Understanding the U.S. Illicit Tobacco Market Characteristics, Policy Context, and Lessons from International Experiences (2015) / Chapter Skim
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2 Characteristics of the Illicit Tobacco Market
2 Characteristics of the Illicit Tobacco Market
Pages 31-54
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From page 31... ...
These features include the cigarette supply chain (with overlapping legal and illegal components) and major illicit procurement schemes, the role of price and nonprice factors in driving illicit trade, and the profitability associated with the illicit market.
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From page 32... ...
Illegal schemes in this phase of the supply chain are rare given the absence of strict regulations in most jurisdictions: that is, given few laws, there are few ways to break them.1 In the United States, the cultivation of tobacco and the production of other materials necessary for the manufacture of cigarettes, such as filter tips and cigarette paper, are not subject to licensing or other regulatory oversight aimed at curbing the illegal production of cigarettes. Production involves the manufacturing of cigarettes, typically including packaging in packs of 20 sticks and in cartons of 10 packs (200 sticks)
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From page 33... ...
. The Main Illegal Procurement Schemes Four main schemes have characterized the illegal cigarette trade globally over the past two to three decades: bootlegging, large-scale smuggling, "illicit whites" (cigarettes that are legally produced under unique brand names or no brand name)
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From page 34... ...
. More sophisticated bootleggers buy cigarettes in bulk from legal wholesalers (in the wholesale phase of the legal supply chain)
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While domestic illegal production (discussed below) and large-scale smuggling of U.S.-made cigarettes do not currently represent major sources of illegal cigarettes, the United States has been and continues to be a destination country for illegal cigarettes from abroad.
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. There are several possible explanations for why, in comparison with other destination countries for contraband cigarettes, the United States appears to be less affected by large-scale smuggling of brand cigarettes and by counterfeit cigarettes and illicit whites.
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From page 37... ...
As discussed below, other countries do not have the large tax differentials in relatively small geographic areas that exist in the United States, making domestic smuggling of legally produced, brand-name cigarettes unprofitable in other countries. As a consequence, imported contraband and counterfeits have a larger share of the illicit market abroad than they do in the United States.
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From page 38... ...
, the prevalence of illicit whites may be related to the historical prominence of an illegal cigarette distribution infrastructure. Once there is an illegal distribution network in place, switching from one kind of illegal cigarettes 8 Inaddition to being produced for export with no local taxes paid, illicit whites can, in principle, be sold domestically in the country of production with all relevant local taxes paid.
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From page 39... ...
Illegal Production Illegal production involves the manufacturing of cigarettes in violation of the law. The two main forms are unlicensed or underreported production of unique brand or nonbrand cigarettes and the production of counterfeit cigarettes.
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From page 40... ...
Elsewhere, there has been a partial shift of counterfeit production from traditional source countries, such as China, to consumer countries: since the mid-2000s, illegal cigarette production sites that are manufacturing counterfeit brand cigarettes have been discovered in the Czech Republic, Germany, and the United Kingdom (von Lampe, 2006, p. 240; World Customs Organization, 2013, pp.
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From page 41... ...
Raw Tobacco Given the lack of a regulatory framework, domestically grown tobacco seems to be easily accessible to illegal manufacturers and could be acquired through normal, inconspicuous market transactions. In Canada, do mestically grown raw leaf tobacco is considered an important source of illegal cigarettes (Luk et al., 2007, p.
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From page 42... ...
However, integrated vertical criminal organizations that sell counterfeit tobacco could be subject to methods of detection and enforcement often used to disrupt drug enterprises, such as efforts focused on distributors and retailers that trace retail counterfeit cigarettes up the supply chain to production facilities. Stable infrastructure also makes illegal cigarette production easier to detect, which, in turn, suggests that local law enforcement commitment could be a significant factor in attempts to stop illegal manufacturing.
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; in most jurisdictions, taxes on "other tobacco products" are low relative to cigarette taxes, so that excise taxes account for a lower share of prices for these products. (See Box 2-2 for a discussion of other tobacco products.)
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Overall, interstate tax differentials in the United States are greater than cross-country differences in the European Union,13 while the average tax burden on cigarettes in the United States is significantly lower than in the European Union (von Lampe et al., 2014, p.
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developed a smuggling measure based on cigarette tax rate differentials with North Carolina (at that time thought to be the primary source of cigarettes smuggled by truck) .19 The level of enforcement was posited as being a function of, among other things, whether the state was a member of the Interstate Revenue Research Center or the Eastern Seaboard Interstate Cigarette Tax Enforcement Group, the severity of the felony penalty for smuggling, and the rebate offered to wholesalers 15 The federal excise tax on cigarettes increased from $0.34 in 2000 to $1.01 in 2009 (U.S.
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From page 46... ...
Increases in federal tobacco taxes in the United States would, in principle, reduce incentives for bootlegging and individual tax avoidance, given that relative price differences across jurisdictions would fall. However, unless the federal tax increase is substantial (so that federal taxes account for a much larger proportion of the taxes on cigarettes than state-level taxes 20 The CCTA made commercial cigarette smuggling a federal offense and charged ATF with augmenting the enforcement efforts of state and local officials.
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376) found that "each 1-point increase in a country's transparency index 22 The PPACTE survey is able to distinguish between tax evasion and tax avoidance, identifying tax-evaded cigarette packs as those that were bought "from ‘individuals selling cigarettes independently at local markets, delivery service, door-to-door, just in the street, or, for UK and Spain, cheap cigarettes sold from legitimate retailers'" (Joossens et al., 2014a, p.
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From page 48... ...
, but that global smuggling activities are lower when higher cigarette taxes were accompanied by improved enforcement.24 Of course, causal policy conclusions cannot be drawn from crossnational correlational studies, but these findings suggests that the relationship between taxes and international smuggling may be a function of the law enforcement environment. ESTIMATES OF PROFITABILITY Anecdotal reports about the high profitability of cigarette smuggling are easy to find (Guevara and Willson, 2008; Alderman 2012)
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From page 49... ...
Tables 2-1 and 2-2 present the top 10 most "profitable" routes to Illinois and New York, respectively, excluding legal and social costs and assumng that smuggled cigarettes enter the illicit market after retail pur i chase. Law enforcement reports identify the Virginia to New York I-95 corridor as being the most active route for cigarette smuggling.
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The analysis assumes the driver is paid the state minimum wage of the originating state. For other assumptions used in the analysis, see text.
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The analysis assumes that the driver is paid the state minimum wage of the originating state. For other assumptions used in the analysis, see text.
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State excise taxes on spirits, per gallon, as of January 2013, were taken from the Tax Foundation, and the sales price for 1 kilogram of pure (or of unknown purity) cocaine is based on the mean price paid by federal undercover agents in 2007, as reported in the Drug Enforcement Agency's publicly available System to Retrieve Information from Drug Enforcement (STRIDE)
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illicit market, nor is there any evidence that unlicensed and underreported production, counterfeiting, or illicit whites are a significant source of the illicit market. In contrast, these paths have played a significant role in shaping illicit tobacco markets abroad.
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From page 54... ...
, even though there are other sources of low-tax cigarettes that would appear to generate roughly the same profit. The relative absence in New York City of bootlegged cigarettes from Missouri or North Dakota may be due to several factors: the tax differentials may not fully reflect the actual monetary costs and revenues in the illicit market, existing law enforcement activities may impose a substantially large cost on smugglers, or there are high entry costs (e.g., only being able to distribute through ones social networks)
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