While Indiana is consistently ranked one of the most business-friendly states, its neighboring states are consistently poorer performers. A new law that will raise Illinois’ cigarette tax to $1.98 per pack gives the state the dubious distinction of having the nation's 16th highest tax on cigarettes. The new law will cause the total state and local cigarette tax in Chicago to total $4.66 per pack.
Proponents of this tax hike have promised lower health care costs as a result of reduced cigarette use, in addition to roughly $350 million in additional tax revenue to bolster the state’s Medicaid program. But if history is any guide, proponents of the tax have over-promised and are doomed to under-deliver, as they failed to account for a serious unintended consequence of particular interest to Northwest Indiana — cigarette smuggling.
Cigarette smuggling takes on two forms: commercial and casual. Commercial smuggling involves organized criminals who counterfeit and distribute state tax-paid stamps, the physical cigarettes and packaging, or some combination of the two. Casual smuggling occurs when a consumer drives across the state line to avoid paying higher tax rates. With an impending tax differential of $3.66 between Chicago and Northwest Indiana, retailers in Northwest Indiana should expect a stark increase in cross-border shoppers.
In a 2010 policy paper I co-authored with the Mackinac Center’s Michael LaFaive, we estimated the extent to which taxes caused cigarette smuggling along state borders over the last two decades. As of 2009, about 6 percent of all cigarettes consumed by Illinois smokers were from smuggled sources.
With the additional $1 tax on cigarettes, our model suggests the state will see a significant rise in cigarette smuggling — roughly 28 percent will come from smuggled sources, which would make the state the ninth largest net importer of illicit smokes. The state will still realize an increase in tax revenues, but it will fall at least $100 million short of the figure put forth by advocates.
Expenditures on law enforcement must also rise to combat the increased criminal activity, particularly given that commercial cigarette smuggling has been shown to be closely linked to other major crimes. Other major costs affiliated with organized commercial smuggling include property damage, bodily injury and death of innocent citizens. Thus, the costs of raising revenue should not be viewed as negligible.
It’s also important to note what our results don’t find: A reduction in consumption. Cigarette smuggling occurs because Illinoisans will still demand cigarettes following this new tax — they’ll just search for a cheaper way to obtain them. As such, the health benefits likely will be negligible.
Proponents of cigarette tax increases present the policy as a win-win — both improving the well-being of the poor while also bridging state budget shortfalls. Factoring in smuggling, the better solution to state budget problems is not to turn to increased taxation but to spending reductions instead.
Todd Nesbit is a senior lecturer at Ohio State University and an adjunct scholar at the Mackinac Center for Public Policy. The opinion expressed in this column is the writer's and not necessarily that of The Times.
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