Tobacco Underground

Published — December 19, 2008 Updated — May 19, 2014 at 12:19 pm ET

SMOKE2U

Tobacco sales take off in cyberspace

Introduction

There’s something odd about PO Box 365, Irving, New York. Located on the Seneca Nation — nestled just at the Empire State’s southwestern tip — the box is the mailing address for at least 10 online vendors registered in far-flung locations, from New York City to Ankara, Turkey. Boasting names like BigChiefCigarettes.com, Smoke2U.com, and EZTobacco.com, the sites bear no apparent affiliation to one another, except that they all sell one product: untaxed cigarettes.

For years, tax-free cigarette sales on New York reservations have made the state among the country’s top destinations for discount smokes — and not surprisingly, either. With New York City home to the nation’s highest cigarette taxes, the tax-free trade offers a prodigious payoff for the enterprising cigarette vendor. (Between state and city taxes, a carton of cigarettes in New York City can cost up to $80; that same carton, untaxed, costs just $40.) There’s one problem, though: The trade is illegal.

In 2007, New York’s reservations — home to fewer than 17,000 people — sold a towering 6.4 billion cigarettes, leaving state revenue officials scrambling. Every year, the state loses nearly $1 billion in city and state taxes from reservation sales. While the Supreme Court has ruled that states can collect taxes on tribal sales to non-natives, ever since a violent Seneca protest beat back then-Governor Pataki’s attempt to enforce such taxes in 1997, successive governors have been loath to entangle themselves in the issue.

On December 15, though, with the state facing a projected $51 billion budget shortfall over the next four years, Governor David Paterson signed a law that mandates tax collection on reservation tobacco sales. Specifically, the law requires that cigarette manufacturers supply only wholesalers that certify their products won’t be resold, tax-free, to reservations (and in turn distributed through smoke shops and online vendors). But the bill’s impact remains to be seen. State officials would have to overcome past reluctance to collect taxes on reservation cigarette sales; Indian leaders this week, meanwhile, expressed vigorous opposition to the new law. The law, also, does not stop tribes from selling untaxed, native-manufactured brands.

The United States’ patchwork of state cigarette tax laws has long spurred a brisk industry of cross-state smuggling. It’s not hard to see why: While the tax in a tobacco state like South Carolina is a low 7 cents per pack, the rates in a high-tax state like New Jersey are up to 36 times higher. In the 1960s, mobsters such as John Gotti — the flamboyant “Dapper Don” of Mafia fame — were known to capitalize on the trade’s vast profit margins, bootlegging cigarettes across state lines.

But these days, with the advent of the Internet, it has become a lot easier to jump into the bootlegging game: All it takes is a modem and access to a post office. Likewise for smokers, tax-free cigarettes are just a handful of clicks away.

Over the past decade, as cigarette taxes have soared throughout the United States — rising an average of nearly 90 percent between 1998 and 2002 alone — websites catering to tax-dodging smokers have proliferated. In 2006, an estimated 772 sites were selling to U.S. consumers, up from just 88 in 2000. According to Jeff Cohen, associate chief counsel for the Bureau of Alcohol, Tobacco, Firearms and Explosives’ (ATF) Northeast division, it’s common for entrepreneurs to maintain five or six differently branded websites to drive traffic, “even though they’re just shipping from one address.”

Some sites are based in low-tax states such as the Carolinas; others sell duty-free packs from overseas. Increasingly, overseas cigarette vendors drive traffic: The number of sites based overseas jumped from at least 10 percent in 2003 to over 45 percent by 2006, according to Kurt Ribisl, an associate professor at the University of North Carolina’s Gillings School of Global Public Health, who has extensively studied online sale patterns.

In the United States, the real action is taking place on Indian reservations. As of 2005, nearly two-thirds of websites had some apparent affiliation with Indian reservations. For western New York’s Seneca Nation, in particular, the online business has developed into the tribe’s cash cow. Together, two Seneca reservations accounted for over three-quarters of all Indian websites in 2005. A 2003 tribal study found that fully 95 percent of Seneca sales were conducted over the web or phone (the rest were sold over-the-counter in reservation shops).

The opportunities are such that even those who cannot claim tribal heritage have allegedly sought to exploit the status it confers. This September, shopping plaza developer and former New York City bus driver Joseph Roosa was charged with using a resident of the Allegany reservation as a front for an online cigarette business that sold $4.9 million worth of tax-free cigarettes throughout New Jersey. (The case is still pending.) This July in another case, Lloyd Long pleaded guilty to using a similar ruse to purchase tax-free cigarettes for sale on two online sites, EZsmokin.com and MightySmokes.com.

