Online smoking sales choking states

Online sales of cigarettes could be costing states millions of dollars in unpaid taxes, a report from the General Accounting Office says.

Margaret Kane
Margaret Kane Former Staff writer, CNET News
Margaret is a former news editor for CNET News, based in the Boston bureau.
3 min read
Online sales of cigarettes could be costing states millions of dollars in unpaid taxes, according to a new report.

Almost all states charge taxes on the sale of cigarettes, but the issue has come to the fore as municipalities such as New York City and other locales raise taxes to close budget gaps.

As with many other products, one of the attractions of purchasing cigarettes online has been the avoidance of those taxes. A report from the General Accounting Office (GAO), the investigative arm of Congress, pointed to a Forrester Research study that predicts Internet tobacco sales in the United States will exceed $5 billion in 2005 and the states will lose about $1.4 billion in tax revenue from these sales.

But, as with sales taxes, although consumers aren't charged the excise tax by the vendor when they purchase the item, they are still responsible for remitting it to their home state. In the case of cigarettes, a 1949 federal law known as the Jenkins Act requires dealers who ship cigarettes across state lines to people other than a licensed distributor to report the sale to the buyer's home state, so that state can collect excise tax.

Only 5 percent of the Internet retailers surveyed posted notices of their responsibilities under the Jenkins Act, although those that did stated that they didn't comply with it, according to the GAO. And many Internet retailers even stated on their Web sites that they did not have to comply with the Jenkins Act, 16 percent of these citing their Native American status, the Internet Tax Freedom Act, and other laws as reasons for not complying with the act.

"However, our review of the laws cited, as well as the Jenkins Act and its legislative history, indicates that neither Native American status nor any of the laws cited relieve Internet vendors of their Jenkins Act responsibilities," the GAO report states.

Enforcement of the Jenkins Act is technically the purview of the Justice Department and the FBI. However, prosecution has been limited. The GAO found only three federal investigations involving such potential violations, and none of these had resulted in prosecution.

"No Internet cigarette vendors had been penalized for violating the act, nor had any penalties been sought for violators," the report said.

To beef up enforcement, the GAO recommended that the Bureau of Alcohol, Tobacco and Firearms (ATF), which currently has some jurisdiction to enforce the Act, be given primary jurisdiction. That would also help ease the FBI's burden as it tries to fight terrorism, the GAO report said.

In addition, all of the agencies involved thought the act might be more easily enforced if violations under it were upgraded to felonies from misdemeanors.

The ATF is already working on ways to increase enforcement, the report said, including asking tobacco manufacturers to help determine who is selling cigarettes to Internet and mail order companies.

Some states are trying to enforce the Act on their own. Of the nine states surveyed by the GAO, California had the most success in collecting taxes, taking in about $1.4 million in between 1997 and 2001. But the state received information from only 20 out of 167 online cigarette retailers, and responses from 13,500 of the 23,500 residents subsequently notified of their tax responsibilities.

"Officials in the nine states said that they lack the legal authority to successfully address this problem on their own. They believe greater federal action is needed, particularly because of their concern that Internet cigarette sales will continue to increase with a growing and substantial negative effect on tax revenues," the report said.