Washington, D.C. 20575 March 1985 Advisory Commission on Intergovernmental Relations A-100 ACKNOWLEDGMENTS Thisreport was researched and written by ~ob- ert J. Kleine with the assistance of Karen M. Benker and Emmeline Rocha. Helpful suggestions were provided by staff members Mark Menchik and Daphne Kenyon. Ruth Phillips and Arlene Preston provided valuable secretarial and clerical assistance. The Commission and the staff benefited from the help of many individuals and organizations. The preparation of this report was greatly aided by those individuals who participated in the "think- ers" and "critics" sessions and in the public hear- ing before the Commission. However, special gratitude is expressed for the cooperation and as- sistance provided by Richard Reeder, Leon Roth- enberg, Morris Weintraub, Melvin Bruce, William O'Flaherty, James Madison, Michael Murphy and Guy LaMolinara. Special thanks also go to the state tax administrators who responded to the ACIR questionnaire on cigarette tax evasion and re- viewed the preliminary report for accuracy. The Commission staff, of course, takes full re- sponsibility for the contents and accuracy of this report. S. Kenneth Howard Executive Director John Shannon Assistant Director PREFACE In1977 the Advisory Commission on intergov- ernmental Relations issued a report on cigarette bootlegging recommending that Congress make smuggling cigarettes across state lines a federal crime. Due, in part, to the Commission's efforts such legislation was passed and signed into law in 1978 (PL 95-575). In 1983, the House and Senate Committees on Appropriations directed the Commission to devel- op current estimates of cigarette tax losses, par- ticularly those losses attributable to organized interstate smuggling, and to recommend what ac- tions the national or state governments could take to further reduce these losses. The Commission notes in this report that the magnitude of commercial interstate smuggling has declined dramatically since the 1970%largely due to the 1978 Contraband Cigarette Act. The Com- mission also notes that tax rate disparities among the states have widened since 1980, suggesting the need for continued federal law enforcement to pre- vent a resurgence of cigarette smuggling. Finally, the Commission identifies the illegal sale of ciga- rettes on military bases and Indian reservations as the major sources of current revenue losses for most states-problems that may require legislative or administrative action by the national government. In this report the Commission seeks to illumi- nate an issue of intergovernmental concern, both in terms of past actions and future requirements. Robert B. Hawkins, Jr. Chairman Appendix A: Description of Methodology Used to Estimate State Cigarette Sales and Revenue Losses from Tax Evasion .................................65 Appendix B: Summary of Responses to Cigarette Bootlegging Questionnaire: April-June1984 ............................................................79 Appendix C: Cigarette Sales and Taxes: Statistical Tables .......................83 Appendix D: Examples of Cigarette Tax Reporting Forms .......................89 Appendix E: Other Estimating Methods ........................................95 Appendix F: Contraband Cigarette Act, PL 95-575 .............................107 TABLES 2-1 Types of Smuggling Problems in the States ................................. 10 2-2 Changes in State Cigarette Tax Rates. 1970-83 .............................. 12 2-3 Cigarette Tax Rates by State. in Cents Per Pack. 1976 and 1983 ..............13 2-4 Distribution of Cigarette Tax Rates. 1976. 1980. 1984 ........................14 2-5 Comparison of Per Capita Sales in High and Low Cigarette Tax States. FY 1983 ...15 2-6 Per Capita Sales by Tax Rate. FY 1983 .....................................16 2-7 Per Capita Cigarette Sales as Percent of National Average. by Region. SelectedYears.196 0.83 .....................................................16 2-8 Unfair Cigarette Sales Laws ...............................................17 3-1 Disposition of Suspects Apprehended through Contraband Cigarette Program. FY 1979-84 .......................................................23 3-2 Law Enforcement Results. FY 1979.84 ......................................24 3-3 Disposition of Federal Defendants in Bureau of Alcohol. Tobacco. and Firearms Contraband Cigarette Cases. FY 1979.84 ........................24 3-4 Characteristics of Federal Defendants in Bureau of Alcohol. Tobacco. and Firearms Contraband Cigarette Cases. FY 1979.84 ........................24 3-5 Summary of State Cigarette Tax Penalties for Illegal Possession or Transportation of Untaxed Cigarettes ........................................28 3-6 Cigarette Smoking Practices ...............................................32 3-7 Expenditures for Tobacco Products and Disposable Personal Income. 