Websites catering to tax-dodging U.S. smokers jumped from just 88 in 2000 to some 772 in 2006.

Beyond lower prices, online sales also offer smokers broader options, including popular discount brands such as Seneca and Niagara. That, in part, may help account for why Philip Morris has been among online sellers’ chief opponents, filing more than 20 different suits against such retailers in recent years. The company has also actively pushed model legislation to curb online sales in states around the nation. Over the past decade, about 40 states have passed laws to limit or ban the direct shipment of tobacco products to consumers, to varying effect. (In 2007, the Supreme Court, citing concern about interstate commerce interference, struck down a Maine law that required shipping companies to verify a recipient’s age before delivering tobacco to a home address.)

To fight the trade, meanwhile, state officials have turned to the obscure 1949 federal Jenkins Act, which requires all vendors to report cigarette sales to the relevant state tax authorities. Failure to submit reports, though, is only a misdemeanor. Accordingly, almost no cigarette vendors bother to file, and once the packs are delivered, few consumers remit the owed taxes, either. Some do not realize they are still required to pay taxes on Internet purchases, while others take a more generally cavalier attitude toward the law. As Patrick Fleenor, chief economist at nonpartisan research group the Tax Foundation, puts it, buying untaxed cigarettes online “is still not really considered a crime, but more like a form of bargain shopping.”

But opponents of the online cigarette trade charge that sales aren’t so innocuous, and that they can spur addiction among underage smokers: “We spend all this time trying to stop kids from buying cigarettes at 7-Eleven, when they could more easily be at home buying cigarettes with their mom’s credit card,” said Marlene Trestman, special assistant to Maryland’s attorney general. Few online vendors verify purchasers’ ages, and one 2005 western New York study found 6.5 percent of ninth graders had made at least one cigarette purchase online. Likewise, opponents say, low online prices discourage smokers who might otherwise be pushed by high taxes to kick the habit.

And though thumbing your nose at the taxman may be a quintessential American sport, the overall tax losses add up — particularly at a time when at least 43 states are facing budget shortfalls. “There’s a mad dash right now to get money into state coffers,” said Timothy Quirin, an analyst at CCH, a private research group that tracks tax laws. “States are looking at any revenue stream they can tap into.” In 2005, online sales cost states an estimated $2 billion in lost taxes, according to ATF’s Cohen.

Virtually all online cigarette sales are illegal, for one or more reasons: Vendors do not take sufficient steps to confirm customers’ ages, fail to report their shipments under federal law, or — depending where they ship — they break laws prohibiting direct cigarette shipments to individual consumers.

Questions of jurisdiction continue to hamstring state efforts to reduce sales, especially given the prominence of reservation-based vendors. While the Supreme Court has ruled states have the legal right to require that cigarette retailers on reservations collect taxes on cigarettes sold to non-tribal members — and keep records for each sale — tribal sovereign immunity bars states from directly suing tribal governments for lost revenue.

Accordingly, states have sought alternate routes, cobbling together a strategy of pressure on retailers and consumers, as well as the shippers and credit card companies that help supply them. States such as California have used outreach to vendors, encouraging them to report their sales, or — in the event that strategy fails — subpoenaing or suing them to winnow out customer information. Using data gleaned from these efforts, in recent years over a dozen states have gone so far as to bill customers directly for unpaid taxes. Alaska, for example, has sent letters to roughly 5,000 delinquent taxpayers (including some tax bills for up to $30,000). Since 2005, Pennsylvania has billed 31,000 smokers for $26.3 million in unpaid taxes, and so far has retrieved $16 million in payment. Likewise, Connecticut has recouped at least $2.48 million through such efforts; Michigan, $12.5 million (out of a total owed $36 million); Wisconsin, at least $1.4 million; Oregon over $2 million. Those amounts, too, are only the tip of what is owed, given that states are only contacting customers of sites that have given up their information. The $26.3 million Pennsylvania is currently seeking, for example, represents losses from just a half-dozen sites.

Tax bills appear to have had some deterrent effect: Oregon officials report that while in 2005, about 2,500 smokers a month were frequenting two sites sued by the state — Smartsmoker.com and Ordersmokesdirect.com — today, that figure has dropped by more than half.

