Cigarette Smuggling Costs States Billions in Forgone Tax Revenue

TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. avoidance is a natural consequence of tax policy. For about as long as there have been excise taxes on cigarettes, illicit market operators have been smuggling the easily transportable products. The cumulative impact of annual smuggling since 2007, the first year for which we have historical data, demonstrates the severity of the issue.

Over this 17-year period from 2007 to 2023, the total loss from net cigarette smuggling exceeded $83.8 billion, which amounts to an annual average loss of $4.93 billion.

States with high cigarette tax rates have experienced the greatest losses from cigarette smuggling. New York has been the biggest loser by far, forgoing $21.95 billion in revenue. California has lost out on the second most, forgoing $14.27 billion. Texas ($7.50 billion), Washington ($4.50 billion), and Michigan ($4.39 billion) round out the next biggest loser states.

Overall, 32 states have suffered net inbound cigarette smuggling (meaning cigarettes are purchased elsewhere and brought into the state) since 2007, and 15 of those have lost out on more than $1 billion of tax revenue.

Conversely, 16 states have experienced net outbound smuggling since 2007 as business has been driven to consistently low-tax states (Alaska and Hawaii are not included in the analysis). New Hampshire has experienced the biggest gain from net cigarette smuggling, generating more than $1 billion in revenue from cigarettes purchased there but consumed elsewhere. The next largest gains were in Indiana ($848 million), Virginia ($574 million), and Delaware ($382 million).

Major Changes

New Hampshire took in an estimated $46 million in additional tax revenue from cigarette smuggling in 2023, bringing the cumulative total for the state to more than $1 billion since 2007.
North Carolina was added after cigarette smuggling data began reporting there in 2023, which means the state’s cumulative total only reflects one year for which there is data.
New York retained its status as the largest cumulative loser from cigarette smuggling, but California continues to close the gap.
Maryland overtook New Jersey in cumulative forgone tax revenue after losing out on almost $180 million in tax revenue from cigarette smuggling.

Tax rate differentials between states are a primary driver of cigarette smuggling. The larger the difference in tax rates, the more money that can be saved by driving across state lines to purchase products in lower-tax jurisdictions. Sometimes this happens “casually,” with individuals cross-border shopping for cigarettes for personal consumption in nearby low-tax states (tax avoidance), while other times this happens “commercially” via a large-scale criminal enterprise (tax evasion). These organized criminal enterprises, often operating out of China, may counterfeit tax stamps, sell counterfeit cigarettes, or deal in prohibited products.

Other policies, like flavor bans or bans on sales to young adults, also yield smuggling of prohibited products from either states without a ban or illicit operators that merely view a ban as a grant of market share to the illicit market.

The rest of the states in the New England region show no signs of slowing their tax and prohibitionary policies that drive business to New Hampshire. However, a recent drastic tax hike in Indiana will likely reverse much of the smuggling the state experiences and will be an interesting case study when the data for 2025 and 2026 are available.

The most recent data for 2023 show that the net effect of cigarette smuggling into US states was a loss of more than $4.4 billion in forgone tax revenue. This is slightly less than the historical average of $4.93 billion from 2007 to 2023, likely due to declining cigarette consumption.

The cumulative impact of net inbound smuggling over the historical period, $83.8 billion, is much greater than the cumulative impact of net outbound smuggling, at only $4.31 billion. The tax revenue gained from smuggling is much lower due to both the legal sales occurring in jurisdictions with lower taxes and the large share of illicit sales of counterfeited cigarettes or those smuggled from other countries like China or Mexico.

Cross-border shopping tends to be a zero-sum economic activity since domestically produced cigarettes are still being purchased legally. This still undermines some of the intended discouragement of smoking from high excise taxes by lowering the effective rate. It also disrupts funding meant to address any externalities from cigarette consumption by decoupling the state generating tax revenues from the state where the consumption takes place. However, all the gains from trade stay within the US, and the total tax burden on the market is lowered.

Larger problems, both for public health and state revenues, are introduced by international smuggling and counterfeiting. Hundreds of millions of cigarettes are smuggled into the US from international sources every year through sophisticated global smuggling distribution networks. Cigarette smuggling is a highly profitable, but comparatively low-risk, criminal enterprise that generates billions in profits. Sometimes, these profits are funneled to more dangerous activities, like global terrorism. Counterfeit cigarettes tend to be much more dangerous to consumers, often containing highly elevated amounts of lead and other heavy metals, insect eggs, or even human feces.

Cigarette consumption has been steadily decreasing for about 50 years, which means state tax revenues tend to decrease if the rate is held constant. Facing consumption declines, many states periodically hike their tax rates to make up for those losses. This often yields a temporary spike in revenues but tends to push legal consumption down further while the overall consumption trend remains unchanged. Ultimately, revenues tend to decrease faster as consumption continues to fall and more of the remaining consumption switches to black or gray markets. States that have historically chased revenues with tax increases seem to suffer most from cigarette smuggling.

While taxes and flavor bans have been minimally effective at encouraging smokers to quit, the introduction of alternative tobacco products (ATPs), like vaping or oral pouches, has enabled the consumption of nicotine but with substantially less harm than combustible cigarettes. As ATPs have gained market share, many states have incorporated them into their tax scheme. These products, too, are smuggled to avoid those taxes or prohibitions. The vaping market is an especially striking example of the avoidance of prohibition, with most of the vaping in the US done with illegal products imported from China.

The history of prohibition and smuggling shows that, even with zealous enforcement efforts, the illicit market will find ways to supply in-demand products to consumers. Exorbitant taxes on products like cigarettes grant opportunities to illicit operators, predictably resulting in a shift away from legal purchases. Cigarette tax avoidance costs states billions in forgone tax revenue and necessitates additional spending on enforcement of the ineffective policies. Policymakers should consider the unintended consequences—both to public health and public coffers—of the excise taxes and regulatory regimes for cigarettes and other nicotine products.