The state of Indiana is facing a push by advocates to raise cigarette excise tax rates by $1.50 per pack, a move that would affect both smokers and nonsmokers.
If the increase is adopted, Hoosier taxes would leap to $2.495 per pack. Instead of being a cigarette export state — commonly selling cigarettes to residents of other states — Indiana would become an import state. Its smokers would travel to other states for their cigarettes, and profits from large-scale smuggling would become more enticing.
We are the co-authors (along with Scott Drenkard of the Washington, D.C.-based Tax Foundation) of a 2016 study that estimates the degree to which cigarettes are smuggled in most states. Through 2014, Indiana had a net outbound smuggling rate of 17.4 percent. That is, for every 100 cigarettes consumed in the state in 2014, an additional 17.4 were shipped elsewhere, such as to Michigan or Illinois.
The $1.50 tax hike represents a 150.8 percent increase in Indiana’s excise tax. We estimate that, if adopted, it would lead to a decline in legal paid sales of 38.8 percent. Despite the decline, state cigarette excise tax revenue would still increase by more than 50 percent. This is a benefit to the state but there are costs as well, which include lawlessness in the form of tax evasion and avoidance, among other unintended consequences. Declines in legal sales of cigarettes are linked more to tax evasion and avoidance than people giving up the habit.
Our estimates are based on a statistical model of our own creation that compares smoking rates by state and legal paid sales. The difference between the two must be explained somehow, and we — like other scholars — attribute it to smuggling.
Rather than exporting 17.4 percent of its cigarettes, Indiana would become a destination state for smuggling, with just over 28 percent of instate consumption coming from elsewhere. With a tax of nearly $2.50 per pack, Indiana will be surrounded by sister states Michigan ($2), Ohio ($1.60), Illinois ($1.98) and Kentucky (60 cents), all with lower state excise tax rates, so people and criminal organizations will work to capture the difference to save and make a buck.
The biggest beneficiary of a large excise tax hike in Indiana may be policymakers in surrounding states — hungry for more revenue — and border county retailers. We would expect smuggling from Indiana into Michigan to decline as residents of southwest Michigan would have one less place to go for cheaper smokes. Increased revenue from more legal sales in Michigan would accrue to the treasury of the Great Lake State.
In 2007, we obtained a private set of sales data, down to the county level, from a large Midwest cigarette wholesaler. This let us observe what happened to sales of cigarettes to Michigan retailers in counties that bordered Indiana when Hoosiers raised their cigarette excise tax by 44 cents (79 percent) in 2007.
The data indicate that sales of cigarettes from our large wholesaler to Michigan retailers on the Indiana border leapt by 53.2 percent. In other words, retailers in southwest Michigan recognized that Indiana smokes would be less attractive to Michigan consumers and thus stocked up to accommodate the higher demand they anticipated. If Indiana adopts an excise tax of nearly $2.50 per pack in 2017, we expect to see Michigan retailers up their purchases (and then sales) again, not only for Michiganders but also for their Hoosier neighbors.
What lawmakers and others don’t seem to realize is that all of this activity undermines health goals. We have seen studies that suggest as much as 85 percent of the change in legal paid sales of cigarettes following a tax increase comes from tax evasion and avoidance, not from people who quit smoking.
Indiana lawmakers and voters should think as much about the costs associated with higher excise taxes as their purported benefits.