The Black-Market Boom

When you mention “the black market,” it evokes imagery of back-alley deals among criminals, not the less fearsome picture of mom-and-pop grocers conducting transactions with their regular customers.

 

Yet it was the latter who recently came up in headlines about the black market. Independent operators sold much of the estimated 20,000 cartons of illegal cigarettes a week brought into New York City as part of a $55 million dollar smuggling ring taken down by the New York Attorney General and the New York City Police Department last May. 

 

These cigarettes were not counterfeits made by illegal manufacturers. They were legitimate products smuggled into New York—which boasts the highest cigarette excise tax in the country—from lesser-taxed states such as Virginia.

 

It was a big bust for the NYPD and attorney general, but it was only one interception in a game of many passes and illicit completions. A widening gap in state excise taxes is spurring a dramatic increase in similar black-market trade across the country. With much money to be made “importing” untaxed cigarettes into high-taxed states, many believe this single smuggling ring—which cost New York approximately $80 million in lost sales revenue—represents only a minute sample of the illegal activity going on.

 

“We applaud the enforcement agencies for interdicting this smuggling ring,” says New York Association of Convenience Stores (NYACS) president Jim Calvin. “Unfortunately, it’s only the tip of the iceberg.”

 

Lyle Beckwith, senior vice president of government relations for NACS, agreed that the high-profile bust was merely “scratching the surface. A few high-profile drug smuggling busts doesn’t stop the flow of marijuana and cocaine into the U.S.” 

 

Black-market tobacco encapsulates a wide variety of trade and products: Besides state-to-state smuggling, it can include counterfeit products, legitimate or altered products smuggled in from other countries and products sold by unlicensed retailers. Beckwith defines illicit tobacco as “any tobacco sold outside legitimate channels that collect and remit taxes and verify age.”

 

With so many options for criminals, it’s understandably a huge market. A 2009 Federal Bureau of Alcohol, Tobacco, Firearms and Explosives report estimated tobacco product smuggling and black market activity cost state and federal governments more than $5 billion a year in lost revenue from unpaid tobacco excise taxes. It’s a figure that likely is growing. 

 

“With certain states and cities raising cigarette and tobacco tax rates further in the past four years, the loss of tax revenue is even higher given the expansion of the black market,” says Tom Briant, executive director of the National Association of Tobacco Outlets (NATO), Minneapolis.

 

Internationally, it’s an even bigger issue. Just ask Bryan Jones, vice president of corporate affairs in the Americas region for JTI. Jones says almost 40% of Ireland’s tobacco sales come through the black market; that figure “drops” to 30% in areas such as the U.K. and Brazil.

 

“Globally, it’s a massive problem,” he says. “It’s estimated that about 10% of all cigarettes are counterfeit, contraband or duty-not-paid.”

There’s quite a bit the United States can learn from the rampant black market plaguing Jones’ home base of Canada, he says. While Canada’s illegal tobacco centers around illegally produced products, as opposed to the intrastate smuggling in the United States, the central issue—price—is similar. 

 

In Ontario, a carton of legally purchased cigarettes costs $100. On the street, a “baggie” of 200 counterfeit cigarettes runs just $10.

 

“They’re readily available at lunch-money prices,” Jones says of these illegally manufactured cigarettes, which once accounted for more than 30% of Canada’s tobacco market. “For the price of a movie ticket, you can get a carton of cigarettes. It started out very small and quickly grew to about a third of the marketplace because of the price point and because of very sophisticated distribution lines.”

 

It’s this same price disparity that fuels the black market in the United States. The Mackinac Center for Public Policy, Midland, Mich., in January released its latest estimates for cigarette smuggling by state, and the data clearly shows a link between high state excise taxes and illegal tobacco trade. States with top smuggling rates included Arizona (who had a $2-per-pack state excise tax in 2011), New Mexico ($1.66 per pack), Washington ($3.03 per pack) and Rhode Island ($3.46 per pack). Not surprisingly, New York—with its $4.35-per-pack excise tax—had the all-time high rate for the Mackinac Center of nearly 61%, up 70.2% since 2006.

 

“With high taxes on cigarettes, states are creating a ‘prohibition by price’ with all of the same consequences of real prohibition,” said Michael LaFaive, director of the Mackinac Center’s Morey Fiscal Policy Initiative, in a news release.

