A cigarette tax hike will worsen cigarette smuggling in Minnesota
In 2018, Minnesota ranked the fifth highest in the country for cigarette smuggling. About 36 percent of cigarettes consumed in Minnesota were smuggled in from other states. According to a study by the Tax Foundation, Minnesota’s high excise tax rate on cigarettes was to blame for this trend.
Unfortunately, in light of Gov. Walz’s budget proposal, this trend might get worse.
Termed “Minnesota’s COVID-19 Recovery Budget”, the proposal includes a tax hike on cigarettes. This is intended to raise revenue and reduce smoking, especially among the youth. The proposal will raise the tax per pack by $1 with a corresponding moist snuff increase, and will also include “a floor stock tax on existing product.”
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High taxes = more smuggling
Currently, Minnesota’s $3.04 excise tax per pack of cigarettes is the ninth-highest in the nation. Adding the $0.633 cigarette sales tax, the total tax burden per cigarette is $3.673, the fifth highest in the nation. Raising the excise tax by $1.50 will push the tax burden to $5.173 – the highest in the nation. Minnesota will be among the only five states with a cigarette excise tax above $4 per pack.
Figure 1: Cigarette excise tax per pack
What does this mean for our state? Potentially more cigarette smuggling.
Consider, for instance, the difference between Minnesota’s proposed rate with that of North Dakota. Among Minnesota’s four neighbors, North Dakota has the lowest excise tax per pack at $0.44. Compared to Minnesota’s current $3.673 tax per pack, a person buying a pack of cigarettes in North Dakota stands to save $3.233 per pack. To a smuggler transporting about 100,000 packs a trip, this would mean a $323,000 profit.
Raising the excise tax by $1.50 saves a person buying cigarettes in North Dakota $4.733 a pack, and to a big-time smuggler carrying 100,000 packs, a trip’s profits rise from $323 000 to $470,000. Ergo, raising the cigarette tax makes what was already a lucrative industry even more lucrative.
The last time that Minnesota raised its excise tax on cigarettes, the cigarette smuggling rate for cigarettes doubled, as estimated by the Tax Foundation. In 2014, the percentage of cigarettes consumed in Minnesota that were smuggled was 35.5% compared to 18.06% in 2013. As Figure 2 shows, there is a strong positive correlation between cigarette taxes and the smuggling rate.
Figure 2: Smuggling rates vs. Cigarette taxes per pack
Source: Mackinac Center for Public Policy, The Tax Foundation
Smuggling hurts our businesses and the Minnesota economy
When Minnesota raised its excise tax on cigarettes by 130% in 2013, Minnesota retailers and our economy suffered. Minnesota businesses selling cigarettes saw a decline in taxed tobacco sales. The decline was even more significant for communities around the Minnesota border. In contrast, other states saw a significant boost in cigarette sales after the Minnesota tax hike. Minnesota not only lost business to other states, but also lost the associated tax revenue.
Business losses moreover extended beyond tobacco sales. Since tobacco sales, especially in convenience stores, are associated with non-tobacco sales, Minnesota also lost potential sales of things like gas, snacks, food, and beverages.
Incentives matter
As Gov. Walz declared in his own voice, taxes do indeed incentivize behavior. However, this does not mean people always respond to incentives in the way that politicians expect them to.
Taxes on cigarettes, while potentially well-intentioned, do not significantly reduce smoking among intended populations. Instead, price differences between states incentivize people to find lower-priced sellers. In addition, well-connected smugglers also see an opportunity to enter a lucrative market.
Cigarette taxes are already high in Minnesota. Raising them further will do little, if anything, to reduce smoking. However, it will make cigarette smuggling even more profitable.