Minnesota's cigarette tax: Trouble from the beginning

  • Article by: PATRICK FLEENOR
  • Updated: February 28, 2012 - 7:08 PM

Raise it, and people will try to avoid it. And that often will lead to smuggling.

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Earlier this month, the federal Bureau of Alcohol, Tobacco, Firearms and Explosives announced that it had broken up a ring that smuggled millions of packs of cigarettes from Virginia to New Jersey, where state officials estimate that bootleg cigarettes constitute 40 percent of the market.

"The trafficking of contraband tobacco is all about greed from the enormous profits that can be made by engaging in such criminal activity" said Special Agent in Charge Matthew Horace.

The illicit cigarette trade and the crime that accompanies it have plagued the Garden State for decades. Here's a question for legislators considering hiking Minnesota's cigarette tax: What do they think creates this problem?

It is taxes, of course. For years, New Jersey has levied one of the highest cigarette taxes in the country.

Today it is $2.70 per pack, near the level to which State Sen. Carla Nelson and state Rep. Mike Benson, both Republicans, have proposed hiking the Minnesota excise ($2.52).

At this rate, bootleggers would be able to earn more than $1 million on every truckload of cigarettes smuggled into the state.

Like New Jersey, Minnesota has long had problems with cigarette-tax evasion. Trouble began shortly after the state enacted its cigarette tax in 1947. Soon smokers began crossing into neighboring states to secure their nicotine fix.

Others began buying tax-exempt cigarettes at military bases and on American Indian lands. Still others purchased tax-free cigarettes via mail order. More ominously, criminals began to smuggle cigarettes into the state, mixing them into the retail market.

By the mid-1950s, official figures show, the sale of legal, tax-paid cigarettes had plunged 20 percent below the national level. Frustrated by the inability to collect the taxes due, the state's chief cigarette tax administrator quipped that "even the attorneys who come into my office are smoking untaxed cigarettes."

The state government's response was to increase enforcement and try to discourage consumers from buying tax-free cigarettes, but nothing worked. In spite of this, lawmakers repeatedly hiked the tax, and by the mid-1970s, Minnesota had one of the highest cigarette excises in the country. Soon illegal cigarettes from as far away as Kentucky and North Carolina were pouring into the state.

Minnesota was far from alone in its battle with the illicit tobacco trade. During the late 1960s and early 1970s, high-tax states across the country were inundated with contraband, and in 1975, the federal government released a major report on cigarette bootlegging.

It described the smuggling problem in Minnesota as one of the worst in the country and estimated that nearly 15 percent of the cigarettes consumed in the state were the product of bootlegging.

Commenting on the report, then Minnesota Commissioner of Revenue Arthur Roemer noted that cigarette bootlegging deprived states of millions of dollars in tax revenue, corrupted government officials and encouraged a wide range of criminal activity.

The massive tax evasion and ancillary crime that came with it tempered legislators' enthusiasm for additional tax hikes for much of the next decade, and by 1985 inflation had effectively lowered the cigarette excise to levels not seen in decades.

This reduced the incentive to evade the tax, and sales of legal cigarettes in Minnesota rose to record levels by mid-decade. Unfortunately, lawmakers' memories are woefully short when it comes to the harmful effects of excessive cigarette taxes.

A series of hikes in the late 1980s and early 1990s raised the tax to 48 cents by 1992. Not surprisingly, taxed sales fell as smuggling and border-shopping surged.

The latest series of hikes, which began in 2005, have pushed the per pack tax to $1.58. A 2009 report commissioned by the Department of Revenue found that the state government loses millions of dollars annually to cigarette tax evasion.

These losses do not include those incurred by the private sector, such as those resulting from lost sales and increased thefts.

Nelson and Benson defend their proposal by arguing that the funds raised by hiking the cigarette tax will allow the government to improve education and the business climate in the state.

If such broad public benefit is possible, doesn't tax equity call for the reliance on a broad-based tax -- such as one on income, property or sales -- rather than one that falls on just a small, relatively low-income subset of the population?

The history of cigarette taxation in Minnesota clearly shows that adherence to this simple principle would not only improve fairness, it would go a long way in improving tax administration and respect for the law in the state.

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Patrick Fleenor is chief economist of Fiscal Economics Inc. and is the author of "Cigarette Taxes, Black Markets and Crime," published by the Cato Institute in 2003.

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