

Fake Western brand cigarettes for sale in Shaqlawa, Iraq

A National Academy of Sciences committee meets this week to study a large, growing and little-understood black market in drugs. But rather than cocaine, heroin and methamphetamine, the committee members will be discussing tobacco cigarettes.

The global black market in tobacco is estimated to supply 11.6% of the world’s consumption, a startling 650 billion cigarettes a year. And there are two components to this market that have drawn the particular scrutiny of law enforcement: fake cigarettes and tax avoidance.

The reason why fake cigarettes are big business will be obvious to anyone who tunes in to Mad Men. Cigarettes have arguably been marketed internationally more effectively than any other American product. The resulting worldwide recognition of the Marlboro Man, Joe Camel et al. means that hundreds of millions of smokers are willing to pay a premium for famous Western brands. This has created a lucrative opportunity for criminals – overwhelmingly based in China -- to repackage over 100 billion cheap cigarettes a year as marquee Western brands.

While not enthusiastic about the amount of revenue being generated by fake cigarettes, U.S. policymakers have been even more concerned about smugglers avoiding taxes for selling genuine cigarettes.

Some of the tax avoidance is conducted via off-shore suppliers who take orders over the Internet. But in recent years policymakers and law enforcement have cracked down on this trade, with formal and informal controls on credit card companies, shipping companies and the U.S postal service.

However, there is a simpler way for criminals to evade cigarette taxes which requires neither a shipper nor an Internet connection: Buy them in bulk in a low tax jurisdiction and physically transport them to a high tax jurisdiction. For example, the tax difference between Virginia and New York State cigarettes is just over $4 a pack, and even more in New York City where further taxes are applied. An individual who throws two cases of legally-purchased cigarettes in his car trunk and drives from Richmond to Brooklyn can make a thousand dollars re-selling them illegally; someone driving a loaded tractor trailer truck can make over a million.

This smuggling raises multiple problems. First, criminals sell the smuggled cigarettes at a lower price than locally-purchased cigarettes in the high-tax jurisdiction, thereby undermining the public health benefit of higher prices (i.e., more smokers quitting). Second, governments in high-tax jurisdictions lose an unknown but undoubtedly large amount of tax revenue from smuggling. Third, major league criminals – perhaps including terrorists – are reaping substantial income from the trade, with which they can fund other even more dangerous activities.

California has had some success reducing tax evasion by requiring more sophisticated, hard to counterfeit tobacco tax stamps. But the policy that would help high-tax states the most in the battle against cigarette smuggling – increased tobacco taxes in low tax states – is the hardest to implement. States with low tobacco taxes tend to have significant tobacco production and the economic and political clout that goes with it to protect those low rates.

Could the federal government end the smuggling incentives that are created by the disparities in state-level taxation? A hike in the federal tax on tobacco, which the Obama Administration proposed last year, would not change the dynamics of cross-state smuggling because the differences between state tax amounts would stay the same. A federal tax that was partly or fully refunded to states which set their taxes within a particular range could in contrast reduce the financial incentive for cross-state smuggling. But at the moment that idea appears to have no strong advocates in Washington.

Keith Humphreys is Mental Health Policy Director and Professor of Psychiatry at Stanford University. He is on Twitter at @KeithNHumphreys