Smuggling Facts Into the Tax Wars

Last week a startling number ricocheted around the web, from CNN to the New York Times Economix blog: More than 60 percent of cigarettes smoked in New York State, which has the highest tobacco taxes in the nation, are “smuggled” in from out of state and consumed tax free. The smuggling number originates with an an anti-tax-leaning think tank in Michigan, the Mackinac Center. If that number is right, it would give pause to advocates of cigarette taxes.

Figuring out just how much cigarette taxes lead to tax evasion, though, is harder than the initial reports make it sound. It’s clear that higher taxes — New York raised its excise tax from $2.75 a pack to $4.35 in 2010 — cut cigarette sales. The difficulty with this, as with other sin taxes, is in understanding how much of the decline in sales comes from tax evasion and how much from changes in behavior.

Similar questions come up in almost all tax discussions, and they’ll be high on the political agenda. Think about the debate over “carried interest.” Will higher taxes make hedge funds pay more, or just send them overseas? The answers to such questions tend to line up along party lines.

The analysis that drove the new findings comes from Michael D. LaFaive and Todd Nesbit of the Mackinac Center, who have looked at cigarette smuggling in several reports over the years, the first issued in 2008. Nesbit, a senior lecturer in economics at Ohio State University, developed a model that analyzes the flow of tobacco sales from high-tax to low-tax states. In the Mackinac Center’s previous study, based on 2009 data, Nesbit calculated the share of untaxed cigarettes smoked in New York at 47.5 percent.

Now that’s gone up to 61 percent, the headline number for “smuggled” cigarettes (for the Mackinac Center that includes not just commercial smuggling, but bringing cartons or packs in from out of state). What happened in the interim was a big New York State tax increase. LaFaive and Nesbit argue that the “harsh and unintended consequence” of tax increases is to create a black market for untaxed tobacco.

Delve more deeply, though, and you’ll see that the story is more complicated. Because New York raised its taxes on July 1, 2010, you can get some really interesting information by looking at cigarette tax revenue from 2009 and 2011. From the publicly available New York State tax data you find:

Jan – Dec 2009 tobacco tax revenue: $1.37 billion
Jan – Dec 2011 tobacco tax revenue: $1.65 billion

The tax on each pack of cigarettes went up from $2.75 a pack to $4.35, an increase of 58 percent. Tax revenue, though, went up much less, only 20 percent. So with a bit of arithmetic:

Change in taxed packs sold: -24 percent

What accounts for the drop in legal cigarette sales? Nesbit argues that the overwhelming majority of the decrease came from untaxed smoking. “When you raise taxes to a prohibitive level,” Nesbit told me in a phone conversation, “it doesn’t really prohibit consumption. It prohibits legal purchases.”

The difficulty comes in how Nesbit’s model accounts for the possibility that the drop in sales came from smokers cutting down. In a word, it doesn’t. As Nesbit explained, according to data from the federal government, overall smoking rates in New York actually rose very slightly, from 18 percent to 18.1 percent, from 2009 to 2011.

But what about folks who kept on smoking cigarettes, just fewer of them? Nesbit told me that his model does take into account a steady decline in what he calls “smoking intensity,” the number of cigarettes a smoker lights up in a year. The big caveat here is that it  assumes a slow decrease over many years; as Nesbit says, it’s hard to find reliable data that would quickly reflect changes in a single state. If there is a sharp drop in a single year — say, from smokers cutting down because prices jumped — the model wouldn’t show it.

When you think about that, you’ll see why it’s not at all surprising that the model would find an increase in smuggling. There’s a 24 percent drop in legal sales and the model attributes essentially all of that to smuggling. It’s not a coincidence that by Nesbit’s calculations the proportion of cigarettes that are not smuggled drops from 52.5 percent to about 39 percent, a drop of about one-quarter that mirrors the drop in legal cigarette sales.

Is that valid? Nesbit says that his model has been good at predicting the effects of taxes on sales. And make no mistake: that taxes cause some shift to smuggling is clear. That has concerned New York’s budget-makers for a long time. Other studies also come to the conclusion that New York’s high cigarette prices drive purchases from out of state (this one finds that close to 7 of the 15 cigarettes the average New York smoker consumes each day come from out of state).

But you can’t really decide how much of the tax effect lies in smuggling and how much in behavioral changes  unless you can reliably measure not just how many people in New York smoke, but how much.

Untangling those kinds of effects is a major concern in every tax debate. Sin taxes are very much on the agenda now, with supporters on both the left and the right advocating taxes that raise revenue while cutting harmful behavior. The problem is that supporters of taxes tend to look at the numbers and see changes in behavior, while opponents see tax evasion and all the consequent downside of pushing folks into a black market.

On that, the Mackinac Center has been pretty breathless, pointing to dangers from counterfeit cigarettes “adulterated with fillers containing anything from sawdust to human excrement.” So it often goes in tax debates. Though they’re chock-full of data, much of it gets marshaled to support partisan interests, and buried under rhetoric.

What do you think about this article? Comment below!