Huffpost Business

Higher Cigarette Taxes Lure Buyers To Black Market

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NEW YORK — The big cigarette tax increases that many states are instituting to balance their out-of-whack budgets are raising fears that the trend will make black-market smokes more profitable and lead to more cigarette smuggling.

Cigarette smuggling has been going on for generations and already costs states untold billions in lost tax revenue.

Criminal gangs stock up in low-tax states like Virginia and Missouri, truck the cigarettes north and illegally resell them in high-tax states like Michigan and New Jersey. Other buy cartons and cartons of tax-free smokes on Indian reservations and sell them elsewhere. Buyers order untaxed cartons of murky origin on the Internet. And ships arrive from China carrying cargo containers filled with counterfeit cigarettes.

Law enforcement officials and others worry that the widening price spread between taxed and untaxed cigarettes will only make the situation worse.

Phillip Awe, the chief tobacco law enforcer for the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives, said the agency has taken notice. ATF is refining its national strategy for fighting cigarette trafficking, he said, and has substantially expanded its investigations, opening up some 700 new cases in the past five years.

"There are truckloads of cigarettes that are being transported across state lines right now," he said, "all for the sake of exploiting the difference in the tax rates."

Fourteen states have raised tobacco taxes in the past two years, according to the Tobacco Merchants Association, an industry group. With the economy in a slide, legislation asking for increases is pending in 19 other states. They include a proposed 50-cent increase in South Carolina, where the current 7-cent tax is the nation's lowest.

New York state is raising its tax $1.25 to $2.75 a pack, the highest in the nation. New York City charges an additional $1.50, which will bring the cost of a typical pack of cigarettes here to $9.

Arthur Katz, executive director of the New York State Association of Wholesale Marketers and Distributors, which represents tobacco dealers, said the changes are certain to drive greater numbers of smokers to underground sources for their cigarettes.

"You'd have to be crazy to go and buy cigarettes at the store at almost $9 per pack," Katz said.

Reservation shops and other sources of tax-free cigarettes could be primed to pick up even more business from smugglers.

Cigarettes are sold tax-free on tribal lands in New York state, a status that has been exploited for years by crooked entrepreneurs who resell the packs as far away as the Midwest and Canada. Indian reservations in New Mexico, Oklahoma and other states also have had trouble with smuggling.

Places like New York's Poospatuck Indian Reservation have become major sources of contraband cigarettes. Hidden away in a nondescript suburb on eastern Long Island, it is a 60-mile haul from New York City. But to bootleggers, the trip is worth it.

The reservation sold an eye-popping 10.4 million cartons of cigarettes last year _ enough to supply every smoker in New York City with a pack a day for 3 1/2 months. One store grossed an average of $35 million per month, federal agents said.

Rules regarding cigarettes sold on Indian reservations vary from state to state, but in general, buyers may not purchase huge quantities of low-tax or untaxed reservation cigarettes and resell them elsewhere without paying a state tax.

Smugglers have also long turned to counterfeiting cigarette tax stamps to disguise packs on the black market. New York state officials announced Wednesday that they had seized $6.1 million worth of fake stamps from a Jordanian tobacco distributor.

Illegal cigarettes can put a big dent in state budgets. California officials estimate that taxes go unpaid on about 15 percent of all tobacco sold in its markets, at a cost of $276 million per year. New York put its losses at more than $576 million in a study released in 2006.

Congress is considering bills that would increase the penalties for smuggling, bar the shipment of cigarettes through the mail, and require all tobacco products to carry a high-tech federal tax stamp that would enable law enforcement officials to spot counterfeits and identify packages that have illegally crossed state lines.

Rep. Anthony Weiner, D-N.Y., a sponsor of one of the bills, called it a "great mystery" why New York hasn't done more to crack down on bulk purchases at Indian reservations. New York's reservations sold nearly 304 million packs last year _ nearly a third of the state's recorded total.

"You go stand in front of the Shinnecock Reservation on Long Island, in the Hamptons, and you can see people loading boxes and boxes and cases into their trucks," Weiner said.

Law enforcement agencies have at times put reservation smoke shops under surveillance to catch outsiders illegally loading up on cigarettes, and over the years there have been dozens of arrests. New York City has tried an alternative approach _ suing wholesalers that do business with the tribes.

On the Poospatuck reservation, federal authorities have also charged the owner of the Peace Pipe Smoke Shop, Rodney Morrison, with engaging in a "reign of terror" to protect his multimillion-dollar business.

Prosecutors said Morrison orchestrated the 2003 murder of an associate who opened a competing store, robbed another rival of tens of thousands of dollars, and set fire to the car of a third competitor. Morrison's lawyers say he is innocent. A jury began deliberating in the case last week.

Harry Wallace, the owner of a smoke shop on the reservation and the chief of the Unkechaug Nation, is quick to point out that Morrison is not an Indian by birth. Before marrying into the tribe and moving to the reservation, he lived in Brooklyn, where prosecutors say he was a cocaine dealer.

"Whatever crimes he's committed, or not committed, we're not like he is," Wallace said. He said the tribe doesn't condone purchases of tobacco by anyone who doesn't intend it for personal use.

As for New York's tax increase, the Indian chief complained: "We're going to be scapegoated again as the sole reason why there is all this illegal activity."