SPEAKERS CONTENTS INSERTS
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86–786 PDF
2003
YOUTH SMOKING PREVENTION AND STATE REVENUE ENFORCEMENT ACT
HEARING
BEFORE THE
SUBCOMMITTEE ON COURTS, THE INTERNET,
AND INTELLECTUAL PROPERTY
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
ON
H.R. 1839
MAY 1, 2003
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Serial No. 19
Printed for the use of the Committee on the Judiciary
Available via the World Wide Web: http://www.house.gov/judiciary
COMMITTEE ON THE JUDICIARY
F. JAMES SENSENBRENNER, Jr., Wisconsin, Chairman
HENRY J. HYDE, Illinois
HOWARD COBLE, North Carolina
LAMAR SMITH, Texas
ELTON GALLEGLY, California
BOB GOODLATTE, Virginia
STEVE CHABOT, Ohio
WILLIAM L. JENKINS, Tennessee
CHRIS CANNON, Utah
SPENCER BACHUS, Alabama
JOHN N. HOSTETTLER, Indiana
MARK GREEN, Wisconsin
RIC KELLER, Florida
MELISSA A. HART, Pennsylvania
JEFF FLAKE, Arizona
MIKE PENCE, Indiana
J. RANDY FORBES, Virginia
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STEVE KING, Iowa
JOHN R. CARTER, Texas
TOM FEENEY, Florida
MARSHA BLACKBURN, Tennessee
JOHN CONYERS, Jr., Michigan
HOWARD L. BERMAN, California
RICK BOUCHER, Virginia
JERROLD NADLER, New York
ROBERT C. SCOTT, Virginia
MELVIN L. WATT, North Carolina
ZOE LOFGREN, California
SHEILA JACKSON LEE, Texas
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
TAMMY BALDWIN, Wisconsin
ANTHONY D. WEINER, New York
ADAM B. SCHIFF, California
LINDA T. SÁNCHEZ, California
PHILIP G. KIKO, Chief of Staff-General Counsel
PERRY H. APELBAUM, Minority Chief Counsel
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Subcommittee on Courts, the Internet, and Intellectual Property
LAMAR SMITH, Texas, Chairman
HENRY J. HYDE, Illinois
ELTON GALLEGLY, California
BOB GOODLATTE, Virginia
WILLIAM L. JENKINS, Tennessee
SPENCER BACHUS, Alabama
MARK GREEN, Wisconsin
RIC KELLER, Florida
MELISSA A. HART, Pennsylvania
MIKE PENCE, Indiana
J. RANDY FORBES, Virginia
JOHN R. CARTER, Texas
HOWARD L. BERMAN, California
JOHN CONYERS, Jr., Michigan
RICK BOUCHER, Virginia
ZOE LOFGREN, California
MAXINE WATERS, California
MARTIN T. MEEHAN, Massachusetts
WILLIAM D. DELAHUNT, Massachusetts
ROBERT WEXLER, Florida
TAMMY BALDWIN, Wisconsin
ANTHONY D. WEINER, New York
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BLAINE MERRITT, Chief Counsel
DEBRA ROSE, Counsel
DAVID WHITNEY, Counsel
MELISSA L. MCDONALD, Full Committee Counsel
ALEC FRENCH, Minority Counsel
C O N T E N T S
MAY 1, 2003
OPENING STATEMENT
The Honorable Lamar Smith, a Representative in Congress From the State of Texas, and Chairman, Subcommittee on Courts, the Internet, and Intellectual Property
The Honorable Martin T. Meehan, a Representative in Congress From the State of Massachusetts
The Honorable Mark Green, a Representative in Congress From the State of Wisconsin
WITNESSES
Mr. Paul L. Jones, Director, Homeland Security and Justice, General Accounting Office
Oral Testimony
Prepared Statement
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Mr. Henry ''Hank'' O. Armour, Chairman of the Board, National Association of Convenience Stores
Oral Testimony
Prepared Statement
Mr. Matthew Myers, President, National Center for Tobacco-Free Kids
Oral Testimony
Prepared Statement
Mr. Patrick Fleenor, Chief Economist, Fiscal Economics
Oral Testimony
Prepared Statement
APPENDIX
Material Submitted for the Hearing Record
Letter to Paul L. Jones, Director, Homeland Security and Justice from Rep. Lamar Smith
Letter to Rep. Lamar Smith from Paul L. Jones, Director, Homeland Security and Justice
GAO Report No. GA–02–743, Report to Congressional Requesters, August 2002, Internet Cigarette Sales, Giving ATF Investigative Authority May Improve Reporting and Enforcement
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Prepared Statement of Ali Davoudi, President, Online Tobacco Retailers Association (OLTRA)
YOUTH SMOKING PREVENTION AND STATE REVENUE ENFORCEMENT ACT
THURSDAY, MAY 1, 2003
House of Representatives,
Subcommittee on Courts, the Internet,
and Intellectual Property,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:04 a.m., in Room 2141, Rayburn House Office Building, Hon. Lamar Smith [Chairman of the Subcommittee] presiding.
