State Created Black Markets

This is a very interesting article in the WSJ about how it apparently now seems to be more profitable (and less risky) to steal a semi full of cigarettes than to steal an armored car full of cash. This is mainly due to the mountains of taxes that the various agencies in New York have put on the product. You have a huge state tax on top of the New York City tax, making a very nice spread between a non taxed product and a taxed product.

From the article:

But if history is any guide, most cigarettes sold will actually be trucked up from Virginia, or shipped in from China, by “butt-leggers” who can make over $1 million on each tractor-trailer load of smuggled smokes. The blunt fact, which politicians of both political parties are determined to ignore, is that high cigarette taxes in New York have led to a bloody, decades-long smuggling epidemic. While the problem first surfaced during the Great Depression, tax hikes in the early 1960s created a major profit opportunity for smugglers and kicked the epidemic into high gear. By 1967, a quarter of the cigarettes consumed in the Empire State were bootlegged. New York City’s finance administrator labeled cigarette smuggling the “principal stoking facility of the engine of organized crime.”

I have always been fascinated by black markets and this one seems to be state created. Black markets, to me, respond to supply and demand almost perfectly as a market is supposed to with no government in the way to interfere with laws or taxes to regulate them. I wonder when there will be black markets for other skyrocketing commodities such as oil, gold and other things. There probably are already. In the end, tobacco is just another commodity.

There is no shortage of cigarettes, and from the anecdotal evidence that I have seen the demand seems to be flat. So what created the black market and the associated violence involved in stealing trucks full of cigarettes? The spread between taxes placed in New York and other places. Of course the smokers play a willing part in this as well by creating demand. With very minimal risk (any?) the smokers can enter their local convenience store or bar or whatever and pay less than half of the regular price for black market smokes. I would probably do the same thing (for the record, I do not smoke). The main risk is placed on the black marketers. They are the ones facing stiff jail time. But their monetary reward is astonishing. The spread on a single pack of smokes, between New York taxed and non taxed smokes, looks to be over five dollars. That is fifty bucks a carton. How many cartons can fit into a semi? I have no clue, but a lot. They could even be making more money than that – why not charge $7 when the state taxed smokes are $9? Of course you probably have middle men and a distribution network taking a piece in here as well, and what better distribution network than organized crime?

So the state of New York along with the City should be congratulated, as they have provided those of us who are interested in the economics of black markets a beautiful test case and everything seems to be working out as it always does.

High inflation in those years (late 70s and early 80s) drove cigarette prices up, but the fixed excise tax – the smuggler’s profit margin – declined by more than 40%, greatly reducing bootlegging and related crime. Lawmaker memories are short, however, and the state again began raising the cigarette tax in the 1980s. As a state tax enforcement official noted, it soon became “literally more profitable to hijack a cigarette-delivery truck than an armored truck.” More tax hikes followed in the 1990s. City and state records of tax-paid cigarettes show sales plummeting, despite stable smoking rates. This signals the resurgence of smuggling and large-scale tax evasion. As the Bureau of Alcohol, Tobacco and Firearms said in September 2002 of New York’s cigarette smuggling, “Traditional organized crime is involved, terrorist groups are involved, and street gangs are involved.” Rivalry among these groups has resulted in numerous shootings and homicides. The connection to terrorism is no exaggeration. When New York police cracked another smuggling ring in 2005, they uncovered a multimillion dollar flow of funds from New York City to unknown individuals in the Middle East. Police Commissioner Raymond Kelly gave voice to the obvious conclusion: Terrorists probably got the money.

I can see this happening over and over again as politicians start piling more and more sin taxes on things like booze and smokes without first understanding that there will be a black market created if other states don’t follow suit.

Cross posted at LITGM.

4 thoughts on “State Created Black Markets”

  1. Black markets are always created by the State; by definition they do not exist in the absence of prohibition, price controls or high taxation. Black markets in crude oil and fuel existed in the ’70s when there were price controls on petroleum and refined products. There may be a black market in untaxed fuel oil sold as motor fuel, but there is probably not enough money in this to justify widespread criminal involvement. There is no black market in gold, nor will there be one unless ownership of gold by individuals is again prohibited (unlikely). There are black markets in narcotics and, where gun ownership is prohibited or severely restricted, firearms. In countries with exchange controls there is often a black market in currency. A black market is nothing more than a free market in a product that the government does not want a free market in.

  2. I can see this happening over and over again as politicians start piling more and more sin taxes on things like booze and smokes without first understanding that there will be a black market created if other states don’t follow suit.

    It’s that dynamic that leads to increased federalization. I think that the small, high density states in the northeast vote for so much federalization because they have are so prone to these kind of situations. States like Texas usually could care less what the policies the surrounding states have.

    The people respond to high taxes by trying to avoid the tax. The higher the tax, the more avoidance. High taxes on income lead to diminished work, tax shelters and political support for loopholes.

  3. I remember reading a book called “Hit 29” when I was in high school. It was presented as a autobiographical story of a hit man executing a mob killing. The book opens with the hit man having just completed a job running a truckload of cigarettes up from North Carolina to New York.

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