Consumers typically pay lower taxes for goods bought online, either because the levies don't apply in their jurisdictions or the collection process isn't enforced. Some of the companies selling cigarettes online are based on Indian reservations, where taxes are lower or nonexistent.
"This is a national thing," said one online operator at Cigaretteshop.com, based on the Pojoaque Pueblo Indian reservation in New Mexico, where cigarettes can be legally sold tax-free. "We send a lot to California, Alaska and Hawaii, which have very high taxes."
The trend has prompted states such as California, Washington, Iowa and Wisconsin to crack down on online and mail-order cigarette sales. Citing the federal Jenkins Act, which governs the interstate sale of tobacco products, those states and others are demanding that online cigarette businesses turn over their customer lists. With this information in hand, the states then notify residents that they owe local taxes if they have ordered cigarettes online or through mail-order catalogs.
"Your remittance of the tax is due for the amount of cigarettes and tobacco products that were shipped to you," the California Board of Equalization said in a letter sent in January to some 3,200 state residents who bought cigarettes through out-of-state companies. "If a response is not received within 30 days, a billing may be issued for the tax, interest and penalty due."
Even before cigarette purchases became popular online, several states had planned to raise taxes in an apparent attempt to increase revenues and discourage smoking for health reasons. California, for instance, added a 50 cents-per-pack tax on cigarettes as a result of Proposition 10, passed by voters in November 1998. Alaska raised its cigarette taxes to $1 a pack in October 1997.
At the same time, consumers are spending ever-growing amounts online for everything from books to groceries--including tobacco products. Forrester Research estimates that consumers will spend $38.8 billion online this year, up from $20.2 billion last year.
The issue of taxes and jurisdiction in e-commerce has been raised repeatedly as mainstream use of the Internet has boomed. Although few pay it, many regional governments argue that consumers technically owe a use tax to their home states for each purchase they make online that originates somewhere else.
But because most businesses are not regulated as strictly as the tobacco industry, states have no way of forcing out-of-state companies to report who bought a book or CD online or how much that person spent. That makes the collection of those use taxes difficult, if not impossible.
A costly habit
Taxes largely account for the price difference between brick-and-mortar cigarette stores and their online counterparts. In California, for example, the passage of Proposition 10 has helped push the total taxes for a pack of 20 cigarettes to 87 cents, or $8.70 per carton.
Thus, a carton of cigarettes--10 packages--costs about $35 at convenience stores in California, including Russell's Convenience Store in San Francisco. In contrast, a carton of Marlboro, Camel or Salem cigarettes costs $26.90 at Cigaretteshop.com. And some online cigarettes sell for as little as $12 per carton.
To get its discount price, Cigaretteshop.com customers must buy at least five cartons, but shipping is included in the price. UPS second-day air is available for $1 extra per carton.
"Thousands of people" are looking to cut costs by purchasing cigarettes online, through mail order or out of state, said Raymond Sasso, president and co-founder of Forces, a smokers rights group.
"We are a sovereign nation, and state taxes don't apply to us," said Shana Lindell, manager at Wolfpack Tobacco, which operates a Web site. "The law allows us to send 290 cartons a day to the same address, but it's only for personal use."
California sent letters to more than 160 online and mail-order businesses last year but has only received customer lists from about 12, said Dennis Maciel, head of the excise taxes division of the state's Board of Equalization. Likewise, Wisconsin, which has contacted far fewer companies, has received customer lists only from four out-of-state companies, said Jim Jenkins, head of alcohol and tobacco enforcement with the state's department of revenue.
"These companies that are selling to our citizens are outside of our jurisdiction," Jenkins said. "We can't get a handle on them legally. That's the main problem."
The letters sent to citizens have resulted in minimal tax payments. Many state enforcement officers estimate that the average customer who has bought cigarettes online owes a little more than $100 in unpaid taxes. Washington state, for instance, has received about $12,000 in taxes from residents it has contacted since last August, said state department of revenue spokesman Mike Gowrylow. Alaska has received about $38,000 from consumers since it began scrutinizing out-of-state sellers in late 1997, state revenue auditor Johanna Bales said.
"What we are thinking is that the enforcement is going to dry up some of these sales," Jenkins said.
Despite the minimal revenue, Jenkins is trying to organize a national effort targeting online cigarette businesses. And some cigarette sellers are already starting to feel the heat.
"A lot of states are coming out with scare tactics," said the operator at Cigaretteshop.com.
Others say the states ought to re-examine their tax laws before going after citizens.
"The higher tax rates go on any given product or activity, the greater the temptation there is for individuals to try and find ways to avoid them--legally or otherwise," said Pete Sepp, spokesman for the National Taxpayers Union. "This example of tax avoidance ought to serve as a wake-up call to public officials: They can't set a tax rate that people won't pay."
News.com's Jeff Pelline contributed to this report.