Mr. SMITH. The Subcommittee on Courts, the Internet, and Intellectual Property will come to order. We have an interesting hearing this morning. I will recognize myself and the Ranking Member and also Representative Green for our opening statements, and the entire opening statements of all members will be made a part of the record without objection, as well as the entire testimonies of all witnesses today.
Teenagers who make it through adolescence without having smoked are nearly certain not to become regular smokers. Among adults who smoke, most report having their first cigarette before the age of 13. Governments at all levels have worked with those in the public health community to enact policies that discourage individuals from smoking cigarettes.
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Two cornerstones of our effort have been, one, strictly enforcing minimum age laws and, two, increasing the collection of excise, sales and use taxes from consumers in an effort to drive the price of smoking up and the demand down.
Due to their limited incomes, underage smokers are especially sensitive to increases in cigarette prices. They are also among the most proficient users of the Internet, and they have a great incentive to seek anonymity for their purchases. Regrettably, a new breed of remote sellers doing business by mail order, the telephone, and the Internet now promise cigarette consumers both discounted prices and anonymity.
With names such as zerotaxcigs.com and zerotaxsmokes.com, and taxfreecigarettes.com, their activities are raising serious questions about the ability of governments at all levels to enforce their public health, youth access, and State tax policies effectively. These remote sellers have made it easier for customers to avoid paying taxes and for teenagers to avoid minimum age laws.
The purpose of our hearing today is to consider H.R. 1839, the ''Youth Smoking Prevention and State Revenue Enforcement Act,'' which was introduced by Representative Mark Green of Wisconsin. Representative Green's bill authorizes State attorneys general to bring a civil action seeking injunctive relief in an appropriate U.S. district court for violations of the Jenkins Act.
Since enacting the Jenkins Act in 1949, our Federal policy has been to support State and local efforts to tax and regulate the sale of cigarettes in interstate commerce.
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The Jenkins Act requires any person selling cigarettes for profit in interstate commerce to report to State tobacco tax administrators the name and address of the persons to whom the cigarettes were shipped and the brands and quantities shipped.
The Act's purpose is to enable State authorities to have an effective mechanism for recovering excise, sales and use taxes from consumers who seek to avoid paying State taxes by purchasing cigarettes from low-tax or no-tax jurisdictions.
One projection is that U.S. Internet tobacco sales will exceed $5 billion in 2005 and that States will lose $1.4 billion in State tax revenues as a result. Representative Green's legislation enables States to enforce compliance with their public health, youth access, and cigarette tax policies, thus both increasing States' revenue and reducing health care risks and costs.
I would like the record to show and reflect that representatives from two online tobacco retailers were asked to testify, and it is no surprise perhaps that they declined to do so, but we do look forward to hearing from the witnesses who are here today.
I will now recognize the Ranking Member, Mr. Meehan of Massachusetts, for his opening statement.
Mr. MEEHAN. Thank you, Mr. Chairman, and I want to thank you for scheduling these hearings. As you know, I have been working on Internet and mail order tobacco sales for 5 years. I certainly appreciate the willingness to address this issue. I also want to thank Congressman Green for offering to work together on this issue. We have had some constructive discussions about H.R. 1839, and I am convinced that he understands the need for an effective solution to the problem of tax avoidance in connection with remote sales of tobacco products.
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I would like to be able to support H.R. 1839, but I cannot do so in its current form. I have drafted my own version of the bill, but I have not introduced it because I didn't want to preempt Mr. Green or this hearing. I hope that we will be able to reach an agreement on a strong bipartisan bill.
