U.S. Department of the Treasury

(Archived Content)

Thank you very much, Senator Conrad and distinguished members of the Task Force. I am pleased to have this opportunity to discuss administrative and enforcement issues arising from the implementation of new tobacco legislation, particularly those issues related to controlling illegal domestic diversion and cross-border smuggling of tobacco products.

As we all agree, the prospect of comprehensive tobacco legislation is an issue of enormous consequence to the health and economic well-being of the American people. That is why the Administration looks forward to continuing to work with Congress to enact comprehensive legislation this year.

I think we all share a common and very strong interest in assuring that the enactment of tobacco legislation will not result in either a domestic black market or the smuggling of tobacco into the United States. It is essential that comprehensive tobacco legislation contain provisions that will minimize the diversion of cigarettes from legitimate domestic channels of distribution and the smuggling of cigarettes into the United States from abroad.

Designing an effective system to combat smuggling will depend on the other provisions that are included in tobacco legislation. For example, incentives to smuggle are likely to be sensitive to the details of such legislation. Nonetheless, we are convinced that the creation of a sound system -- one that will close the distribution chain for tobacco products -- will ensure that the diversion and smuggling of tobacco can be effectively controlled and will not defeat the purposes of comprehensive tobacco legislation.

By closing the distribution chain for tobacco products, we will be able to ensure that these products flow through legitimate channels and that we will be able effectively to police any leakages that do take place. Treasury already licenses tobacco manufacturers and export bonded warehouses in connection with the collection of tobacco excise taxes. We believe that such licensing should be extended to the other entities at the upper end of the tobacco distribution chain -- wholesalers, exporters, importers and distributors. We are comfortable with a system that places primary responsibility for licensing retailers on State governments, as provided in the Commerce Committee bill.

To be effective, a system must include the following elements:

• First, as I have described above, all entities in the distribution chain for tobacco products -- manufacturers, wholesalers, exporters, importers, distributors and retailers -- should be required to hold a license or a permit. Licensing of retailers can be done at the State level. Licenses would be issued based on certain clearly specified criteria and could be revoked or suspended for specified violations. Those conducting business without a license would be subject to penalties. Licensed entities would only be authorized to sell tobacco products to other licensed entities or purchase tobacco products from other licensed entities. The sale or distribution to any entity that is unlicensed would be unlawful.

• Second, legislation and this is a critical point should require the effective marking, branding and identification of packages of tobacco products intended for domestic distribution and for export so that they may not be diverted or smuggled in circumvention of the legitimate channels of distribution.

   

 

 

as I have described above, all entities in the distribution chain for tobacco products -- manufacturers, wholesalers, exporters, importers, distributors and retailers -- should be required to hold a license or a permit. Licensing of retailers can be done at the State level. Licenses would be issued based on certain clearly specified criteria and could be revoked or suspended for specified violations. Those conducting business without a license would be subject to penalties. Licensed entities would only be authorized to sell tobacco products to other licensed entities or purchase tobacco products from other licensed entities. The sale or distribution to any entity that is unlicensed would be unlawful.
• Third, any regulatory system should include penalty and administrative provisions that will deter would-be smugglers and will allow for effective, efficient and uniform enforcement of controls over distribution. Simply stated, those contemplating entering the black market must believe that the chances of being caught are high, and that the cost of getting caught will exceed the profits from smuggling.

Under such a system, tobacco products would move through legitimate channels. Most importantly, such channels would not be open to America's youth.

A licensing system for tobacco products such as that I have just described would be similar to the way the Federal Government has effectively regulated alcoholic beverages for over sixty years and would incorporate the years of experience we have in administering that system. In addition, all states currently regulate their alcohol retailers. The system in place has allowed for commerce in alcoholic beverages while effectively curtailing trafficking in illicit, non-tax paid products.

Current federal laws regulating tobacco are aimed at collecting the Federal excise tax and assisting states in their efforts to collect excise taxes imposed on certain tobacco products, not at regulating the distribution of tobacco products and preventing smuggling. For example, the Contraband Cigarette Trafficking Act, or CCTA, was designed solely to assist states in enforcing their tax laws. It does not address or ensure a closed national distribution system and was only intended to proscribe domestic diversion as it applies to State taxes. The CCTA does not address cross-border smuggling, and it applies only to cigarettes, and not to any other tobacco products. We support amendments to the CCTA that would, among other things, expand the scope of the law to several tobacco products in addition to cigarettes, reduce the quantity of tobacco products necessary for a violation, apply the CCTA to states that do not require a tax stamp, and provide for forfeiture of proceeds of CCTA violations. These amendments would enhance the Treasury Department's mandate to control the unlawful trafficking in tobacco products to avoid State tobacco taxes.

