Tobacco road: It’s a term that historically referred to the tobacco-producing region of North Carolina. But it has taken on a much more nefarious meaning as lower-taxed states such as Virginia have become an origin point for those looking to make a quick profit smuggling cigarettes into the highly taxed Northeast.
According to a British Medical Journal study last year, nearly 50% of black-market cigarettes missing New York tax stamps came from Virginia. The reason is clear: New York boasts the highest cigarette excise tax in the country ($4.35 per pack) vs. Virginia’s 30-cents-per-pack rate (the second lowest in the nation). Given the states are separated by mere hours by car, trafficking cigarettes from Virginia and into New York and New England has become quite the lucrative business.
It’s not surprising that retailers and law enforcement officials in New York take this issue seriously. “It siphons legitimate sales and gross margin dollars away from tax-collecting stores,” says Jim Calvin, president of the New York Association of Convenience Stores (NYACS).
What is surprising is how seriously Virginia is taking the smuggling issue. It might seem easy to downplay black-market cigarettes as a problem New York regulators brought upon themselves, but Ken Mosley of the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives in Richmond, Va., says the ramifications are surfacing in his state.
“It’s an immense problem here … a huge organized-crime problem in this state,” he recently told the Richmond-Times.
New York and Virginia are far from alone in recognizing the severity of the rapidly growing cigarette black market. Major manufacturers such as Altria Group Inc., Richmond, Va., and Reynolds American Inc., Winston-Salem, N.C., have invested time and money into stamping out illicit trade (despite the fact that, technically, cigarette manufacturers do not actually lose money when cigarettes are bought in one state and smuggled into another).
“People will say that we’ve made the money off a sale of Marlboros in Virginia that are trafficked to New York,” says Michael Thorne-Begland, director of Altria’s brand and trade channel integrity department. “They are right—we have, and that’s why we believe we have a role to play in fighting the illicit trade in tobacco. We also recognize that when illicit pipelines get built, it doesn’t matter if it’s smuggled cigarettes from Virginia or counterfeit Marlboros from China. An illicit market can gain a foothold and become a significant business threat.”
“Illicit trade has a negative impact on the entire supply chain: manufacturers, wholesalers and retailers,” says Bryan Hatchell, Reynolds’ director of communications. “There are retailers and wholesalers across the country trying to make an honest living, and we are committed to supporting them. Anytime we can secure their long-term existence, it also helps us.”
With so much money on the line and substantial price differences between high-tax states and lower-tax states, combating the illicit tobacco trade is not easy. It can’t be eradicated by Big Tobacco’s deep pockets, nor by the efforts of retailers and law enforcement in states with the highest rates of cigarettes being smuggled in.
“You can’t look at what illicit trade can do to the market and somehow think you’re immune to it,” says Thorne-Begland. “We all collectively have a problem. What are we going to do about it?”
Illicit Trade
The amount of money black-market cigarettes cost New York retailers is not news. However, the potential downside for export states is something that’s only recently begun to attract attention.
“While Virginia is a source state for products that go up to New York, with that comes elements that Virginia doesn’t want,” Thorne-Begland says. “In the past several months, the state’s had a rash of carjackings, burglaries and more, all targeted at the illicit cigarette trade.”
Once limited to luring smaller mom-and-pop players buying just a few cartons at a time, the low excise tax is now drawing in new, seedier players, according to Virginia law enforcement officials. These organizations often buy or open small tobacco, grocery or convenience stores to use as fronts for the trafficking rings. At times, they graduate to more serious forms of illicit trade, including firearms, automobiles, hard drugs and even human trafficking.
Mosley said these groups are increasingly leading to violence within the state: four men were charged in a recent Richmond case in connection with carjackings and robberies of cigarette wholesalers, and the Richmond-Times cited at least one murder that could be tied to cigarette trafficking. In Virginia, Mosley says, “the violence is increasing.”
“Profits from illicit cigarette trades are really funding organized crime,” Hatchell says. “It’s one of those low-penalty crimes with high returns.”