My basic concern is that H.R. 1839 does not do enough to strengthen the Jenkins Act, which already normally requires cigarette distributors to comply with the tax laws of the States where they send their products. If we don't close the loopholes and strengthen the weaknesses that have made the Jenkins Act completely ineffective, we will not be accomplishing much but simply passing a new version of the law.
Coalition for Tobacco Free Kids will outline some of the specific provisions that need to be addressed to make sure that H.R. 1839 gets the job done, but I will highlight a few areas that I think are particularly important. The first problem is that H.R. 1839 contains no felony provision or increased fines. In a report issued last year the GAO noted that prosecutions under the Jenkins Act are extremely rare because U.S. attorneys have little interest in prosecuting misdemeanors. Retailers who rely on the Internet to generate sales are largely fly-by-night operations. Injunctive relief is meaningless against these sellers because they simply close up shop and then start over under a new name. The idea of giving States the ability to bring civil claims against other out-of-state sellers in Federal court is a step in the right direction, but is unlikely to have much practical effect when defendants have nothing at risk but the tax money that they should have paid in the first place. The credible threat of criminal prosecution, backed up by meaningful penalties, including substantial fines and imprisonment, is essential in order to make this bill work.
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The second issue I want to point out is that H.R. 1839 covers only cigarettes. I do not think there is any logical reason to leave a loophole for Internet mail order smokeless tobacco such as chew and snuff.
The third concern or set of concerns I want to raise is that H.R. 1839 includes a number of drafting problems that appear minor and may have unintended consequences. I know that Congressman Green has been working diligently to finish his draft of the bill in time for this hearing, but these issues will also need to be addressed.
For example, I think H.R. 1839 is intended to establish the right of States to sue tobacco sellers and distributors for the failure to obey State tax laws, but it is not entirely clear from the language whether the States would be entitled to hold a seller or distributor responsible for refusing to collect taxes that they are owed by consumers, such as excise tax. If States are forced to sue individual consumers for tax evasion, the bill is simply not going to be effective.
I hope that we can rework some of these areas and provisions in 1839 to make sure that it achieves its intended goals. I am optimistic that together we will be able to produce a strong bipartisan bill that could pass both Houses of Congress and solve the problem.
Thank you, Mr. Chairman.
Mr. SMITH. Thank you, Mr. Meehan. The gentleman from Wisconsin, Mr. Green, is recognized for his opening statement.
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Mr. GREEN. Thank you, Mr. Chairman. Thanks first for the opportunity to have the Subcommittee consider this legislation. This legislation addresses a growing problem in this country, the largely unregulated sale of cigarettes by mail, telephone, and the Internet. As you have already heard, these remote sales usually occur across State lines and result in cigarettes being delivered directly to someone's door while evading State laws, sales to children and sales taxes.
I want to acknowledge my colleague and friend, Congressman Meehan. He has been a leader on this subject and I admire his work very much and I do want to work with him. I am hopeful that we can produce soon a product that will be effective. My bottom line is to get something done that will work.
This legislation will give State attorneys general the tools they need to enforce their laws against habitual evasion by remote sellers. My bill will allow attorneys general to bring suit in Federal court against all remote sellers.
This is a problem that is getting out of hand. Anyone today can get on the Internet, run a quick search for tax free cigarettes or a variation of that phrase and find literally hundreds of Web sites offering cigarettes for sale. In fact, there is a special Internet search engine set up just for Internet tobacco sites. With nothing more than a credit or debit card our children can access these sites, buy cigarettes and have their cigarettes delivered right to their door without an ID. This will only get worse because, as we all know, children are among the most frequent and proficient users of the Internet.
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States are largely powerless to stop those rampant violations of the minimum age laws because the businesses selling to their children are outside of their borders or otherwise outside the reach of State law. The New York Department of Consumer Affairs has managed to get traditional retail sellers of cigarettes to an 85 percent compliance rate with minimum age laws. But the department has found its efforts literally gutted by the proliferation of remote sellers that it cannot regulate.
At the same time, as has been mentioned, States are losing taxes on these sales. One of our witnesses today, economist Patrick Fleenor, will estimate that State governments will lose over $552 million in sales and excise tax revenue this fiscal year and this figure will grow to 1.2 billion by fiscal year 2005. My home State of Wisconsin is expected to lose 9 million this year and over $26 million in 2005 at a time when my State, like so many others, is suffering and is challenged in trying to balance its books.
