviate it, the temptation to commit the crime.”[10]

To Smith, the cure was obvious: either remove the temptation to smuggle by lowering the tax or increase the difficulty of smuggling by “establishing that system of administration which is most proper for preventing it.”[11]

Prime Minister William Pitt realized that the only way to end Britain’s rampant tea smuggling was to get rid of its tempting profits, and in 1784 he slashed the tea tax to 12.5 percent. Legal tea prices plunged accordingly; so did smuggling. A year later legal tea imports had more than tripled.[12] Soon, tea smuggling was only a memory.

Granted, it’s probably unrealistic to expect state legislators and governors to know much about British history or spend rainy weekends reading Adam Smith. But just before the increase in Michigan’s cigarette tax, they had another demonstration, right next door in Canada, that should have taught them something.

The Canadian Lesson

To curb smoking, a few years back the Canadian government tripled its “sin tax” on cigarettes. In 1994 a carton of ten packs of cigarettes sold for $41 Canadian, $33 being attributable to taxes, versus just an average $16 total in the United States. Canadian cigarettes exported tax-free were cheaper still. Smugglers quickly took advantage of the price differential. They bought up Canadian cigarettes in America from wholesalers, ran them back into Canada, and peddled them on the black market.

Canada tried to crack down—as Adam Smith might have said, raising the penalty in proportion to the temptation. In 1992 it increased smuggling penalties from five years in prison and $25,000 to five years and $500,000. Canadian customs made 14,500 contraband-cigarette seizures, and about 100 people were convicted of smuggling after the increase. More money and manpower went to enforcement, yet the smuggling continued. Predictably enough, given the incentives, smugglers proved imaginative and resourceful in finding ways to hide cigarettes in vans and motor homes.[13]

Finally, in February 1994, Canada’s federal government caved in. It cut taxes $5 per carton and gave province governments incentives to cut their own taxes up to $10 per carton. Taken together, the cuts would slash the carton price in half. Quebec and Ontario, where the bulk of Canadians reside, went along. Overnight, prices plummeted from $41 to just $18. With the profits gone, Canada’s smuggling problem ended.

The same thing happened in neighboring Ohio. In 1993, Ohio raised cigarette taxes, driving the cost of a pack to between $2.20 and $2.30. Many smokers bought their cigarettes in Michigan, where cigarettes were then cheaper. Ohio folded and cut its cigarette tax.

They Didn’t Learn

Yet despite these illustrations of the likely consequences, in 1994 Governor John Engler’s Proposal A, reforming Michigan’s taxes and school financing, called for tripling the state cigarette tax, and Michigan voters approved it. The higher tax went into effect May 1. In short order, all the smuggling-related problems that plagued Britain and Canada hit Michigan.

No sooner was the boost on the books than Michigan smokers began flocking to Ohio and Indiana, where a carton could be bought for about $11.30, versus about $18 in Michigan. One Indiana convenience-store owner just over the border estimated that his cigarette sales had risen over 40 percent in just the first three weeks after the tax increase. My former landlady, a chain smoker, would drive an hour to Toledo to buy several cartons. Even allowing for the cost in gasoline, it was cheaper

than buying in Michigan.

Legal cigarette sales in Michigan suffered accordingly. The Michigan Coalition Against Crime and Smuggling’s study estimated that nearly 20 percent of cigarettes smoked in Michigan were contraband. In October 1995, Joseph Sarafa, executive director of the Associated Food Dealers of Michigan, warned that within a year as many as 10 percent of Michigan party stores could close, partly due to competition from cheaper contraband cigarettes sold at dishonest businesses.

Proliferating crime has been another bitter fruit of the tax increase. The tax makes the profit from smuggling cigarettes into Michigan enormous—up to $8,000 on a shipment of 1,200 cartons—and gives store owners a financial incentive to buy contraband cigarettes. There is, then, a strong temptation for both individuals and businesses to become criminals.

Many have yielded to it. In December 1994, police seized over 4,000 cartons of contraband cigarettes from a drugstore in Sterling Heights, and $60,000 worth of cigarettes from a party store in Lake Orion. Another 5,600 cartons (and $4,000 in dynamite) were seized from a Metro Detroit man at an Erie weigh station. In its first ten months of operation, a state police task force created to combat cigarette smuggling confiscated $1.6 million in cigarettes. By October 1995, according to the federal Bureau of Alcohol, Tobacco and Firearms, Michigan was America’s biggest market for smuggled cigarettes. Dozens of Michigan residents have been arrested in New York state near Indian reservations, which don’t levy cigarette taxes and are major sources for smugglers. In 1997, at least 22 people and one company were indicted on smuggling charges, and over 25,000 cartons of contraband cigarettes were seized.

