Cigarette with cigarette tax

Smoke ‘em if you got ‘em — but only if you’ve paid your fair share in taxes first. Because they contribute to health problems and are seen as a vice, cigarettes are subjected to “sin taxes” in many countries around the world. Because these taxes are sometimes very high compared to the initial price of the product, tax jurisdictions thousands of miles away a shared problem: a black market for tobacco that often develops alongside higher taxes.

In India, black market cigarette smuggling, mostly for foreign cigarette brands, has reached epidemic proportions in some provinces. “High VAT (Value Added Tax) makes legally traded cigarettes expensive. This is the reason for rapid growth of illegal cigarette industry in the state,” said a government official in the western Indian state of Gujarat, which is especially prone to smuggling because of its long coastline.

South Africa’s cigarette smugglers cost the government the equivalent of nearly a quarter of a billion US dollars annually in unpaid taxes and import duties by selling 19 million illegally imported cigarettes every day. The Tobacco Institute of South Africa has proposed a new licensing system that would make it tougher for untaxed cigarettes to get into the hands of consumers.

Some criminals will take audacious risks to get out of paying taxes on cigarettes. Two British friends were charged with evading the equivalent of about $75,000 in taxes after being caught in the airport with a truly mind-boggling haul: a total of 124,400 cigarettes and 40 pounds of rolling tobacco, smuggled from low-tax Egypt.

In the United States, where most states subject cigarettes to both excise taxes and sales taxes, the black market has also taken hold — usually on an interstate level.

But trafficking in cigarettes doesn’t just mean sneaking a carton of smokes across state lines to save a few bucks. According to a report by the U.S. Department of State, “the cigarettes tend to be moved by 40-foot shipping containers and may or may not include a cover load, such as household materials, toys, furniture, textiles, charcoal, timber, and even legal cigarettes.”

The State Department considers cigarette trafficking a threat to national security, because the same cartels that profit from smuggling cigarettes also engage in terrorism and other international crimes. The most common and profitable smuggling route in the United States may be Virginia to New York, where the difference in excise tax is very large and the journey relatively short. While many of the smugglers using this route are caught, police in New York City estimate that over half of the cigarettes bought within the limits of the five boroughs do not have the proper New York tax stamp — in other words, they’ve been brought in illegally.

Not everybody agrees that cigarette smuggling is related to high levels of taxation. In Canada, the Ontario Tobacco Research Unit, for example, has called this idea a “myth,” noting that there are more consumers of contraband tobacco in the two provinces with the lowest taxation.

For many tax jurisdictions, it’s really all about the numbers. While the Indiana Tobacco Prevention and Cessation recognizes that illegal sales may cost the state money if taxes are raised, they note that states with higher tobacco taxes still make higher revenues from these taxes than they did when taxes were lower. With state and national budgets tightening, it’s likely that cigarette taxes will continue to appeal to legislatures as a ready source of revenue — even if that means more black market sales.

Calculating taxes gets tricky when borders are crossed. Learn more about the complexities of VAT from Will’s Whiteboard today.