The Jenkins Act, which first became law in 1949, requires remote sellers of cigarettes to report their sales to the States so that States can collect the taxes. This is a great idea. The problem is that remote sellers don't comply with the law and no one has been able successfully to enforce it.
The United States General Accounting Office recently reviewed 147 Internet sites that sell cigarettes and not a single one of those sites complied with the Jenkins Act. In fact, many of these sites openly promote their law breaking by offering tax free cigarettes and say they, quote, don't report sales. The Web addresses, as, Mr. Chairman, have you pointed out, clearly reveal the sellers' intentions. These sites include notaxcigarettes.com and zerotaxcigarettes among many others.
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In light of these open violations of the law, the GAO looked at State efforts to enforce the Jenkins Act and they didn't find very much. Why? Well, the GAO heard from nine States on this and every one of them said that they did not have the necessary legal authority. The GAO also looked at Federal enforcement efforts and found that, quote, no Internet cigarette vendors have been penalized for violating the act nor had any penalties been sought for violators. These lost funds again loom even larger now that so many States are laboring to find ways to cut their budgets to make up for revenue shortfalls.
Obviously the public health consequences are also very important. Many States increase cigarette costs through State excise taxes for the stated purpose of deterring smoking. We lose those benefits of these taxes when we allow large volumes of sales to evade those tax schemes.
Remote sales of cigarettes are also hurting local economies. Local small businesses cannot compete with the legal tax free sales by remote businesses.
Mr. Chairman, we should not allow the situation to continue. The rampant evasion of State law is precisely the type of issue that Congress should address, and the best way for to us do this is to give States the tools they need to effectively enforce their laws against all remote sellers.
This legislation will do this and do it the right way. It will keep the authority to enforce State and local laws in the hands of State law enforcement. It avoids creating an unfunded mandate, avoids creating a new Federal bureaucracy and it avoids interfering with or outlawing legitimate commerce.
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Mr. Chairman, I hope you will agree with me that this is a problem and these illegal cigarette sales to children is an issue that we must take up as a Committee. Again, I do want to work with some who are currently opposing this legislation. I think there are some things that we can do. I think we all agree that the bottom line is to pass something that will work and work soon.
Mr. Chairman, thank you again for holding this hearing and I appreciate the willingness of our witnesses to come and testify today.
Mr. SMITH. Let me thank other members who are here for their attendance as well. Mr. Jenkins of Tennessee, Mr. Keller of Florida, Mr. Forbes of Virginia and also Mr. Boucher of Virginia as well. This Subcommittee consistently has interested Members and good attendance. I am very pleased that that continues.
Let me proceed now to introduce our witnesses. And our first witness is Paul Jones, the Director of Homeland Security and Justice at the U.S. General Accounting Office. Mr. Jones is responsible for the management of programs and issues in the U.S. Department of Justice and the Department of Homeland Security. Mr. Jones graduated with honors from Elizabeth City State University with a B.S. in mathematics and earned a Master's Degree in public administration from George Washington University.
The next witness is Hank Armour, President and Chief Executive Officer of two corporations, West Star and Epoch, with convenience stores in the Northwest. Dr. Armour founded West Star in 1982 and Epoch in 1988. Mr. Armour earned a B.A. and Ph.D. in economics and an MBA from Stanford. He also holds a degree from the London School of Economics.
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Our next witness is Matthew Myers, president and CEO of the Campaign for Tobacco Free Kids, a non-profit organization established to focus attention on reducing tobacco use among minors. Mr. Myers formerly represented the Coalition on Smoking and Health, which was comprised of the American Cancer Society, the American Lung Association, and American Heart Association. He holds a B.A. from Tufts and a J.D. from Michigan.
Our last witness is Patrick Fleenor, a Washington-based economic consultant who specializes in taxation. Prior to opening his own practice he was a senior economist with the Joint Economic Committee. He has also served as Chief Economist for the Tax Foundation, one of the nation's oldest think tanks. Mr. Fleenor holds a B.A. from Albion College and an M.A. in economics from George Mason, and an M.A. in political science from American University.
Welcome to you all. As I mentioned to you a while ago, all your complete statements will be made a part of the record, and I will remind you that we would like for you to hold your opening statements to 5 minutes so that we will have plenty of time for questions.
I should also mention to members that are here that we are expecting a vote on the House floor on the rule somewhere around 11 to 11:15 and will hope to be finished with the hearing by that time.
