Priceonomics

Puff, puff, puff, exhale, and cough-cough-cough when you’re climbing up the subway stairs. New Yorkers smoke over 735 million packs of cigarettes each year according to a study by the New York Association of Convenience Stores, despite some of the highest taxes on cigarettes in the country. New York State charges an excise tax of $4.35 per pack, and New York City charges an extra $1.50 on top of that. Additional taxes fall upon wholesalers, while retailers must fill out a four page application to win the right to sell tobacco products in the state.

These taxes are both a profit center for the state and city governments and an attempt to control public health costs caused by tobacco use. Cigarette taxes produce over $1.5 billion in revenue for New York State each year according to the same study by the NYACS.

But there’s an additional set of less-than-legal profiteers from the high taxes on smokes: cigarette smugglers and their affiliates at the retail level. This has led to a massive, tough-to-estimate trade in black market cigarettes both into the state and the city. The NYACS estimates that smuggled cigarettes account for unit sales valued at over $380 million. According to studies by the Mackinac Center, in 2011, smugglers shipped over 60% of all cigarettes sold in New York, the highest proportion of any state studied. 

The high prices that New Yorkers expect to pay at the counter gives smugglers flexibility in how much they want to trade off between the risk of being busted and the reward of profits. Small-timers can sell moderate quantities to their buddies for modest earnings. Major smuggling rings can do millions of dollars in business by managing an entire national supply chain that goes all the way down to retail distribution. Bodegas and convenience stores can neglect to attain a license and hope that no one notices as they forge tax stamps using cheap equipment. Or they can mix legally-purchased inventory with illegally smuggled cartons. 

The result is that smuggled cigarettes are more the norm than an exception. An Associated Press reporter dug through the trash on a street in the Bronx and found as few as 1 in 10 cigarette packs with proper legal stamps. The reporter wrote: 

The reason for so many out-of-state packs is simple: A bootlegger who stuffs a van with 50 cases of cigarettes in Virginia, where the tax is 30 cents a pack, can evade $166,500 in tariffs by selling that load in New York City, where the combined city and state tax is $5.85.

The best way to understand the smugglers’ operations is from the law enforcement efforts that try to thwart them. Police in all states stop and inspect trucks for controlled goods like smuggled cigarettes and a special task force of the New York Police Department focuses on large operations.

William Masso, the leader of a small smuggling ring, earned yearly revenues of over $600,000 by transporting cigarettes, slot machines, and assault rifles into the city in his car. He boasted:

“I was sticking them in my car, I was driving around, they said, ‘Be careful, you get caught, you’re [expletive]. But it was good money. I needed it at the time.”

Masso’s activities ended when his gang took what they thought was $500,000 in stolen cigarettes off two trucks, and resold it in New York. What they didn’t know was that they were the targets of a sting operation by the FBI and the NYPD internal affairs division. Other small-time smugglers often prefer to use minivans with the back seats pulled out, to make room for black trash bags full of cigarettes. 

On a larger scale, the NYPD busted a smuggling cartel earlier this year that used shell businesses in Virginia to pose as legitimate distributors, purchased cigarettes wholesale in Maryland, trucked the cargo to Delaware, and then resold the cigarettes to bodegas in the city. The New York Attorney General alleges that they smuggled 20,000 cartons of cigarettes per week. The city alleges that the group earned over $50 million in revenue over the past year.

New York state is attempting to establish a cigarette task force, impose new fines on smugglers, and pursue further penalties on retail store owners, rather than just clerks. But their fighting a deeply ingrained practice. As the Wall Street Journal reported in 2011, even police officers have indulged in the trade.

The Internet has complicated efforts to reduce smuggling as it enables one-click tax avoidance. Few online cigarette retailers bother charging sales tax or the appropriate state excise taxes. Rather than smuggling cartons by car or truck, it’s possible for anyone with a credit card to buy a carton of Marlboros for $22.31 (and $8.49 in shipping) from an online store like cigarette-deals.com. Legally, anyone buying those in the city would be obliged to pay an extra $68.50 in excise taxes. Smugglers who buy from these legitimate online stores often later charge closer to the taxed price (advertised at every convenience store in the state as the going price for a pack of smokes) and pocket the profits. 

Highly-taxed products have enabled the smuggling trade since America’s founding, when a band of Bostonians dressed up as native Americans and destroyed a cargo load of British tea that was stamped for excise taxes due to the British crown. Ironically, before the original Tea Party, the British parliament was attempting to lower the excise taxes to reduce the smuggling of untaxed Dutch tea into Britain and the Americas.  

Cigarette smuggling also fuels modern wars. Last September in the Suez Canal, two militants reportedly linked to Al Qaeda fired rockets from shoulder-mounted launchers at a container ship. The resulting damage revealed a cargo hold full of cigarette cartons being smuggled on behalf of another paramilitary group — the Irish Republican Army.

Wherever there are high taxes on goods, it creates an incentive for smugglers to profit by purchasing that good in a lower-taxed environment and shipping it to somewhere with higher taxes. Whether cigarettes or tea leaves, the underlying social mechanism remains the same.

This post was written by contributor JC HewittTo get occasional notifications when we write blog posts, sign up for our email list.

Photo is courtesy of Mel Schmidt from Flickr. 



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