Online Cigarette Sales Hurting State Revenues

Nineteen states have hiked tobacco taxes this year, causing scores of smokers to buy “tax-free” cigarettes over the Internet. States are trying to collect taxes on these sales, but a federal law that could help them isn’t being effectively enforced, officials say. As a result, some states, especially those with high tobacco taxes, say they’re being shortchanged by this surge in online sales.

Internet tobacco sales are expected to reach $5 billion nationwide by 2005, but states stand to lose approximately $1.4 billion in revenue from these sales, a research firm cited in a recent report by the General Accounting Office said.

Taxing online tobacco sales is complicated. Under a 53-year old federal law, cash-strapped states are collecting what taxes they can, but they often lack the resources and legal authority to do it. “State law doesn’t extend into other states where retailers are located,” said Jim Jenkins, chief of alcohol and tobacco enforcement for the Wisconsin Department of Revenue. “We need federal assistance.”

The law in question is the Jenkins act (not related to the Wisconsin official), which was enacted in 1949. It requires online retailers to provide sales records to states where the goods are shipped so states can collect excise taxes.

However, violation of the act is only a misdemeanor with a penalty of $1,000, six months in prison or both. The act is supposed to be enforced by the Department of Justice and the FBI, organizations that have greater priorities, such as fighting terrorism, some state officials say.

No online cigarette vendors have been prosecuted for Jenkins act violations, the GAO report said.

To remedy the situation, the GAO recommended transferring enforcement of the Jenkins act to the federal bureau of Alcohol, Tobacco and Firearms.

“We’re recommending that Congress give enforcement authority to the ATF” said Paul Jones, director of tax and justice issues at the GAO. He added that both the DOJ and ATF suggest that if violations were a felony, rather than a misdemeanor, U.S. attorneys’ would be more willing to investigate and prosecute.

U.S. attorneys in Iowa and Wisconsin responded with a cold shoulder when state officials wrote letters requesting federal intervention.

“They just told us to use our administrative means, but we have none,” Jenkins said.

At least seven states Alaska, California, Iowa, Massachusetts, Rhode Island, Washington and Wisconsin have tried to enforce the Jenkins Act on their own. They’ve called and written letters to consumers and online cigarette retailers notifying them of their responsibilities to pay taxes and comply with federal law.

Some online retailers simply don’t respond. Others claim immunity from the Jenkins act because of Native American status. Roughly half of online cigarette retailers are Native American-owned, according to Eric Lindblom, manager for policy research at the Campaign for Tobacco-Free Kids, an advocacy group located in Washington, D.C.

According to the GAO report, Native American status doesn’t relieve retailers of Jenkins act responsibilities. “Our legal folks found nothing in the act that would prevent (online retailers) from adhering to the law,” the GAO’s Jones said. “If no enforcement is taken they can continue to violate the law.”

A New Jersey legislator has taken a different approach. State Sen. Peter Inverso recently proposed legislation requiring shippers such as Federal Express or UPS — not online retailers, to ensure that cigarettes shipped into his state are labeled as tobacco products. Inverso’s bill would require shippers to check the consumer’s ID upon delivery to verify age and also to submit an invoice to the New Jersey department of taxation so the state could collect due taxes.

The bill, originally intended to deter minors from buying cigarettes online, would also help the state collect revenue lost to Jenkins act noncompliance.

“The current enforcement mechanism isn’t effective,” said Steven Cook, Sen. Inverso’s chief of staff. “We’re targeting shippers because we know they will fall under our jurisdiction.”

Cook estimates that New Jersey could face a revenue shortfall of more than $2 million because of Jenkins act non-compliance this fiscal year.

Though some states recouped nominal amounts of cigarette taxes, most of their Jenkins act enforcement efforts have proven futile, state officials say.

Some examples:

• California regained $1.4 million in the past fiscal year, but losses from noncompliance with the Jenkins act amounted to nearly $15 million since 1999, state officials said. This figure is only a fraction of the $1.2 billion generated annually by the state’s 87 cents-per-pack cigarette tax. But it’s still a significant sum, said Vic Day, complaint supervisor for the California Board of Equalization.
• Wisconsin, with a 77-cents-per-pack tax, recouped about $2.8 million in the past fiscal year. Steps to enforce Jenkins act compliance regained $80,200 since1997, but the department of revenue estimates that Wisconsin lost approximately $118,000 from noncompliance last year.
• Iowa, which hasn’t raised its 36-cents-per-pack tax since1991, has lost revenue, too. But the state doesn’t track losses specifically due to Jenkins act noncompliance. “Our loss isn’t growing as fast as states where they’re raising their (tobacco) taxes,” said Dale Thede, program manager at the Iowa department of revenue and finance.  

States with higher cigarette taxes lose money because of Jenkins act noncompliance, among other factors such as organized smuggling and a drop in cigarette sales in their states. But statistically, these losses are nominal in comparison to revenue gain.

“When a state raises cigarette taxes they always raise revenue,” Lindblom said. “Even with all that loss, they still make a ton more money.”