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The Massachusetts Internet tax mystery

CNET News.com's Declan McCullagh explains how state tax collectors learned the identities of residents who bought cigarettes over the Web.

A mystery is brewing in Massachusetts over how state tax collectors learned the identities of residents who bought cigarettes over the Internet.

Since early this year, the Massachusetts Department of Revenue has been busy firing off 3,264 letters to online shoppers, ordering them to submit a check for unpaid cigarette taxes, plus interest and penalties--or risk fines and imprisonment. Like its tax-happy neighbors of New York, Rhode Island and Connecticut, the Bay State ranks in the five most expensive places in the United States to buy cigarettes. Massachusetts levies $1.50 a pack in state excise taxes, not counting state sales taxes and local taxes.

The 7-Eleven store on Hanover Street in Boston's North End sells a carton of Marlboros for $55.75. Online retailer DirtCheapCig.com sells Marlboros for between $27.19 and $31.19 plus shipping. That's a huge competitive advantage for DirtCheap, explained in large part by its location in the verdant tobacco fields of Kentucky, which has the lowest tobacco excise taxes in the nation.

What's a great deal for Massachusetts smokers horrifies the state's tax collectors, who acknowledge that they've obtained the names and addresses of DirtCheap customers but refuse to divulge their source.

What's a great deal for Massachusetts smokers horrifies the state's tax collectors.
The two possible culprits: DirtCheap and the United Parcel Service, which the company uses to ship cigarettes. DirtCheap's lawyer told the Boston Globe that his client did not turn over the customer lists but said the state had obtained UPS spreadsheets that have delivery information. (DirtCheap did not respond to CNET News.com inquiries Friday.)

UPS spokeswoman Susan Rosenberg confirmed that her employer has complied with legal requests that relate to DirtCheap customers but won't say whether they came from Massachusetts or another state. "I'm not going to go investigate whether we did or we didn't in this particular case," Rosenberg said. "We're not going to address individual circumstances, where we might have received a legal request for information."

The company's privacy policy is somewhat ambiguous, saying "we do provide personal data to government agencies as required by law or regulation." Rosenberg said that means "a subpoena or part of the discovery process in a formal manner to comply with the law--it's definitely more than a mere request."

Note that if a lawsuit had been filed, UPS and DirtCheap would be required to turn over their records. That's the normal discovery process that takes place in lawsuits, and no firm could be faulted for complying with a proper court order. But no lawsuits were filed at the time the taxocrats began sending out the threatening letters. That means that if UPS did divulge customer records, it may have done so voluntarily, a horrific privacy breach if true.

National consequences
The details of this case are important to Massachusetts residents, but the implications are national. State and city governments are hungrily trying to cover budget shortfalls by boosting cigarette taxes. The advocacy group Campaign for Tobacco-Free Kids calculates that 31 states have increased taxes since January 2002,

The details of this case are important to Massachusetts residents, but the implications are national.
with the average tax rate skyrocketing by 68 percent during that time. In New York City, state and local taxes alone on a carton of cigarettes now total $30, more than the entire cost of a carton of DirtCheap smokes.

When local tax rates ascend into the stratosphere, more smokers turn to the Web, making online retailers a tempting target. At a hearing in May in the U.S. House of Representatives, politicians warned that Internet tobacco sales will exceed $5 billion in 2005 and states will lose $1.4 billion in tax revenues as a result.

With limited exceptions, Internet sellers do not have to collect sales taxes on shipments made to other states. (The National Governors Association is hoping to persuade Congress to change this.)

Cigarettes are one of those exceptions. A 1949 law called the Jenkins Act says anyone who ships cigarettes nationally must file monthly reports with each state tax collector listing "the name and address of the person to whom the shipment was made, the brand, and the quantity thereof." Washington state attorney general Christine Gregoire filed suit against DirtCheap in October 2002, alleging a violation of the Jenkins Act. The case is still pending, with a federal court in Washington in May denying the company's motion to dismiss the lawsuit.

Established businesses tend to follow the Jenkins Act, but small Internet retailers don't have as strong an incentive. Scores of online retailers sell cigarettes, but spokesman Timothy Connolly said the Massachusetts Department of Revenue has obtained customer lists from only 10 retailers after the state sent out Jenkins Act notifications.

Connolly said one shipping company, which he would not name, has turned over its shipping records to Massachusetts. If the state knows the exact amount of the purchase, it sends a bill for that sum; otherwise, "there's a form to fill out. Tell us how much you bought, and write us a check for that amount." Or, the letter adds, go to prison.

It's obvious that as taxes rise and tax avoidance follows, government agencies typically respond by taking intrusive steps to monitor citizens and snoop on how they spend their money. But there are other side effects, such as high taxes, creating massive black markets that divert billions of dollars to criminals and spawn crime.

A Cato Institute study recounts New York City's horrific experience after it hiked its taxes in the 1970s: "In the aftermath of the act's passage tax officials reported an increase in robberies and thefts from retailers and wholesalers as well as hijackings of trucks carrying cigarettes." Meanwhile, cigarette sales in jurisdictions where New York bootleggers purchased cigarettes rose sharply. In New York City today, a truck that's filled with 200 cases of cigarettes has a retail value of about $1 million--a tempting target for thieves.

Massachusetts may have the law on its side in tracking down its taxpayers, but it doesn't mean that the law is right or that the taxes are wise. Attempts to collect revenue should be weighed against the privacy of taxpayers. Turning UPS or other shipping companies into government informants that report on Internet shoppers is not an acceptable price to pay.