Will Raising North Dakota's Tobacco Tax Decrease Use, Or Increase Smuggling?

“North Dakota needs to do everything it can to prevent more people from smoking and to encourage smokers to quit,” opines the Bismarck Tribune in an editorial today which is generally supportive of legislation to increase the state’s tobacco taxes.

One might quibble with the idea that government ought to be using the tax code to manipulate people into what the government sees as a better sort of lifestyle – it seems the lessons of prohibition have never been learned by the busybodies – but here’s a question to ask ourselves: Will increasing tobacco taxes really reduce tobacco use?

That’s a question the folks at the Michigan-based Mackinac Center have been seeking to answer, and what they’re finding is that higher tax rates have a dramatic impact on smuggling. They looked at the difference between smoking rates published by the Centers for Disease Control and government reports of taxes sales of cigarettes and they found a big gap. Which suggests a lot of people who are smoking, but who are avoiding taxes through one of two means.

One is what the authors describe as “casual smuggling,” which is something like driving across a state border or onto an Indian reservation in order to buy tobacco at cheaper prices for personal use. The other is what the authors describe as “commercial smuggling,” which is the large-scale transport of tobacco products from a low-cost area to a high-cost area for profit.

You can read their study here. I spoke with Michael LaFaive, one of the authors, about legislation currently before lawmakers in Bismarck and what their impact would be in North Dakota, and the numbers are interesting.

First, here’s what lawmakers are considering in terms of changes to tobacco taxes.

HB1421, sponsored by Rep. Jon Nelson (R-Rugby), would raise the per-pack tax on cigarettes by about 250 percent, from $0.44 per pack to $1.54. It would also include these other increases:

• The tax on snuff would go from $0.60 per ounce to $2.72 per ounce, a 353 percent increase.
• The tax on chewing tobacco would go from $0.15 per ounce to $0.73 per ounce, a 356 percent increase.

On the Senate side, Senator Tim Mathern (D-Fargo) has introduced SB2322 which would raise the per-pack tax on cigarettes to $2.00 per pack, a 354 percent increase. Like Nelson’s bill, it contains tax increases for other tobacco products as well:

• The tax on snuff would go from $0.60 per ounce to $2.10 per ounce, a 250 percent increase.
• The tax on chewing tobacco would go from $0.15 to $0.56 per ounce, a 250 percent increase.

The Mackinac folks focused on the changes to the cigarette tax. They note that currently, because North Dakota has some of the lowest tobacco tax rates in the nation, the state is an exporter of sorts. Meaning more tobacco is flowing into the state’s taxable jurisdictions than out of it. But the legislation described above would change that, as this chart shows:

What you’re looking at is what the Mackinac researchers see as a reverse of the flow of cigarettes from outbound due to lower taxes to inbound thanks to higher tax rates.

North Dakota currently sees about 3.74 percent of all cigarettes get “smuggled” out of state. If Rep. Nelson’s bill were to become law, the Mackinac researchers estimate that 14.85 percent of all cigarettes consumed in the state would be smuggled into the state. If Senator Mathern’s bill were to become law, they see that number going as high as 21.5 percent.

[mks_pullquote align=”right” width=”300″ size=”24″ bg_color=”#000000″ txt_color=”#ffffff”]I have no doubt that certain entrepreneurs in Native American communities are watching the state’s debate over raising the tobacco tax with great interest. At the current $0.44 per-pack tax there probably too much of an opportunity for reservation smoke shops. But after a 200 percent increase in the tax (Nelson’s bill) or a 354 percent increase (Mathern’s bill)?[/mks_pullquote]

Keep in mind, this is just cigarettes we’re talking about. We’d likely see similar trends for other tobacco products.

So what would the real impact of raising the cigarette tax be? Would fewer people use tobacco? Or would many people just change how they’re getting tobacco?

It’s an important question. Regulations are static, but markets are dynamic. Raising the state’s tobacco tax would create room in the market for illegal cigarette smuggling. How many law enforcement dollars would need to be expended to combat that? Also, the state’s Native American communities may well see the hike in the state’s tobacco taxes as an opportunity to get into the smoke shop business. According to the State Tax Commissioner, reservation tobacco sales are exempt from state taxes. According to the state’s website, non-Native Americans purchasing tobacco for their own use “must report and pay tax on purchases.”

C’mon. Nobody is going to do that. North Dakotans are also supposed to report their out-of-state purchases for taxation as well. When was the last time anybody did that? And even if the state tried to enforce the tax on reservation sales, what would the cost be?

I have no doubt that certain entrepreneurs in Native American communities are watching the state’s debate over raising the tobacco tax with great interest. At the current $0.44 per-pack tax there probably isn’t much of an opportunity for reservation smoke shops. But after a 200 percent increase in the tax (Nelson’s bill) or a 354 percent increase (Mathern’s bill)?

It might be a real opportunity for them.

It could, however, be a disaster for the state.

As I’ve noted before, North Dakota already has fairly low tobacco use rates, which calls into question the idea that lower taxes promote tobacco use in the first place. And given the potential complications arising from a dramatic hike in the tobacco tax, wouldn’t it be better to just maintain the status quo?