Bans and high taxes fuel black markets for tobacco & vape products

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As the Biden administration gets closer to finalizing its proposed rule banning the sale of menthol cigarettes and flavored cigars nationwide, a well-known aphorism comes to mind: “The road to hell is paved with good intentions.”

The administration’s logic behind the federal ban is that doing so will reduce smoking and correspondingly improve public health. This is the same logic used to justify increasing tobacco taxes or banning tobacco and vaping products at the state level. 

When a state bans flavored tobacco or increases excise taxes on cigarettes, legal cigarette sales in the state tend to fall as a result. But what about illegal and out-of-state sales?

High cigarette taxes and bans on flavored tobacco products create black and gray markets through which smugglers become the new suppliers of these products. 

Tax rates and smuggling

The Mackinac Center for Public Policy tracks cigarette smuggling in the United States. Its 2021 report showed how cigarette smuggling increases as excise tax rates on tobacco products increase. 

New York, which taxes cigarettes $4.35 a pack, saw the highest rate of inbound smuggling—54.48%. The total number of smuggled packs, more than 254 million, was second in the country behind California’s more than 465 million. California also had the second-highest inbound smuggling rate (44.02%) and a tax rate of $2.87 per pack.

When taxes get high enough to encourage large-scale smuggling, tax revenue falls as people stop buying from legal vendors and start buying on the street, and as some vendors switch to out-of-state suppliers and simply don’t report or pay taxes on those purchases. As a result of their high taxes, California and New York saw the two largest revenue losses—more than $1.3 billion and $1.1 billion, respectively. 

With a tax rate of $3.51 per pack, Massachusetts had the fourth-highest inbound smuggling rate (37.59%) and the ninth-highest number of smuggled packs (more than 63 million), resulting in the sixth-largest revenue loss (nearly $224 million) in 2021.

Where were these Massachusetts and New York smugglers purchasing these products? Mostly in New Hampshire. 

With by far the lowest state tax on cigarette products in the Northeast ($1.78 per pack), the Granite State saw one of the highest outbound smuggling rates in 2021 (-34.13%, which translates to more than 32 million packs). 

As smugglers crossed into New Hampshire to purchase cigarettes, the State of New Hampshire collected an additional $58 million in revenue. 

High cigarette taxes incentivize illicit market activity, encouraging smugglers to purchase products in low-tax states, cross state lines with them, and consume or resell the products in high-tax states. 

A similar dynamic takes place when a state bans tobacco products. 

Bans and black markets

After Massachusetts banned flavored tobacco in 2019, JAMA Internal Medicine found that flavored tobacco sales dropped in the state. Successful policy, right?

Not so fast. “In fact, the flavor ban has been far from successful, as sales in both New Hampshire and Rhode Island experienced double-digit growth—almost making up for the entire decrease in Massachusetts,” according to the Tax Foundation.

After Massachusetts’ ban, total sales of flavored tobacco in New England fell by only about 1% from June 2019–May 2020 to June 2020–May 2021. 

While sales of flavored tobacco decreased by 24% in Massachusetts between the year before the ban to the year after the ban, they increased by 22% in New Hampshire, 18% in Rhode Island, and 6% in Vermont. 

In fiscal year 2021, Massachusetts lost out on $125 million in tobacco excise tax revenue as sales shifted to other states. 

It’s a mistake to equate falling cigarette sales at licensed, regulated shops with an equivalent decline in smoking. The evidence shows that high taxes and bans on tobacco products shift a lot of activity to the black market. 

A University of California at San Diego study of Massachusetts licensed tobacco retailers in the two years before and the two years after the flavored cigarette ban found that the number of new tobacco retail licenses fell by 53% after the ban, with the total number of retail licenses falling by 5.8%. This finding, combined with the documented increases in out-of-state sales and cross-border smuggling, underscores the point that the ban has not ended menthol cigarette smoking in Massachusetts, but rather has moved these products onto the black market. 

Responding to incentives

Massachusetts created strong incentives for people to buy tobacco products elsewhere and bring them into the state for personal use and/or sales. People responded just as expected.