Authorities say it is difficult to know if the smokers simply switched websites, so they are also targeting vendors’ ability to ship and receive payment. In 2005, state attorneys general won a commitment from credit card companies and common carriers such as DHL and UPS to stop allowing their services to facilitate the trade. At the New York Department of Taxation and Finance, spokesman Thomas Bergin observes some successes from the agreement, noting that since hitting a high of 47.6 million cartons per year in 2005, overall shipments to reservations slowed to 31.9 million in 2007. One study likewise found that in the year following the agreement, the Internet purchase rate among smokers fell from 1.2 percent to 0.4 percent.

The crackdown has hit the Seneca reservation, where 1,500 people were once employed by the online business. Since 2005, though, Rick Jemison, spokesman for the Seneca Sovereign Partnership, said that many online shops have folded, leaving hundreds out of work.

Increasingly, overseas cigarette vendors drive traffic: The number of non-U.S. sites jumped from at least 10 percent in 2003 to over 45 percent by 2006.

Yet while credit card companies have pulled back, consumers can still pay by direct electronic banking transfer or personal check. What’s more, though common carriers have agreed to stop untaxed shipments, to date, the U.S. Postal Service has refused to accede to such an agreement. (Postal officials note that Priority Mail, which handles most cigarette shipments, can’t be inspected without a search warrant, and that “extraordinary resources” would be needed to enforce restrictions on tobacco mailings.)

Thus, even with states’ best diligence, cigarettes continue to slip through. “They [the Internet sellers] are resourceful,” said California Deputy Attorney General Laura Kaplan. “They always seem to be one step ahead of us.” In the latest development, she said, California secured an agreement with First Regional Bank to stop processing unlawful cigarette purchases — to her knowledge, the first of its kind in the nation. But as Kaplan notes, there are thousands of other banks out there who have yet to sign on.

Online sites are also moving offshore, beyond the reach of effective U.S. law enforcement. In one high-profile 2004 case, the ATF raided a cargo plane that touched down at John F. Kennedy Airport bearing 60 million duty-free cigarettes from a Switzerland-based company, Otamedia. The company’s original URL Yesmoke.com was shut down, but its operators simply packed up shop and today continue to do business from Italy.

“Websites used to be very clear about where their stated location was, but more and more, you can’t figure out where they’re from,” Ribisl said. According to his research, while about 50 percent of online cigarette sites are based in the U.S., in recent years, more and more sites have been appearing abroad as part of a complicated international supply chain. “A website might say it’s based in Irving, New York, and that the cigarettes come from overseas, like the British Virgin Islands. But then we’ll look at the actual shipping label when it arrives, and it might say ‘customs duty, Ireland.’”

U.S. authorities are hardly alone in feeling flummoxed by the trade. Canada, for example, has experienced a jump in Internet and mail-order sales, with related seizures rising by 151 percent to 1,610 from 2006-2007.

But given how one site can pop up as quickly as another is shuttered, suppressing the trade has become something of a global game of “whack-a-mole.” “We see a lot of sites operating outside the country: Moldova, Israel, Russia, Ukraine,” Kaplan said. Despite states’ best efforts, she said, “We haven’t noticed a real reduction in sales.”

To that end, advocates such as Representative Anthony Weiner, Democrat of New York, and the National Association of Attorneys General are actively pushing the optimistically titled Prevent All Cigarette Trafficking (PACT) Act, which would — among other provisions — make failure to report sales under the Jenkins Act a felony, ban mailings of tobacco through the U.S. Postal Service, and codify existing agreements with credit card companies and common carriers. The bill passed the House of Representatives this September, and is expected to receive a favorable reception in the 111th Congress in 2009.

Although the spate of state actions hasn’t stemmed the tide of online sales, they may be showing an impact. Jeff Kimbel, for example, a 45-year-old smoker from Long Beach, California, was accustomed to getting his untaxed Seneca-brand cigarettes in discreet brown boxes arriving from Buydiscountcigarettes.com. After the site was sued this year, though, his shipments were disrupted, and he was double-billed for his purchases. Similar consumer complaints of being fleeced online abound.

“At one point the site was based in New Mexico, and then I heard they were moving to Kentucky,” Kimbel said. “Now the cigarettes come out of Irving, New York.” (Kimbel — who paid by direct debit — said he never realized that he was violating state tax laws.)

With the accelerating state and federal scrutiny of Internet sales, some online cigarette purchasers figure that even with higher costs, they’re better off buying in person. As one smoker recently posted online: “No online cigarettes for me. Find local store, pay cash, no trail.”

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