COMM ISSlON MEMBERS (NOVEMBER 1976) PRIVATE CITIZENS Robert E. Merriam, Chairman, Chicago, Illinois John H. Altorfer, Peoria, Illinois F. Clifton White. Greenwich, Connecticut MEMBERS OF THE UNITED STATES SENATE Ernest F. Hollings, South Carolina Edmund S. Muskie, Maine William V. Roth, Delaware MEMBERS OF THE U.S. HOUSE OF REPRESENTATIVES Clarence J. Brown, Jr., Ohio L. H. Fountain, North Carolina Richard Vander Veen, Michigan OFFICERS OF THE EXECUTIVE BRANCH, FEDERAL GOVERNMENT James T. Lynn, Director, Office of Management and Budget James M. Cannon, Assistant to the President for Domestic Affairs Carla A. Hills, Secretary, Department of Housing and Urban Development GOVERNORS Daniel J. Evans, Washington Richard F. Kneip, South Dakota Philip W. Noel, Rhode Island Otis R. Bowen, M.D., Indiana MAYORS Harry E. Kinney, Albuquerque, New Mexico Jack D. Maltester, San Leandro, California John H. Poelker, St. Louis, Missouri Tom Moody, Columbus, Ohio MEMBERS OF STATE LEGISLATIVE BOD1ES John H. Briscoe, Speaker, Maryland House of Delegates Robert P. Knowles, Senator, Wisconsin Charles F. Kurfess, Minority Leader, Ohio House of Representatives ELECTED COUNTY OFFICIALS John H. Brewer, Kent County, Michigan William E. Dunn, Commissioner, Salt Lake County, Utah Conrad M. Fowler, Shelby County, Alabama Advisory Commission on Intergovernmental Relations WASHINGTON. D.C. 20575 MAY 1977 Preface It may come as a surprise to some individuals that a matter as prosaic as State and local cigarette taxes could represent a real test of intergovern- mental relations. In this report, the Advisory Commission on Intergovern- mental Relations describes the patrern of cigarette bootlegging that has been building for a decade and recommends Federal, State, and local policies to mitigate its effects. The Commission identifies a Federal interest in the field that stems from the link between bootlegging and organized criminal elements. The Commission notes the disparities in State tax policies with respect to cigarette taxation that have given rise to tax differentials that make both casual and organized smuggling of cigarettes a potentially prof- itable undertaking. The Commission perceives a high degree of citizen indifference to the existence of smuggling-an indifference that results in some citizens paying higher taxes than they might otherwise experience or receiving a lower level of services because States and localities are de- prived of essential revenue. True to its legislative mandate, the Commission in this report is seeking to encourage debate on a public problem that requires intergovernmental cooperation. Robert E. Merriam Chairman Acknowledgements This report was researched and written by Robert J. Kleine and Richard J. Reeder under the general supervision of John Shannon, Assistant Direc- tor. Will Myers, ACIR Senior Analyst, assisted in preparing the report for publication. Jean Ryan and Lavinia Clarke provided valuable secretarial and clerical assistance. The Commission and the staff benefited from the help of many individ- uals and organizations. However, special gratitude is expressed for the cooperation and assistance provided by Leon Rothenberg, Charles Conlon, Morris Weintraub, Melvin Bruce, William O'Flaherty, Edward Lorch, Philip Salafia, J. Robert Murphy, James Lee Taylor, George Stewart, John Deinlein, and James Golden. These individuals along with those who participated in the Commission hearing in conjunction with this report assured a frank exchange of views on this important intergovernmental issue. The Commission staff, of course, takes full responsibility for the contents and the accuracy of the report. Wayne F. Anderson Executive Director John Shannon Assistant Director Taxation and Finance Table of Contents Chapter 1 Findings and Recommendations . .I Summary of Findings . .3 Policy Recommendations . -4 Recommendation 1: Federal Contraband Legislation and Cooperative State Enforcement Efforts . .5 Recommendation 2: Encourage Cooperation Between State Tax Officials and Indian Leaders to Facilitate Collection of State Cigarette Taxes . 