Also to the witnesses, I don't know whether to apologize or just explain, but what is new to you is new to us as well. This is the first time we have seen that screen in the front. Mr. Myers, I am sorry that kind of blocks us. I can't see your name tag there but we will make do. This is also new up here. I want you to know this screen is off but I could be watching a basketball game and I am not. And also new is the corner arrangement over there. All good reasons for all these new arrangements, but nevertheless still may take some getting used to.
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Thank you all for being here.
Mr. Jones, we will start with your testimony.
STATEMENT OF PAUL L. JONES, DIRECTOR, HOMELAND SECURITY AND JUSTICE, GENERAL ACCOUNTING OFFICE
Mr. JONES. Thank you, Mr. Chairman. Mr. Chairman, Members of the Subcommittee, I am pleased to be here today to discuss our review—I forgot to press the button. New technology. I am pleased to be here today to discuss our review of the state of compliance by Internet cigarette vendors with the Jenkins Act.
The Internet offers consumers the option and convenience of buying cigarettes from vendors in low tax States without having to physically be there. The Jenkins Act requires any person who sells and ships cigarettes across a State line to a buyer other than a distributor to report the sale to the buyer's State tax tobacco administrator. The act establishes misdemeanor penalties for violations. Compliance with this Federal law by cigarette sellers enables States to collect excise taxes.
My prepared statement discusses the results of our review of Federal efforts to enforce compliance with the Jenkins Act. I appreciate having my statement included for the record.
The results of our review were requested by Congressman Meehan and Congressman Conyers. The results of that review was reported in August of 2002.
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In my oral statement I would briefly like to make three points. First, we determine that most Internet vendors do not comply with the Jenkins Act or notify their customers of their responsibilities under the act. We identified 147 Web site addresses for Internet cigarette vendors based in the United States. None of these Web sites displayed information suggesting that they comply with the act. Conversely, 78 percent of these Web sites indicated that the vendors do not comply with the act. They posted such statements as we do not comply with the Jenkins Act, we do not report sales to State tax authority, and we keep customer information private. Twenty-two percent provided no indication of whether they complied with the act.
Internet vendors cited the Internet Tax Freedom Act and privacy laws among reasons for not reporting cigarette sales to State authorities. A number of native Americans claim exemption from the act based on sovereign nation status. Our review indicated neither the Internet Tax Freedom Act or privacy laws exempt cigarette vendors from Jenkins Act compliance. Additionally, nothing in the Jenkins Act or its legislative history implies that Native American cigarette sales are exempt.
Second, State and Federal officials are concerned that as Internet sales continue to grow, particularly as State cigarette taxes increase, so will the amount of lost State tax revenue due to noncompliance. One research firm estimated that Internet tobacco sales in the United States will exceed $5 billion in 2005 and that States will lose about $1.4 billion in tax revenue from these sales. California recently estimated that its tax loss revenue due to noncompliance with the Jenkins Act is approximately $22 million annually.
And third, amid these growing concerns the Federal Government enforcement of the Jenkins Act has been limited. The Attorney General of the United States is responsible for supervising the enforcement of Federal laws, including the Jenkins Act. However, the Justice Department and the FBI were unable to identified any investigations of Internet cigarette vendors or other actions to enforce the act. The Bureau of Alcohol, Tobacco and Firearms, which enforces Fed excise tax and criminal laws and regulation related to tobacco products, has ancillary authority to enforce the Jenkins Act. ATF officials identified only three investigations since 1997 of Internet vendors for cigarette smuggling and violating the Jenkins Act.
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States have taken action to promote Jenkins Act compliance but results have been limited. We concluded that States are hampered in their attempts to promote Jenkins Act compliance because they lack authority to enforce the act.
Congressman Green's bill, H.R. 1839, gives States authority to bring civil action against Jenkins Act violators. This could lead to greater involvement of States in the enforcement of the Jenkins Act. Hence, this could enhance States' effort to collect excise taxes.
To improve the Federal Government's effort in enforcing the Jenkins Act and to promote compliance with the act by Internet vendors, we suggest in our report that Congress consider providing ATF with primary jurisdiction to investigate violations of the act. Since our report was issued, ATF was transferred to the Department of Justice. Now it may be possible for the Attorney General to administratively transfer Jenkins Act enforcement authority from the FBI to ATF without involving the Congress. We believe that this possibility deserves further investigation on the part of the Department of Justice.
