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A 2009 study commissioned by the Minnesota Department of Revenue pointed out significant evidence of tobacco tax evasion after the state’s last cigarette tax increases in 2005 and 2006. Should Gov. Mark Dayton’s proposed 94 cent per pack cigarette tax increase succeed, it is likely that the state will see a large revenue shortfall due to smokers shifting their consumption across state lines, to the Internet, or to illicit black market tobacco.

Selected findings from the Department of Revenue’s 2009 study are below. Note that the effective tax increases and unpaid taxes include the cigarette excise tax and the sales tax applied to cigarette purchases.

  • After an effective 31.25 cent per pack increase from 2004 to 2005, the state’s foregone revenue increased 66 percent, from $9.3 million to $15.5 million.
  • After an effective 46.75 cent per pack increase from 2005 to 2006, the state’s foregone revenue increased 103 percent, from $15.5 million to $31.5 million.
  • The $31.5 million in revenue lost due to tax evasion in 2006 represented nearly 8 percent of Minnesota’s total cigarette tax revenue.
  • Gov. Dayton’s proposed tax increase would be more than double the 2006 tax increase.
  • The propensity to evade the cigarette tax was highest in areas bordering North Dakota, which currently has a significantly lower cigarette tax rate than Minnesota. Should Gov. Dayton’s plan pass, South Dakota and Iowa will also have a lower rate than Minnesota.

This research is consistent with the idea that when government raises the cost of a product, consumers travel to lower-cost jurisdictions. This is especially harmful to border retailers, who will see a drastic cut to their bottom lines, to the benefit of small businesses in North Dakota, South Dakota, and Iowa.

And it leads to smaller-than-projected revenues and future budget deficits. Tobacco tax revenue is already declining; it will drop even more precipitously when consumers are given the incentive to buy outside the state. The Mackinac Institute has already noted that nearly 20 percent of cigarettes smoked in Minnesota are purchased elsewhere. As the Minnesota Department of Revenue has proven, that number will only climb should Gov. Dayton raise the tax even further.