Heightened black market activity due to cigarette smugglers continues to rob c-stores of tobacco revenue.
By Anne Baye Ericksen, Contributing Editor
Earlier this year, U.S. Customs & Border Patrol, in conjunction with U.S. Immigration and Customs Enforcement and Homeland Security investigators, took possession of six million counterfeit cigarettes during a warehouse inspection in Florida, with a street value of more than $1 million.
In May 2017, authorities from more than 20 federal, state and local agencies concluded a year-long investigation into illicit cigarette trafficking in Virginia. The bust culminated in 43 arrests, 743 separate charges and shuttered a scheme that involved more than 600,000 cartons of cigarettes worth in excess of $30 million.
Both cases are examples of the nation’s burgeoning cigarette black market. What the news bites don’t reveal is the impact such illegal activities have on convenience stores’ tobacco profit margins. The cigarettes in question are considered smuggled because the people who sold them didn’t pay taxes to the states they live in.
“With high state cigarette and tobacco excise tax rates, cross border purchasing and illicit trade between low-taxed and high-taxed states is a growing concern,” said Thomas Briant, executive director of the National Association of Tobacco Outlets (NATO).
Smuggling continues to chip away at the industry’s most valuable category, no matter the U.S. region.
“The black market for cigarettes is extremely damaging to legitimate retailers in a couple of ways. First, it reduces sales at the stores of responsible retailers, and second, it makes it easier for youth to access these age-restricted products,” said Jonathan Shaer, director of the New England Convenience Store and Energy Marketers Association. “Worse still, it’s extremely difficult to quantify the direct financial impact linked to the black market as it doesn’t occur in a vacuum.”
IN THE BLACK
The National Association of Convenience Store’s (NACS) preliminary State of the Industry report released this year indicates that, despite cigarettes still accounting for a large portion (28.6%) of inside sales last year, the tobacco category has shrunk by 8.3% since 2011.
According to Nielsen data, reported by Wells Fargo Securities, unit sales of cigarettes in all retail channels dropped 4.6% for the four weeks ending April 21, and 4.4% for the previous 12 weeks. Prices during that period rose 2.4%, but not enough to counter volume losses, which in turn resulted in a 2.3% decline for dollar sales. Cigarette sales in c-stores for the same four weeks mirrored national numbers: down 4.3% in volume and 2.4% in dollar sales.
But a smaller smoking population is only one factor affecting product performance. The black market steals sales, too. From shipping thousands of contraband cartons to hustling individual cigarettes, black-market distribution takes on many forms.
“Some [traffickers] will fill their trunks with cigarettes from Virginia by going store to store and purchasing the legal maximum, and then drive to Manhattan where they put the cigarettes in their backpacks or bags to sell on the street, said Michael LaFaive, senior director of Morey Fiscal Policy Initiative with the Mackinac Center for Public Policy.
Take New York state as an example: Several studies rank it with the highest cigarette smuggling rates year after year. In fact, some estimates show that more than half of the cigarettes smoked within its borders are purchased illicitly.
“The tax foundation says nearly 57% of cigarettes consumed in New York state are purchased from unregulated, untaxed sources,” said Jim Calvin, president of the New York Association of Convenience Stores.
Researchers at the Mackinac Center estimate the black market cost the New York government at least $1.5 billion in excise tax revenues in 2016. For c-stores each illegal cigarette carton sold represents more than just one missed tobacco transaction.
“Our members have been crippled by precipitous drops in sales of tobacco and ancillary products due to tobacco customers suddenly shifting their purchases to smugglers and other untaxed outlets to avoid exorbitant taxes,” said Calvin.
As cigarette sales suffer, so do larger basket transactions.
“All of us know fewer trips to our neighborhood facilities impact our overall ancillary sales in other categories, such as snacks, grocery items, beverages, hot prepared foods, and of course, fuel purchases,” said Lance Klatt, executive director of the Minnesota Service Station & Convenience Store Association.
Not every state struggles with an extensive illegal cigarette trade. According to data from the Mackinac Center, Nebraska, Pennsylvania, South Carolina and Tennessee have little illicit activity. That said, analysts suggest there’s a reasonable correlation between the rate of taxes in a state or local municipality and the level of smuggling a community experiences.
“We update our estimates on an annual basis, and in the states with high taxes, make no mistake, there are competitors that do not follow the law, especially those with larger border populations,” said LaFaive. “In states like New York, not only is there a high state excise tax, but retailers in cities like Manhattan also deal with a city tax. They are almost compelled to participate in the illicit market so as not to lose complimentary goods sold with tobacco products.”
New York state excise tax currently sits at $4.35, tied with Connecticut for the highest in the country.
“Effective June 1, New York City is imposing a new excise tax on cigars and other tobacco products (OTPs), new minimum prices on cigars ($8 per stick) and other OTPs, and a higher minimum price on cigarettes ($13 per pack),” said Calvin. “These price spikes will drive even more consumers into the waiting arms of the street dealers.”
While New York holds the dubious honor of incurring the highest smuggling rates, it is certainly not alone. Rounding out the top five states incurring the highest incoming smuggling rates for 2016 included: Arizona (44%; state tax $2); Washington (43%; state tax $3.025); New Mexico (41%; state tax $1.66); and Minnesota (35%; state tax $3.614).
“Tobacco purchases in [Minnesota] have decreased by nearly 30% in the past two years due to high tobacco taxes,” said Klatt.
Conversely, New Hampshire boasts the greatest number of cigarettes taken out of the state. For every 100 cigarettes smoked in the state, another 86 are transported elsewhere.
Complicating matters is the fact that when legislators look for ways to recoup falling tax revenues associated with shrinking cigarette sales, they often land on the solution of raising taxes on more tobacco products. According to NACS research, 26 states have hiked cigarette taxes over the past five years.