Extras on Excise: How Far Will People Go for Cheaper Cigarettes?

California voters’ passage of Proposition 56,which increases the state’s cigarette excise tax from $0.87 to $2.87 per pack of 20 beginning April 1, 2017, may be seen as an opportunity for the state to generate extra revenue while taking a stance against tobacco use. However, the state may be faced with other problems from the tax increase — corresponding increases in cigarette smuggling and tax evasion.

Dealing with smuggling and tax evasion is a common issue for states with higher cigarette taxes. As of 2013, New York was ranked number one for the highest rate of smuggled cigarette consumption in the U.S. at 58 percent, according to the Tax Foundation. California was ranked sixth at 31.5 percent.

While California is no stranger to cigarette smuggling, the upcoming $2 increase may spur more activity as neighboring states have tax rates more than $1 lower than California’s new tax. Nevada’s tax is $1.80 and Oregon’s tax rate is $1.32. Dedicated smugglers willing to travel longer distances could go to Colorado, Idaho or Wyoming, where cigarette taxes are under $1, to purchase cigarettes to resell back in California and make the most profit.

Some states have created task forces to combat cigarette smuggling. For example, New York implemented a special strike force in 2014 to combat illegal tobacco trafficking and sales.       

Although California has not created a task force, the California State Board of Equalization (BOE) inspection teams have detected an increased number of “schemes” involving the collection and reuse of used cigarette tax stamps. Cigarette tax stamps are used solely for indicating that the tax has been paid and are not collectable items; therefore, according to the BOE, the only reason to collect these stamps is to evade taxes on other cigarette packs.

Cigarette distributors in California pay the tax through the purchase of tax stamps, which are affixed to each cigarette pack before they can be circulated or sold. But under the schemes identified by the BOE, legitimate cigarette tax stamps are being removed from tax-paid cigarette packs and then reaffixed to untaxed cigarette packs. This allows individuals, often cigarette retailers, to avoid paying taxes and gives them the ability to mask cigarettes that are “duty free, counterfeit, stolen or smuggled.”

In an attempt to discourage the unlawful use of cigarette tax stamps and limit tax evasion, the California State Legislature passed A.B. 1901, which amends Cal. Rev. & Tax. Code § 30473.5 and extends cigarette tax penalties to include the use of “unaffixed” used tax stamps. Unaffixed stamps are those stamps that a licensed distributor has previously paid the tax on and the stamps were attached to a package and later removed. Unaffixed stamps do not include unused and unapplied rolls of stamps that licensed distributors have obtained from the BOE and currently possess.

The amended § 30473.5 imposes misdemeanor penalties based on the amount of false, fraudulent or unaffixed stamps or meter impressions a person possesses, sells or offers to sell, or buys or offers to buy. The severity of the penalty depends on the number of stamps or meter impressions at issue and ranges from a fine up to $5,000 or imprisonment up to one year, or both, for a quantity under 2,000, or a fine up to $50,000 or imprisonment up to one year, or both, for quantities of 2,000 or more.

In addition to A.B. 1901, Proposition 56 includes additional appropriations, funded by the revenue generated by the tax increase, to support efforts to combat tax evasion and cigarette smuggling. However, only time will tell if these measures and California’s amended law will be enough to suppress “buttlegging.”

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Are California’s legal penalties enough to deter cigarette tax evasion?

With a free trial to Premier State Tax Library, practitioners have a single trusted resource that provides all of the tools and information they need to develop and implement the right tax strategies.