States don t go after taxes owed on Internet cigarette sales

12/26/2007

MADISON, Wis. Wisconsin and other states either don t know who is buying cigarettes over the Internet and not paying state taxes, or they know and don t go after the culprits.

Some states, including Michigan, make high-profile attempts to collect taxes owed on cigarette sales. But even when they do, many Web sites skirt the law by operating overseas or on American Indian reservations where state laws are largely unenforceable.

Tracking down who bought what, and determining how much they owe, is a loophole that anti-smoking advocates and others want to see closed. The issue becomes even more important as states like Wisconsin continue to ratchet up their cigarette taxes, often earmarking the money to pay for rising health care costs.

Wisconsin s cigarette tax becomes the 12th highest in the nation on Jan. 1 when it goes up a $1 per pack to $1.77. The highest is New Jersey at $2.58 a pack.

Dramatically increasing cigarette taxes has become popular as states try to bring in revenue and motivate people to quit with the higher prices.

Research shows that steep tax increases generally impact those least able to deal with the higher costs teenagers and the poor while hardcore smokers with an Internet connection can easily get around it. And those who can find cheap smokes are far less likely to quit smoking. And that hurts states usual goals for raising taxes cutting smoking rates while also bringing in more tax money.

Just how much money is lost on Internet cigarette sales isn t known, but estimates vary wildly from $552 million to $4 billion each year.

Internet sellers typically buy their cigarettes in states with low taxes, or overseas or from Indian reservations, and then sell them to buyers in high tax states. Buyers are expected to pay the taxes and fees owed voluntarily. But that rarely happens.

The savings can be more than $20 per carton in some areas, and Internet vendors play that up in their sales pitches. Most cigarette Web sites don t mention state taxes.

No federal laws require the collection of taxes from Internet sellers, but those that sell across state lines are required to report the sales to state tax authorities.

That requirement is largely ignored. A 2002 study by the U.S. General Accounting Office found that most Web sites openly violate the law.

Even as states try to crack down and file lawsuits against known violators, most companies still do not comply, said Eric Lindblom, director of policy research at the Campaign for Tobacco Free Kids in Washington, D.C.

In 2006 popular online seller eSmokes.com entered into a settlement with New York City under which it submitted 12,500 names of customers from 2000 to 2003, when a New York State ban on Internet cigarette sales took effect.

E-mail messages seeking comment left with eSmokes.com and another site, cheap-smokes.biz, were not returned.

The best strategy for states is to stop the ability of Internet sellers to do business, Lindblom said.

That s what some states are doing.

Philip Morris USA, the nation s biggest tobacco company, agreed in 2006 to stop supplying cigarettes to illegal Internet and mail order dealers. In 2005 major credit card companies agreed to stop processing payments from Internet retailers. Major shippers DHL and UPS Inc. do not ship packages from the vendors.

The state of Maine in November argued a case before the U.S. Supreme Court defending its right to regulate shipment of cigarettes bought online in an attempt to curb youth smoking. The case also involves the collection of sales tax on Internet cigarette sales.

But the sales continue.

The 2002 GAO survey of 147 Web sites found that over half did not comply with a 1949 federal law that requires out-of-state cigarette sellers to provide names and addresses of people to whom they have sent tobacco products.

The GAO contacted 10 states with the highest cigarette taxes to see if they were collecting taxes owed on Internet sales. Seven of those states said most Internet sellers were not complying with federal law.

States are in a tough spot when it comes to collecting taxes owed on Internet sales, said Kurt Ribisl, an associate professor at the University of North Carolina s school of public health who has spent the past eight years studying the issue.

Forcing the constantly changing 800 or so sellers to submit sales information as required under federal law is nearly impossible, especially given that the majority of sites operate overseas or off Indian reservations, he said.

And when the information is submitted, states face a public relations nightmare pursuing taxes from the roughly 300,000 estimated smokers who buy online, Ribisl said.

States that have passed laws trying to force compliance, or to outright ban Internet sales, have not been widely effective, he said.

Even so, that hasn t stopped some states including Michigan, Illinois, Arizona, Connecticut and North Dakota from being aggressive about billing buyers for taxes owed.

But they have had limited success.

Illinois has gone after the taxes since 1999 and has collected $5.3 million to date from 33,264 buyers, according to the state s Department of Revenue spokeswoman Katie Ridgway. But she said the state has only received records of buyers from 18 Web sites.

Michigan has collected $34.9 million in cigarette taxes from 22,827 people who purchased over the Internet since 2005, said that state s Treasury Department spokesman Terry Stanton. Those names came from just five Web sites, and Stanton said he had no idea what percentage of Internet buyers they were capturing.

Between 1995 and 2005, the Wisconsin Department of Revenue mailed less than 1,500 letters to taxpayers who owed cigarette taxes because of Internet sales. In 2005, the department received information on about 6,000 people and sent out 1,000 letters seeking payment.

Mary Barsch, 80, of Milwaukee received one of those letters in 2005 saying she owed taxes on cigarettes she had bought over the Internet. Still a pack-a-day smoker, Barsch said once she found out that she was supposed to pay taxes on those cigarettes, she stopped buying over the Internet and instead gets them at the local grocery store.

Even when Wisconsin s tax goes up a dollar in January, Barsch said she s going to resist the urge to go back to the Internet to save money.

It wasn t right the first time so it wouldn t be right now, she said. Instead, Barsch said she ll try to curb her 57-year habit.

After an outcry from people on fixed incomes like Barsch who got the letters in 2005, Gov. Jim Doyle pulled back and said the collection effort would stop.

The state receives sales information from three Internet cigarette sellers, but Revenue Department Secretary Roger Ervin would not say how many people have been contacted who owe back taxes.

Doing that would neuter our ability to enforce the law, he said.

The department rejected a Freedom of Information request filed by The Associated Press seeking how many people had been contacted. The department said it could encourage noncompliance if buyers knew how many could potentially be audited.

Since 2005, the department has collected $1.4 million through enforcement efforts tied to Internet purchases made from out of state, which includes over the Internet, Ervin said.

Doyle said he doesn t think the Revenue Department should seek individuals who buy small amounts, but should watch for large buyers.

The only real way to tackle the problem is to enact a tough federal law and enforce it, Ribisl and others said. Attempts to rein in Internet sellers have failed in Congress.

Three other states cigarette taxes are also going up in 2008: Maryland on Jan. 1 to $2, Vermont on July 1 to $1.99 and Hawaii on Sept. 30 to $2. In 2007, taxes increased in 10 states. Between 2002 and July 2007, the average state cigarette tax more than doubled.

Wisconsin s higher tax is projected to result in an 80 percent increase in the state s cigarette tax collections over three years. It s hard to know how dramatically that will be decreased by buyers scared off by the higher tax who turn to the Internet.

Even accounting for those who continue to smoke by evading the higher taxes through Internet sales, history has shown that increased cigarette taxes are effective at reducing the number of those who light up, said Aaron Doeppers, director of the Midwest region for the Campaign for Tobacco-Free Kids.

That said, people should not be able to evade the law so easily, Doeppers said.

It s a loophole we would love to see closed, he said.