With the necessary regulatory provisions in place to deal with potential smugglers, we do not expect a large-scale smuggling problem for several reasons. First, the closed distribution scheme I just described would limit drastically smugglers' ability to enter products into a legitimate distribution channel. Potential black marketeers will not be able to move products through legitimate wholesalers or distributors. Nor will they be able to sell products to retail consumers at the local convenience stores or other licensed retail outlets. Instead, without a way to place contraband products in the market legally, smugglers would have to sell cigarettes outside channels of legitimate distribution. This would be a risky proposition and one we do not believe will represent a significant problem.

Second, U.S. cigarette manufacturers would have great incentives not to become complicit in any smuggling operation, as they would encounter enormous legal risks (such as the possibility of losing their license or losing their cap on liability risk) and public opprobrium. Indeed, it is hard to imagine that in the context of comprehensive tobacco legislation, large scale smuggling could occur without the manufacturers' knowledge.

Third, the U.S. Customs Service has the expertise and the experience to deal with imported contraband products and already has made a substantial investment in the introduction of non-intrusive inspection systems and other equipment needed to detect the smuggling of contraband. The organic nature of tobacco and the distinctive shape of cigarettes makes them readily detectable by equipment that Customs currently has in place.

Some have cited current levels of interstate smuggling as a reason for suggesting that comprehensive tobacco legislation would lead to wide-scale smuggling. Such arguments fail to account for the fundamental difference between interstate diversion and cross-border smuggling. Commerce between states is not controlled in the same way or to the same extent as commerce across the United States' international borders. The Customs Service simply does not monitor the movement of products across State borders, while it does effectively monitor our international borders. More importantly, the current levels of interstate smuggling, and this is a critical point, exist without having in place a closed distribution system like the one I described earlier. If anything, the introduction of such a closed distribution system would be expected to have the collateral benefit of substantially reducing existing interstate diversion of tobacco products.

The Canadian experience is frequently highlighted by those who predict the emergence of a large black market. There are several reasons to believe, however, that the Canadian experience is not an appropriate predictor of what would occur if tobacco legislation such as that supported by the Administration were to become law.

First, the size of the Canadian population, as well as its concentration along the border with the United States, makes the Canadian example not particularly instructive for the United States. Because of its smaller population, the total number of cigarettes sold in Canada is only one-tenth as large as the number sold in the U.S., so small amounts of smuggling have a noticeable impact on their tobacco market and would have none on ours. That is, it would take ten times as much smuggling by volume to have an equivalent proportional effect on the U.S. market for tobacco products. Moreover, smuggling became a problem in Canada because of the ease of access to alternative markets. Eighty percent of the Canadian population lives within a two-hour drive of the U.S. border, placing it within easy reach of smugglers transporting cigarettes from the United States. The U.S. population is more dispersed, making the logistics of a nationwide black market in smuggled cigarettes more complex and expensive for organized smugglers. The dispersal of the U.S. population also means that a U.S. resident is less likely than a Canadian resident to be able to cross the border routinely for casual cigarette smuggling.

Second, and most importantly, Canada did not have in place the type of effective licensing and enforcement regime that is advocated by the Administration. For example, Canada did not mark its cigarette packaging with For Export Only labels until after the smuggling problem of 1992-93. Canadian law enforcement had very few personnel devoted to tax evasion. The vast majority of enforcement with respect to Canadian taxes was done at the provincial level and there was little or no coordinated enforcement effort at the national or inter-provincial levels. In addition, Canada does not license the distribution chain with respect to tobacco products, with the exception of manufacturers. Finally, Canada's laws on tax evasion did not contain strong penalties and there were inadequate resources to enforce these laws.

We are confident that a proper regulatory enforcement system will minimize the diversion of tobacco products from legitimate channels and the development of cross-border smuggling. Indeed, the International Association of Chiefs of Police and the Major Cities Chiefs of Police believe that with the proper regulatory scheme in place, tobacco smuggling can be controlled. The International Association of Chiefs of Police have stated that [p]reventing the creation of a tobacco black market will be a difficult task, but one that federal, State, and local law enforcement can achieve if we work closely with one another. As ATF Director Magaw testified on April 30 before the Senate Judiciary Committee: The fear of potential unlawful trafficking in tobacco products should not be a reason for failing to act on these issues because there are workable solutions. . . . [O]ur experience in regulating alcoholic beverages shows that unlawful trafficking can readily be controlled.

As the President has said, we stand on the verge of one of the greatest public health achievements in our history -- an historic triumph in our fight to protect America's children from the deadly threat of tobacco. We look forward to working with Congress on this legislation in a general and its anti-smuggling provisions in particular.

Thank you, Senator.