Smuggling is not the only kind of crime the tax encourages. By making cigarettes so expensive, it creates a powerful temptation for burglary, which frequently entails violence against persons as well as property. One holdup ring operating in the greater Detroit area is suspected of robbing 40 stores selling cigarettes. In one operation in 1997, a woman entered a tobacco store and lured the clerk out from behind the counter with a question about cigars. Three men, at least one carrying a pistol, then entered, tied the clerk up with duct tape, and stole about 650 cartons of cigarettes. As long as there are high profits in contraband cigarettes, this sort of thing is going to continue in Michigan, and sooner or later someone is going to get hurt—or worse.

Given all this, the case for undoing the tax increase is clear. But so far the state government is bearing out Churchill’s gloomy observation about human unteachability.

True to Adam Smith’s observation, Michigan is punishing people for yielding to the temptation the law created. Store owners face felony charges if they possess more than $50 in contraband cigarettes, with a possible $10,000 fine and a prison term. Violators can also suffer tax penalties from the Michigan Attorney General’s office of up to $45,000 per 100 cartons of cigarettes. Smuggling carries a five-year prison term.

Michigan’s latest response to its smuggling problem has been to plunge deeper into statism by creating a tax stamp, which must be on all cigarette packs shipped after December 1, 1997. This will supposedly reduce fraud by making it easier to detect black-market cigarettes.

Will the tax stamp work? Probably not. Manufacturers really can’t keep cigarettes away from smugglers. Smuggling rings will be tempted to raid warehouses containing stamped cigarettes. Moreover, Rod Stamler, a former deputy commissioner of the Royal Canadian Mounted Police, has argued plausibly that a revenue stamp may lead to the dominance of organized crime in smuggling since it can counterfeit the stamp. Indeed, Cigarette Smuggling in the United States, a 1995 report by the Washington-based auditing company Linquist, Avery, McDonald and Baskerville, says evidence of counterfeit tax stamps already exists in California, Illinois, New York, and Texas.

The crime and violence prompted by the cigarette tax are already bad enough. They will get worse if organized crime becomes prominent in smuggling. The gang violence from Prohibition or today’s drug trade grimly indicates what Michigan might experience.

Then, too, tax stamps obviously can’t stop people living near the state line from crossing it to buy cigarettes. Stamler estimates that about a third of the smuggling is done by well-organized, sophisticated smuggling rings, and about two-thirds by small-scale smugglers or individuals going to other states to get their own cigarettes. Put another way, the stamps would only result in the serious smugglers counterfeiting them, or being driven out by organized crime rings able to do so—while the lion’s share of smuggling probably won’t be affected unless police happen to raid smoke shops carrying contraband bought from small smugglers.

The only way to keep contraband cigarettes out of Michigan would be to create border checkpoints to stop and thoroughly search all incoming vehicles—imposing a galling and tyrannical intrusion on motorists, a horrendous inefficiency on businesses, and a staggering burden on Michigan police. Yet after the all-too-predictable failure of tax stamps, that would be the logical next step for an unteachable, obstinate government.

Michigan’s experience with the higher cigarette tax, then, has been a classic case of déjà vu all over again. The politicians apparently can’t learn from history, but must find out the hard way. The pity of it is, their tuition is always paid in other people’s suffering.


Notes

  1. Martin Gilbert, Winston S. Churchill, vol. VI: Finest Hour, 1939–1941 (Boston: Houghton Mifflin Co., 1983), p. 994.
  2. “Headin’ South,” Detroit News, May 22, 1994, p. 1D.
  3. “Cigarette Smuggling Costs State, Police Say,” Detroit News, November 26, 1996, p. 3D.
  4. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: G. P. Putnam’s Sons, 1965), p. 86.
  5. Will and Ariel Durant, The Story of Civilization, vol. X: Rousseau and Revolution (New York: Simon & Schuster, 1967), p. 824.
  6. T.S. Ashton, An Economic History of England: The 18th Century (London: Methuen and Company Ltd., 1972), pp. 162–163.
  7. Ashton, p. 163.
  8. Paul Johnson, A History of the English People (New York: Harper & Row, 1985), pp. 233n, 248.
  9. Ashton, pp. 160, 165.
  10. Smith, pp. 832, 779.
  11. Ibid., p. 835.
  12. Ashton, p. 165; Johnson, p. 248.
  13. Information cited throughout the rest of this article comes from the following Detroit News accounts: “Butting Out Smugglers,” February 16, 1994, p. 6B; “Smokers Breathe a Sigh of Relief,” February 23, 1994, p. 2A; “Ohio Will Be a Draw to State Smokers,” March 16, 1994, p. 12A; “Headin’ South” (see endnote 2); “Millions Lost in Smuggled Smokes,” October 24, 1995, p. 1D; “Cigarette Smuggling Costs State, Police Say” (see endnote 3); “Bootleggers Burn Hole in State’s Pocketbook,” July 14, 1995, p. 1D; “Cigarette Smuggling Getting Worse, Cop Says,” October 28, 1995, p. 10A; “In Chesterfield Township: Suspected Ringleader Held in Cigar Shop Heists,” November 3, 1997, p. 3C; and “Black Market a Worldwide Growth Industry,” July 14, 1995, p. 1D.

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