Law-enforcement agencies aren’t the only entities dealing with the criminal element. It’s not uncommon for smugglers to turn to c-store retailers to meet their export needs. “What you have in a state like Virginia is pressure on legitimate retailers to sell products to bad guys,” says Thorne-Begland.
All too often, selling to the bad guys can lead to a sales clerk violating manufacturer trade programs or even federal law. Retailers are legally required to produce documentation when more than 50 cigarette cartons are sold. Smugglers obviously don’t want that and will often attempt to bribe clerks to make a larger purchase, which can result (and has resulted) in federal charges and the severing of partnerships with major manufacturers.
“We’ve had to end dozens of relationships in Virginia because of these activities,” Thorne-Begland says.
Regardless of how low excise taxes are, it’s nearly impossible to survive as a c-store operator without the ability to sell Marlboro or Camels.
“Whether you’re an import state or an export state when it comes to illicit trade, retailers have a critical role in combating this crime,” Hatchell says. “This is an issue that can affect their bottom line and long-term success. This crime causes retailers to pay higher insurance rates and fund additional security measures, and jeopardizes the safety of their employees.”
CONTINUED: Battling Back
Battling Back
Unfortunately, there’s only so much manufacturers and retailers can do to combat the driving factors behind the cigarette black market. That falls to state and local legislatures.
“From our perspective, the driver really is taxes,” says Thorne-Begland, citing high-tax states and even cities such as New York and counties such as Cook, which includes Chicago. “If you look at what taxation has done to price and look at the corresponding amount of illicit trade in those jurisdictions, there’s a direct correlation.”
From Hatchell’s perspective, it’s not necessarily an issue of taxes, but of varying tax rates. The problem really occurs when individual states, cities or counties enact drastically different rates, creating a market in which the cost of a pack of cigarettes can vary by as much as $10 over a matter of miles.
“Criminals are quick to seize upon it, and it’s the retailers who suffer,” he says.
Many believe that there’s only so much that can be done from an enforcement standpoint so long as a drastic price discrepancy remains.
“Given limited resources and the pervasiveness of the problem, it’s impossible to make any meaningful impact,” Calvin of NYACS says about New York’s smuggling rate. “The horses are out of the barn and long gone.”
Perhaps it’s a case in which the best defense is a good offense. “We’re constantly trying to spread the word that this is something that needs to be addressed nationwide as you have these price differentials between states,” Hatchell says. “Regulators need to understand the unintended consequences of the tax strategies that they’re implementing.”
Thorne-Begland says it’s equally important for retailers and wholesalers—not just manufacturers—to talk with their local legislatures when an increase is proposed.
“We don’t control taxes,” he says, “but we certainly weigh in on them.” It’s a message regulators seem willing to hear. In 2014, 25 states proposed raising cigarette or tobacco excise taxes. However, Vermont was the only state to actually enact a cigarette tax increase, and it raised the rate by only 13 cents per pack.
“It’s starting to garner the attention in the legislatures it deserves,” although it’s too early to credit 2014’s lack of tax increases to an awareness of cigarette smuggling, Hatchell says. “The message is getting out, but there’s a lot more work to be done. “Legislators and law enforcement need to recognize the serious nature of this crime and the impact it has on communities as a whole,” he continues. “It’s not a victimless crime.”
And it’s not going away anytime soon—not when the risk-reward potential is so skewed in favor of the criminal perpetuating the new tobacco road.
“Booming business in high-tax states like New York has given the black marketers a foothold and the opportunity to grow more sophisticated,” Calvin says. “They’re ready at a moment’s notice to pounce in the next state that decides to overtax cigarettes, luring smokers away from tax-collecting retailers.”
Despite the uphill battle, despite the millions of dollars and man hours already spent fighting an issue that right now doesn’t actually cost them sales, it’s a war manufacturers such as Altria will continue to wage.
“It’s worth it to the long-term bottom line for us to invest in protecting the legitimate distribution channel,” Thorne-Begland says. “If the legitimate trade channel is compromised, our ability to succeed is also compromised.”
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