Special Report: Tobacco on Fire Pt. 2

With cigarette and OTP prices about to hit new record highs, the black market may flourish

Published in CSP Daily News

By
Mitch Morrison, Vice President & Group Editor

Editor's Note: This is the second of a four-part CSP Daily News series on how the industry is reacting to the federal excise tax on tobacco that begins in April.
HURON, Ohio -- It's a sore point for Kit Dietz: Canadian tobacco. More specifically, could Canada's Draconian laws come to the United States?

It's a subject Dietz, a longtime industry expert and consultant, has tracked in recent years. "Whenever you get taxation to reach a point it's reaching today, the illicit markets are going to develop. To what point we don't know, but we all better be keeping a [image-nocss] watchful eye," he told CSP Daily News.

"That risk vs. reward is greater now," Dietz said during an exclusive interview. "The risk of getting caught hasn't changed, but with the increased FET, the reward has become much greater." [See related story about cigarette bootlegging in Florida elsewhere in this issue of CSP Daily News.]

Dietz is talking about April 1, when a dramatic federal-excise-tax (FET) increase kicks in on virtually all tobacco segments to finance expansion of the State Children's Health Insurance Program (SCHIP). Among the increases:
A pack of cigarettes jumps from 39 cents to more than $1. A pack of little cigars soars from 4 cents to more than $1 In the biggest hit, the levy on roll-your-own tobacco skyrockets from $1 a pound to nearly $25. The news reminds Dietz of the dramatic tax hikes and merchandising restrictions in Canada that propelled him to complete an authoritative report about the risks facing the U.S. tobacco industry.

In a column that ran in the August 2008 issue of CSP Magazine, Dietz wrote, "In some areas, taxes on a carton of cigarettes are creeping toward $40 (Canadian) and in the Northwest Territories, they have reached $42. In some provinces, tobacco products must be hidden behind doors or other barriers or in drawers. No advertising signage is allowed. Health warnings on packaging are even tougher and must be more prominent than in America, consuming the majority of space on cigarette packs."

With an additional $6.17 tacked to a carton's federal excise tax, Dietz believes the U.S. may be hitting that threshold when the black market could surge as a viable consumer alternative to in-store purchases. "In Canada, legal consumption has declined by 9%, but the actual percent of smoking consumption has fallen by only 3%-3.5%," he said. "That means that most of those smokers that the government says aren't smoking are smoking but are buying cigarettes from the black market and not from their convenience stores."

The majority of the illicit cigarettes being consumed in Canada are not national brands, but cigarettes manufactured on the Native Reserves, sold 200 sticks in a zip-lock bag. The provinces with the highest incidence of illicit sales are not the provinces with the highest tax rates. Proximity to the Native Reserves is driving illicit sales in Canada. Organized crime has become the distribution system.

"That's what could happen in states like New York," said Dietz. "When the federal tax was $3.90 a carton, cigarettes manufactured on the reservations weren't a big seller, but with the FET moving to $10 a carton, there is always the potential that they could shift their focus."

Implicitly underscoring this concern, the federal SCHIP measure creates a new section called "Treasury Study Concerning Magnitude of Tobacco Smuggling in the United States." The legislation directs the Secretary of the Treasury to conduct a study to be submitted to Congress that reports on the "loss of Federal tax receipts due to illicit tobacco trade in the United States and the role of imported tobacco products in the illicit trade in the United States."

For Dietz, his concern is that legal tobacco trade be protected in the United States, a challenge exacerbated by the SCHIP legislation and recent Congressional movement to place tobacco under the oversight of the Food and Drug Administration.

"The decline rate of smokers isn't steepening in Canada, illicit consumption is rapidly increasing," he said. "The FET will have a negative impact on consumption. We need to protect the legal volume in the channel for legitimate manufacturers, distributors and retailers and take a united stand against illicit product sales in the U.S."

For more about SCHIP and its impact on c-stores, see the April issue of CSP Magazine.

For a breakdown of how bootleg cigarettes are most often sold, click the "Download Now" button below.

By Mitch Morrison, Vice President & Group Editor
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