 

Cliff Brazie, director of retail merchandising for Kwik Fill/Red Apple Food Marts, oversees locations surrounding his company’s headquarters of Warren, Pa., as well as in Ohio and New York. For him, it’s a no-brainer why New York’s black market is so massive: “the $43.50 tax per carton in New York state,” he says. “Pennsylvania’s [tax] is only $16 per carton.”

 

“For criminals, the greater the excise tax, the greater the rewards for avoiding these taxes,” concurs Ralph Brown, vice president of legislative affairs at Cheyenne International, Grover, N.C. “The black market generates most of its revenue when it can sell product in a state with high state and/or local excise taxes. If you look at low-tax states, you will find that there is little to no activity in the black market.”

 

Unfortunately for legitimate retailers operating within the confines of the law, as long as this tax disparity exists, illegal tobacco trade is likely to continue to attract criminals looking to make a quick buck.

 

“The illegal tobacco trade generates enormous profits for organized crime that are then used to finance other criminal activity,” says Jones.  

 

Briant reports that NATO members in highly taxed areas have seen a steep decline in their tobacco sales due to black-market activities. This has led to layoffs and, at times, store closures. “These are retailers that followed the law but were penalized because the actions of lawmakers fueled the black market,” he says.

 

NYACS released an economic report conducted by John Dunham & Associates last December, which found that cigarette tax evasion (from smuggling as well as tribal lands and Internet sales) cost the state of New York at least $1.7 billion a year in tax revenue and 6,700 jobs. Calvin says this smuggling epidemic “deprives law-abiding retailers of legitimate business, and undermines the public health policy goal of deterring smoking through hypertaxation.”

 

The effects on retailers will only worsen if the black-market trend continues. According to the Quebec Convenience Stores Association, at one point one c-store a week was closing as a result of contraband tobacco.

And it’s not just the lost tobacco sales retailers need to worry about—it’s also the loss of the total market basket: snacks, beer, coffee and other popular items tobacco consumers often pick up. 

 

“Retailers who only sell compliant products often compete head to head with black-market retailers who sell at the lower price and create a pricing disadvantage that is nearly impossible to overcome,” says Brown of Cheyenne. “When a product is sold through the black market, the retailer loses valuable sales dollars in their stores.”

 

It’s an issue every retailer should care about, even if a company is operating in a lower-taxed state with little black-market activity. As Brazie of Kwik Fill/Red Apple points out, many states follow suit with higher taxes and stricter regulations once New York successfully passes such measures. To help combat the black market, Brazie relies on retail associations such as NACS, NYACS and NATO.

 

“You can’t take on these issues on your own,” he says. “You need a group to support what your thoughts are so you are represented in numbers. [Retail associations] keep us on the cutting edge of what is going on at all times.”

 

Beckwith agrees: “Working as one coordinated voice, the retailers can make their case far better than in a one-off fight.”

 

Of course, it’s not just about retailers coming together to stop the black market, not when lawmakers are the ones responsible for raising excise taxes and creating the disparity that fuels black-market trade.

 

“I would suggest that the lawmakers fully understand the adult consumer and their buying habits,” Brown says, citing that tobacco taxes have forced many to shop for lower-priced (and often illegal) options. “Lawmakers need to know that each time that they increase the tax, they are creating an even increasing demand for products through the black market.”

 

This illicit activity directly contradicts the frequent goals legislators cite for increasing tobacco taxes: to deter people—especially youths—from smoking and raise money for state and local governments. 

 

“Bans and increased taxes create the demand for black-market products … and the black market does not check ID,” Beckwith says. “In fact, the black market exposes youth to other illegal products as well.”

 

On the flip side, legitimate retailers such as c-store operators often join state and local governments in the fight to keep tobacco products out of the hands of minors. As such, Beckwith suggests that politicians need to recognize retailers as their allies in this fight.

 

While retailers working with the politicians who often push for taxes and regulations that often undermine their business may seem an unlikely alliance, Jones has seen firsthand how such collaboration can stymie the black market: Once accounting for as much as 33% of the tobacco market in 2008, Canada’s illicit tobacco trade is down to less than 20%.

“Retailers and manufacturers are intimately familiar with the supply chain,” he says. “Although we might not be experts in public policy or setting rules and regulations, we are experts in our business. 

 

“I think it’s critical that the legal manufacturers and retailers are involved with local governments so we can shut this trade down. We’re all in this together.”