On a clear February morning, a team of inspectors marches into the Subrina Mini Mart in the working-class Queens (N.Y.) neighborhood of Woodhaven. The shelves are stacked with instant noodles, Lysol, canned beans, and, of course, cigarettes. The clerk looks nervous.
The inspectors, employees of a private-investigation firm hired by tobacco giant Altria (MO), are searching for counterfeit packs of Marlboros and any that have slipped past New York tax authorities. Three times over the past year this store allegedly sold fake smokes to an undercover agent employed by the Richmond (Va.)-based manufacturer. Altria sued the Mini Mart, one of 35 such suits it has filed in the past 10 months in New York and New Jersey. A federal judge in Brooklyn issued an order allowing the company to inspect the Woodhaven store and a number of others in the area.
After 20 minutes the Altria squad finds no fakes. Of 30 packs of Marlboro, several bear apparently bogus tax markings, explains Michael Thorne-Begland, Altria's director of brand integrity, who supervised the search. The markings indicate that some of the suspect packs probably were shipped from a low-tax state and stamped to look as if they were originally intended for New York, a high-tax jurisdiction.
Altria says it cares about tax dodging because the practice hurts full-price retailers that have signed deals to promote Marlboro—an important form of marketing in an era when most cigarette advertising is banned. Black market activity also exacerbates a cycle of tax shortfalls leading to higher rates. If taxes rise, some people are more prone to quit smoking; that cuts into Altria's bottom line.
The company can't enforce tax laws on its own, so it passes evidence it gathers to law enforcement officials. "What we want is the message out: Don't sell this," says Thorne-Begland. In a phone interview later, Mini Mart owner Miah Mahnan says he obeys the law and stocks only above-board products.
Cigarette smuggling is booming, in part because New York and 21 other states have raised cigarette excise taxes in recent years. On top of that, the U.S. government increased the federal tax on cigarettes last year by 159%, to $1.01 per pack. A pack now typically sells for about $10 in New York City, more than double what it cost 10 years ago, and the state is considering yet another excise increase.
The high levies, meant to help close huge budget gaps and discourage smoking, have had the unintended side effect of spurring the illicit market. One passenger car filled with Marl-boros bought in low-tax Virginia and driven up Interstate 95 to resell in New York can yield more than $30,000 in profit, says Crisanto Perez, a senior official with the U.S. Bureau of Alcohol, Tobacco, Firearms, & Explosives.
In Asia, Altria employees have begun to build an intelligence network to combat the counterfeiting problem. The company cites academic research estimating that factories in China manufacture 400 billion knock-off cigarettes a year. Altria has hired detectives to try to infiltrate the international distributors that sell Chinese fakes to mom-and-pop shops in the U.S. The company says it will funnel the information it gathers to government authorities.
Back in the U.S., Altria has 21 employees in its brand integrity unit, which it created in 2002. They are assisted by outside contractors hired nationwide. The company even has given nearly $2 million over the past eight years to cash-strapped public police departments in such places as Los Angeles and Suffolk County, N.Y., to help fund contraband investigations.
Tax collectors have their own concerns. New York currently loses $1 billion a year because of cigarette tax cheating, according to a 2009 study by the New York Association of Convenience Stores. Across the country, tobacco excise revenue lost annually to smuggling totals $5 billion, the U.S. Justice Dept.'s Inspector General concluded last year.
Proximity to lower-tax states isn't the only reason New York has become the largest market for illegal cigarettes in the U.S. The tobacco businesses on sovereign Native American lands in the Northeast also present a challenge to tax collectors.
The Seneca Nation of Indians—some 7,900 people who live in generally modest conditions on two remote territories south of Buffalo in Western New York—has sold tobacco products without any taxes for more than 20 years. Altria and the state of New York argue that the Seneca should collect levies on sales to non-Indians. The Seneca have refused, citing 18th century treaties with the U.S. government.
The sale of tax-free cigarettes from the Seneca Nation, over the Web and in person, has become a substantial business. Law enforcement officials suspect that a lot of the product ends up resold illicitly on the street. Indian retailers sell a carton of 10 packs of Marlboro tax-free for about $50. Transported to New York City, the carton might sell for $100 in a convenience store, yielding $50 in black market profit.
Seneca leaders say they don't condone the shipment of large quantities of cigarettes for resale. They allege that Altria's current crackdown is aimed at least in part at squelching sales on Seneca lands, especially those of rival discount brands manufactured locally. "We do a lot of business through our own marketing and brands, and that's competition" for Altria, says Seneca Nation President Barry E. Snyder.
Along with a thriving casino business, cigarettes are an integral part of the impressive $1 billion Seneca economy. Snyder, who began opening tobacco shops in the early 1980s, has prospered. He drives a silver Hummer and spends parts of the winter in Arizona rather than frigid upstate New York.
For a time, Marlboro courted the Seneca trade, sending company representatives to negotiate deals with Native American vendors similar to those offered mainstream retailers. Altria has tried in recent years to cut off wholesalers that supply retailers not charging taxes, including the Seneca. That strategy was successfully challenged in the courts, and Altria has resumed its dealings with the wholesalers. Still, the company alleges that the tribe's sale of large amounts of cigarettes via Internet sites gives teenagers too young to buy tobacco products a chance to obtain Marlboros and other brands. The Seneca vehemently deny this.
The company encouraged the decision in 2005 by all major credit-card companies to stop processing online tobacco sales. It also lobbied for legislation passed by Congress in March that forbids the U.S. Postal Service from shipping cigarettes. Both moves have the effect of limiting the Seneca's online sales.
Seneca retailers operate most of the largest tobacco sales sites online. Tribe member Suzanne Smith built a thriving business at senecasmokeshop.com. These days her top sellers are Seneca, Pride, and other Native American brands. As a result of the new postal restriction, she expects to lay off at least one-third of her 45 full-time workers. Those who stay will work for other businesses she runs, including a temporary-nurse registry.
Her daughter, Alyse Pierce, a mother of five, is one of her mother's employees. She, too, resents Altria's recent actions. "We sell tons of their stuff, yet they work against us," Pierce says. Once, she adds, Marlboro and other major brands comprised 50% of her sales. Now that figure is closer to 10%.
Altria's Thorne-Begland concedes that Native American sales have put a modest dent in Marlboro revenues. The "Seneca do shift buyers from Marlboro" to their own cheaper brands, he says. "They offer a trade-off: If you like Marlboro, you'll love this."
The tobacco company executive portrays Altria as the victim. What's unfair, he argues, is that the Seneca and other retailers sell untaxed cigarettes at half the price of competitors': "We want a level playing field," he says, "where everyone plays by the same rules."