March 25 (Bloomberg) -- Higher cigarette taxes are prompting a burgeoning smuggling trade along routes such as I-95 on the East Coast, and states are trying to stem the flood of illegal smokes to fight crime and regain lost revenue.
Lawmakers in Virginia and Maryland passed bills boosting the penalties on smuggling in the past year, and the Massachusetts Commission on Illegal Tobacco released a report March 1 with recommendations to crack down on trafficking. Legislation is also pending in states including New Jersey and Rhode Island.
As states and the federal government raised tobacco taxes, the profit incentive for smugglers increased. There’s a rate disparity as high as $4.18 per pack between tobacco-producing states like Virginia and North Carolina and places such as New York, where an estimated 57 percent of cigarettes smoked are smuggled. States are cracking down to prevent the loss of billions of dollars in revenue and combat an increase in organized crime.
“We are all-hands-on-deck as far as cigarette smuggling because it’s no longer a mom-and-pop operation,” said Maryland Comptroller Peter Franchot, who has pushed for anti-smuggling legislation. “It’s something that significant criminal entities are involved in, and it’s a target-rich environment.”
While there are many types of tobacco trafficking and schemes to avoid taxes, the most pervasive is smuggling cigarettes between states to take advantage of tax differentials, according to the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives. From $7 billion to $10 billion in state and federal tax revenue is lost each year because of smuggling, up from $5 billion a few years ago, according to the ATF.
The per-pack tax on cigarettes ranges from 17 cents in Missouri and 30 cents in Virginia to $4.35 in New York, where New York City also imposes an additional $1.50 charge, according to the Federation of Tax Administrators in Washington. There have been 113 tax increases in 47 states, the District of Columbia and New York City since 2000, the group said.
Every 10 percent increase in the price of cigarettes reduces overall consumption by as much as 5 percent and lowers the number of children who smoke by about 7 percent, according to the Campaign for Tobacco-Free Kids in Washington.
As the same time, smuggling has been increasing because the higher the taxes, the more incentive there is for criminals, said Jeff Cohen, ATF associate chief counsel in Washington.
Criminals buying 200 cases of cigarettes in North Carolina or South Carolina to sell illegally in New York can clear as much as $500,000, Cohen said. State and local police tend to focus more on drug trafficking and other serious crimes, and the penalties for getting caught are relatively lower, he said.
Almost 57 percent of the cigarettes smoked in New York state in 2012 were smuggled, according to estimates released Feb. 17 by the Mackinac Center for Public Policy, a nonprofit research group in Midland, Michigan, that supports free markets.
Buying illegal, untaxed cigarettes for as low as $6 a pack instead of the legal $12 to $13 is as easy as walking into virtually any bodega, or convenience store, in downtown Brooklyn, said borough resident Terrence Williams, 51.
“I don’t care because if it wasn’t me, it would be somebody else,” he said, a lit Newport hanging from his lips. “Who the hell wants to pay 10 to 12 dollars?”
Alix Bamder, who owns three convenience stores in Brooklyn, said he can’t compete with the stores that sell out-of-state cigarettes cheaply. It’s only when his closest competitor is closed that he sells any significant volume of cigarettes, he said.
“Customers? I don’t blame them,” Bamder said.
Massachusetts boosted its per-pack tax by $1 last year to $3.51, giving it the second-highest levy behind New York. The Commission on Illegal Tobacco, which was created last year, estimated that the change would boost the share of untaxed cigarettes smoked to as much as 27.5 percent from 20 percent.
While the increase will generate an additional $157.5 million a year, the loss from excise-tax avoidance will be as much as $246 million -- plus as much as $49 million in lost sales-tax revenue, the report said.
“That’s real money, even in a budget of 30-plus billion dollars,” said Amy Pitter, commissioner of the Department of Revenue, who led the commission. “Everybody’s dealing with this problem and thinking about what to do about it.”
The commission made 12 recommendations, including dedicating more funding for enforcement and increasing penalties to levels comparable with states that have similar tax rates, such as New York and New Jersey.
Besides the lost revenue, crime is a growing problem, said Kristen Howard, executive director of the Virginia State Crime Commission. That includes gangs stealing identities to buy cigarettes in large quantities using fake credit cards, she said.
The Virginia State Crime Commission studied the issue and released a report with recommendations to combat trafficking in 2012. The legislature then passed measures in 2013 and this year to increase both the civil and criminal penalties and to make other statute changes, Howard said.
“People see cigarettes as just a legal commodity and ask why are we wasting our money and efforts,” Howard said. “We’re bringing criminal activity to our state.”
The schemes can be expansive. Last year, 16 people from New York, New Jersey and Maryland were indicted after New York state and city investigators uncovered a ring that flooded the city and Albany and Schenectady counties with more than a million cartons of untaxed cigarettes illegally imported from Virginia, according to the New York attorney general’s office.
An investigation found $55 million in unlawful cigarette sales and more than $80 million in lost state sales-tax revenue, according to the attorney general’s office. Similar schemes have been used in the past to help fund terrorist organizations, the office said.
Illegal cigarette trafficking also can affect payments to states under a 1998 national settlement in which Phillip Morris USA, Lorillard Inc. and Reynolds American Inc. agreed to make annual payments to the states in perpetuity to resolve their liability for health-care costs attributed to smoking.
Some states and cities issued bonds against those payments, which are based on cigarette shipments. The Massachusetts Attorney General’s Office estimates that the state loses about $1,000 of its settlement payments for every million cigarettes that escape federal taxes, according to the commission report.
“Smuggling certainly doesn’t help tobacco bonds,” said Richard Larkin, director of credit analysis in Iselin, New Jersey, at Herbert J. Sims & Co.
To contact the editors responsible for this story: Stephen Merelman at email@example.com Mark Schoifet, Justin Blum