It’s important to recognize that criminals respond to incentives too. Gangs and drug smugglers can increase their revenues by adding cigarette smuggling to their repertoire of illicit activities. In the name of public health, states can find themselves strengthening existing organized crime networks and even creating new ones by imposing bans or high tax rates. 

Bans and punitive tax rates also induce evasive behaviors among otherwise law-abiding citizens. 

The Massachusetts Department of Revenue’s Illegal Tobacco Task Force issues press releases boasting of its enforcement of the state’s tobacco laws. Those press releases list people charged with running large-scale smuggling operations that include flavored tobacco, vapes, and marijuana. But they also include store owners arrested, convicted, and jailed for purchasing tobacco products out of state to avoid Massachusetts’ high taxes. 

It’s worth noting that the task force is part of the Department of Revenue. It was created “to address the problem of illegal tobacco distribution in the Commonwealth and the loss of millions of dollars of legitimate tax revenues to the state every year [emphasis added].” Massachusetts’ tax policy stimulated so much tax evasion that the state created a separate team just to find and punish tax evaders.

The solution to this interstate smuggling, some advocates argue, is a nationwide ban. Such policies used to be called “prohibition.” But as that term has fallen out of political favor, advocates instead use the term “ban” now.  

There is a large overlap between the people who want to ban tobacco and vaping products and the people who want to maximize government revenue for social welfare programs. Those two goals are in conflict. A Tax Foundation analysis of a proposed menthol cigarette ban shows how.

“A nationwide ban would result in a federal revenue decline of $1.9 billion in the first full year after prohibition,” according to the Tax Foundation. “In the states, the decline in excise tax revenue would be $2.6 billion, the decline in sales tax revenue would be $892 million, and the decline in MSA payments would be $1.2 billion, for a total state revenue loss of $4.7 billion.”

In New Hampshire, where menthol cigarettes make up 34% of the state’s market, a federal ban would mean more than $49 million in lost revenue, of which 71% would be a decline in excise tax revenue. 

And just like Massachusetts’ ban resulted in 90% of its lost sales merely moving to neighboring states, a federal ban would increase sales and consumption of other tobacco products like non-flavored cigarettes, and it would move sales and consumption of menthol cigarettes underground. 

For example, according to Reason Foundation, “approximately 22 million additional packs of nonmenthol cigarettes were sold in those states in the year after [Massachusetts’] flavor ban, leading to a net increase in cigarette sales.”

Where will illicit menthol cigarettes come from after a nationwide ban is enacted? The same place so many other banned products do: China. 

In 2020, the U.S. Food and Drug Administration banned flavored vaping products. It boasts that since the ban, it has rejected 99% of requests to sell new e-cigarettes, implying that the ban has reduced access to undesired products. 

But CBS News reported in June that the “number of different electronic cigarette devices sold in the U.S. has nearly tripled to over 9,000 since 2020.”

The FDA’s ban excludes disposable vape products. So, predictably, consumers migrated to disposables. But closing that “loophole” isn’t the solution advocates think it is. The surge in different vape products sold has been “driven almost entirely by a wave of unauthorized [emphasis added] disposable vapes from China.”

Consumers and suppliers always find ways to circumvent federal bans.

The primary achievement of such bans will be to replace legal, regulated products with illegal, unregulated ones, often from unscrupulous manufacturers. In a legal market, manufacturers and sellers have strong incentives to build market share by building trust with consumers. Legal markets promote accountability. Black markets do the opposite. Manufacturers and sellers have strong incentives to conceal their identities, which weakens accountability and reduces consumer safety. 

Any federal ban would bolster illicit trade, flooding the market with less safe products from unaccountable manufacturers. 

The goal of high cigarette taxes and flavored tobacco bans may be an altruistic one, namely to reduce smoking and improve public health. But the actual outcome of such policies is what’s important. Creating black markets, reducing accountability, shifting money from legitimate businesses to criminal networks, and reducing overall economic and personal freedom create a net negative for the economy and society. 

Reducing teen smoking is a worthy goal. Which is why it’s already illegal for teens to smoke. Rather than using policy levers that distort market incentives and infringe on the personal freedom of adults, activists should focus on improving their efforts to educate young people about the risks of smoking.