6 Recommendation 3: Strengthen State Cigarette TaxLaws ......................................6 Recommendation 4: Establish Education Programs to Increase Public Awareness of the Consequences of Cigarette Smuggling Activities. .7 Recommendation 5: Extend State and Local Cigarette Taxes to Military Bases . .7 Chapter 2 The Nature and Causes of Cigarette Bootlegging . .9 Types of Tax Evasion Activities . .9 State Tax Differentials . .12 Unfair Cigarette Sales Laws . .19 . - Chapter 3 Cigarette Smuggling and Organized Crime . .21 vii Chapter 4 Federal and State Policies ......................27 Federal Policies and Assistance ....................27 JenkinsAct ....................................27 Proposed Federal Contraband Legislation ..........27 Law Enforcement Assistance Administration ........28 Interstate Revenue Research Center ...............28 State Polici-es ..........: .........................29 State Enforcement Efforts ........................29 State Cigarette Tax Laws ........................33 Tax-Free Purchase of Cigarettes ..................36 Chapter 5 The Quest for More Uniform Rates .............39 History of Federal Incentive Proposals ..............39 Uniform Tax Options .............................41 Criteria for Federal Tax Credit Proposal ...........44 The Cigarette Tax as a Revenue Source ..............44 A Proposed Federal Incentive Plan ..................45 Chapter 6 Cigarette Tax Administration ...................51 Use of Stamps ...................................51 Distributor Discounts .............................51 Stamps as an Enforcement Aid .....................55 Centralized Cigarette Tax Collection ................55 Chapter 7 Cigarette Bootlegging .Impact on State Revenues ......................................59 Social and Demographic Factors ....................59 Economic Factors .................................62 Factors Affecting Bootlegging .......................62 Results of the Statistical Analysis ...................63 A ppendicies .................................................67 Appendix A: Selected Statistics on Cigarette Taxes ....69 Appendix B: Description of Statistical Methodology Used to Estimate Cigarette Sales and Revenue Impact of Cigarette Bootlegging .................... 79 Estimating Cigarette Sales .......................79 Estimates of Gains and Losses From Cigarette Bootlegging ....................................84 viii The Impact of Cigarette Bootlegging on State Cigarette Revenue Estimates. ....................86 Data Sources ..................................89 Appendix C: Proposed Federal Legislation to Implement ACIR Recommendations With Respect to Cigarette Bootlegging. ..........................91 Appendix D: Testimony Presented to the Advisory Commission on Intergovernmental Relations, December 16,1976 ...............................95 Statement by Leon Rothenberg, Executive Director, Federation of Tax Administrators. ........95 Statement by Owen L. Clarke, President, National Association of Tax Administrators ........97 Statement by James H. Tully, Jr., Commissioner, New York State Department of Taxation and Finance ......................................99 Statement by Arthur C. Roemer, Commissioner of Revenue, Minnesota State Department of Revenue .....................................100 Statement by J. Robert Murphy, President, National Tobacco Tax Association ...............I02 Statement by Edward Lorch, Detective, Intelligence Division, New York City Police Department ..................................105 Statement by Louis H. Ehrlich, Jr., Chairman, National Association of Tobacco Distributors' Committee on Legislation and Taxation. ..........107 Statement by William A. O'Flaherty, President, Tobacco Tax Council, Inc. ......................I09 Statement by Morris Weintraub, Council Against Cigarette Bootlegging ..........................I11 Letter From Rufus L. Edmisten, Attorney General, State of North Carolina ........................114 Chapter 7 Findings and Recommendations Cigarette bootlegging is a tax administration 6. Cigarette smuggling is a law enforce- problem that has developed since 1965. Tax ment problem and most tax administra- evasion, resulting from the transportation of tors are not equipped to handle this cigarettes from low-tax States for sale in high- type of problem. tax States, has been described by the Federa- tion of Tax Administrators, "to be among the The basic cause of cigarette smuggling is the most troublesome in the entire State tax field." disparity in State tax rates. (See Map 1.) Tax There are six basic reasons why the States rates range from 2 cents in North Carolina to have had difficulty in controlling cigarette 21 cents in Massachusetts and Connecticut, and bootlegging: 23 cents in New York City. The tax rate dispar- ity between New York City and North Carolina I. Cigarettes are relatively easy to handle translates to a difference in price of $2.10 per and transport and smuggling them across carton, which provides a highly attractive prof- open borders is difficult to detect. it opportunity and invites criminal activity. In 1965, the range in tax rates was from zero 2. Penalties for cigarette bootlegging are to 11 cents and the profit incentive for smug- generally light and are not an effective gling was much less. Today, after a decade of deterrent to bootleggers. fiscal pressures and the cigarette-smoking health scare, many States have very high ciga- 3. Cigarette