1974-83.................................................................... 33 3-8 State Taxable Cigarette Sales as Percentage of Federal Removals .............34 3-9 Tax Exempt Sales-Indian Reservations. FY 1983 ...........................35 3-10 Cigarette Sales on Military Bases. FY 1983 ................................38 3-11 Smoking Prevalence. by Amount Smoked. in Four Branches of the Armed Services. 1980.............................................................. 42 4-1 The Total Monetary Amounts of Discounts Retained by Cigarette Distributors. 1982 ..........................................................46 4-2 changes in Cigarette Tax Rates and Distributor Discounts. 1983 .............47 4-3 State Cigarette Tax Rates and Distributors Discounts ........................ 48 4-4 Distribution of Distributors Discounts ...................................... 50 5-1 Variance in State Per Capita Cigarette Sales from U.S. Average. FY 1975. 1980. and1983 .............................................................54 5-2 Cigarette Smoking Status of People 20 Years of Age and Over. According to Sex. Race. and Age. 1965. 1976. 1980. and 1983 ...........................56 5-3 Percent Distribution of People 20 Years of Age and Over by Smoking Status and Percent Distribution of Current Smokers by Number of Cigarettes Smoked Daily. According to Selected Characteristics. 1977.................... 57 5-4 Cigarette Tax Evasion-Estimated Gains and Losses by State. FY 1983 .......60 5-5 Comparison of Earlier ACIR and Bureau of Alcohol. Tobacco. and Firearms Tax Evasion Estimates with Current ACIR Estimates .................63 A-1 Results of Regression .....................................................68 A-2 Estimated Cigarette Sales. with and without Smuggling Variables. FYI983 ...70 A-3 Estimated Gains and Losses from Cigarette Tax Evasion. FY 1983 ........... 72 A-4 Local Cigarette Tax Revenues. FY 1983 .................................... 74 A-5 Estimated Gains and Losses from Cigarette Tax Evasion Using Alternative Population-Weighted Method. FY 1983...................................... 76 v iii C-1 Per Capita Cigarette Sales and Tax Rates by Region. and Tax-Paid Sales by State and Region. 1983 .....................................................84 C-2 Peak Year for Per Capita Taxable Cigarette Sales, 1950-83 ..................86 C-3 Selected Statistics for Municipal Cigarette Taxes. Selected States. FY 1983 ...87 C-4 State Cigarette Tax Rate Changes from November 1. 1983. to July 31. 1984 ...87 E-1 Results of Regression in 15 Nonbootlegging States. 1981-83 Data .............96 E-2 Cigarette Tax Evasion Gains and Losses-Direct Method. 1983 ...............98 E-3 24-Year Average of State Per Capita Cigarette Sales. 1960-83 ............... 100 E-4 Montana ................................................................101 E-5 Washington .............................................................102 E-6 Oklahoma ..............................................................103 E-7 Pennsylvania ............................................................103 E-8 Texas ...................................................................104 E-9 Maryland ...............................................................104 E-loVirginia ...............................................................105 1-1 Reduction in Cigarette Tax Evasion in Packs Per Capita. 1975-80 .............3 1-2 Increases in State Cigarette Tax Rates. in Cents Per Pack. January 1. 1981. to July 1. 1984 ..............................................................5 Chapter I FINDINGS AND RECOMMENDATIONS Cigarette tax evasion began to pose serious prob- lems for state tax administrators in the late 1960s. There had always been some casual smuggling across state lines and some problems with mail order sales of cigarettes, but large-scale organized smuggling was practically nonexistent. Organized smuggling emerged as tax rate differentials among the states began to widen in the mid-1960s. In 1965 New York doubled its cigarette tax rate from 5 cents to 10 cents and other states began to follow suit. The cigarette tax became an attractive rev- enue source for the states in the wake of the 1964 report of the U.S. Surgeon General linking smok- ing with cancer. Although not a major revenue source it became politically convenient for states to fill small gaps in their budgets with increased cigarette tax revenues. In 1960, cigarette tax rates ranged from 0 in Virginia, North Carolina and Or- egon to 8 cents in Texas. The rates for the vast majority of states were between 2 and 6 cents. By 1970, tax rates ranged from 2 cents in North Caroli- na to 18