Michael LaFaive is senior director of fiscal policy at the Mackinac Center for Public Policy. Todd Nesbit is an economist and assistant professor at Ball State University.
Public officials in Indiana drew attention and applause last month when they claimed that cigarette use had declined by 40 percent. They credited a $2 per-pack tax hike that took effect in July.
We wish it were true, but state officials made the common error of assuming a decline in legal cigarette sales meant fewer people were smoking. A closer look at the data tells a different story.
Theory and evidence show some will quit smoking in response to higher costs. Economics also teaches that people will seek out lower-cost substitutes. A 2012 study found that it takes a 100 percent increase in cigarette tax rates to reduce the adult smoking rate by 5 percent. So, when Indiana raised its cigarette taxes by 200 percent, it could have expected consumption to fall by roughly 10 percent, not the 40 percent lauded by state officials.
Indiana is now surrounded by states with lower cigarette taxes. Predictably, many Hoosiers responded by purchasing cigarettes elsewhere. Some crossed state lines to buy legally at lower prices. Others turned to illicit sellers. This kind of tax avoidance and evasion — what we call “smuggling” — undermines the health goals lawmakers hope to achieve by raising prices.
The year-over-year local sales data of a large Midwestern wholesaler of cigarettes allows us to examine sales to retailers in Indiana-Michigan border counties. We found that 92 percent of Zip codes in Indiana bordering Michigan saw a decline in sales to retailers there. Conversely, 64 percent of Michigan Zip codes in counties bordering Indiana saw an increase. This suggests that an increasing number of Hoosiers are purchasing cigarettes in Michigan to avoid taxes.
But this isn’t just happening in Indiana: Cigarette smuggling is rampant across the country, particularly in high-tax states. We have tracked these patterns for years by comparing estimated cigarette consumption with reported legal sales. When the gap is large, cigarettes are likely being obtained elsewhere.
We estimate that California and New York had the highest smuggling rates in the country — over 50 percent of total consumption. That means every other cigarette smoked in those states was likely smuggled. Unsurprisingly, those states have some of the highest cigarette taxes in the nation, and the Golden State also recently banned popular flavors of tobacco and other nicotine products. Massachusetts has the third-highest smuggling rate at 38 percent and also prohibits certain flavored products, such as menthols.
But prohibition hasn’t made menthol cigarettes go away any more than alcohol prohibition made gin vanish in 1920. The products are simply being acquired in other states and brought across state lines by people for personal consumption or by organized criminals to make a profit.
States with low cigarette taxes are sources for cigarettes purchased for consumption elsewhere. Wyoming is the top cigarette smuggling export state, where 55 are smuggled out for every 100 consumed — followed by Virginia (48 percent) and Delaware (38 percent).
These states receive higher revenue from cigarette sales than they would otherwise, due to smuggling. Their gain, however, comes at the expense of the higher-taxed states that lose out on this potential revenue stream. According to our study, California loses nearly $1.5 billion annually in tax revenue because so many untaxed cigarettes are consumed.
Retailers do not need a doctorate in economics to understand that consumption in Indiana would shift with a large excise tax increase. Michigan’s excise tax is nearly $1 less per pack, so retailers expect not only more locals to shop in their own state, but also more Hoosiers.
Other states are poised to repeat the same mistake as Indiana. Maine recently raised its cigarette tax to $3.50 per pack, widening the gap with neighboring New Hampshire, which imposes a lower tax of $1.78 per pack. The result will almost certainly be more cross-border purchasing and a larger illicit market.
Smuggling is not the only unintended consequence of high excise tax rates. All across the country, they drive violence against people, property and police, as well as brazen cigarette-related thefts — from truck hijackings to destructive smash-and-grabs as well as public corruption. In Pennsylvania, police have nicknamed a prolific retail thief with 50 robberies under his belt the “Newport Bandit.” Two years ago, Arkansas Tobacco Control arrested a smuggler moving nearly 28,000 packs of untaxed cigarettes worth more than $243,000.
Increased law enforcement effort is another consequence of tax-inspired scofflaws. Last year, U.S. Customs and Border Protection seized 150,000 illegal cigarettes from cruise ship passengers in California. One month later, the state indicted five others for tobacco tax evasion involving cigarettes and other products. In 2023, investigators in New York recovered more than 1,800 cartons of untaxed cigarettes in a bust that required 16 search warrants. And these busts just involve cigarettes. Loose tobacco, pouches and electronic cigarettes get smuggled, too.
We do not smoke. We don’t want you to. But lawmakers from Maine to California should recognize that their cigarette excise tax policies may do more to enrich smugglers than to help people quit.
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