This concludes my oral statement. I would be happy to respond to questions from the Committee.
[The prepared statement of Mr. Jones follows:]
PREPARED STATEMENT OF PAUL L. JONES
I am pleased to be here today to discuss our work on the extent of compliance by Internet cigarette vendors with the Jenkins Act.(see footnote 1) The Jenkins Act requires any person who sells and ships cigarettes across a state line to a buyer, other than a licensed distributor, to report the sale to the buyer's state tobacco tax administrator. The act establishes misdemeanor penalties for violating the act. Compliance with this federal law by cigarette sellers enables states to collect cigarette excise taxes from consumers.
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However, some state and federal officials are concerned that as Internet cigarette sales continue to grow, particularly as states' cigarette taxes increase, so will the amount of lost state tax revenue due to noncompliance with the Jenkins Act. One research firm estimated that Internet tobacco sales in the United States will exceed $5 billion in 2005 and that the states will lose about $1.4 billion in tax revenue from these sales.(see footnote 2)
My testimony today is based on the results of work that we completed in August of 2002—namely, our report entitled Internet Cigarette Sales: Giving ATF Investigative Authority May Improve Reporting and Enforcement (GAO–02–743). Overall, we found that the federal government has had limited involvement with the Jenkins Act concerning Internet cigarette sales. We also noted that states have taken action to promote Jenkins Act compliance by Internet cigarette vendors, but results were limited.
We determined that most Internet cigarette vendors do not comply with the Jenkins Act or notify their customers of their responsibilities under the act. Vendors cited the Internet Tax Freedom Act, privacy laws, and other reasons for noncompliance. A number of Native Americans cited sovereign nation status. GAO's review indicated that these claims are not valid and vendors are not exempt from the Jenkins Act.
We concluded that states are hampered in attempting to promote Jenkins Act compliance because they lack authority to enforce the act. We suggested that to improve the federal government's efforts in enforcing the Jenkins Act and promoting compliance with the act by Internet cigarette vendors, which may lead to increased state tax revenues from cigarette sales, the Bureau of Alcohol, Tobacco and Firearms (ATF), instead of the Federal Bureau of Investigation (FBI), should be provided with primary jurisdiction to investigate violations of the act.(see footnote 3) We noted that transferring primary investigative jurisdiction was particularly appropriate because of the FBI's new challenges and priorities related to the threat of terrorism and the FBI's increased counterterrorism efforts.
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To perform our work, we obtained information from the Department of Justice (DOJ) and ATF headquarters regarding federal Jenkins Act enforcement actions with respect to Internet cigarette sales. We interviewed officials and obtained documentation from nine selected states(see footnote 4) regarding states' efforts to promote Jenkins Act compliance by Internet cigarette vendors and estimates of the impact of noncompliance on tax revenues. In addition, we reviewed 147 Internet cigarette vendor Web sites, and we interviewed representatives of five Internet vendors.
BACKGROUND
Each state, and the District of Columbia, imposes an excise tax on the sale of cigarettes, which vary from state to state. As of January 1, 2003, the state excise tax rates for a pack of 20 cigarettes ranged from 2.5 cents in Virginia to $1.51 in Massachusetts (see fig.1). The liability for these taxes generally arises once the cigarettes enter the jurisdiction of the state.
Jones1.eps
Many states have increased their cigarette excise taxes in recent years with the intention of increasing tax revenue and discouraging people from smoking. As a result, many smokers are seeking less costly alternatives for purchasing cigarettes, including buying cigarettes while traveling to a neighboring state with a lower cigarette excise tax. The Internet is an alternative that offers consumers the option and convenience of buying cigarettes from vendors in low-tax states without having to physically travel there.
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Consumers who use the Internet to buy cigarettes from vendors in other states are liable for their own state's cigarette excise tax and, in some cases, sales and/or use taxes. States can learn of such purchases and the taxes due when vendors comply with the Jenkins Act. Under the act, cigarette vendors who sell and ship cigarettes into another state to anyone other than a licensed distributor must report (1) the name and address of the person(s) to whom cigarette shipments were made, (2) the brands of cigarettes shipped, and (3) the quantities of cigarettes shipped. Reports must be filed with a state's tobacco tax administrator no later than the 10th day of each calendar month covering each and every cigarette shipment made to the state during the previous calendar month. The sellers must also file a statement with the state's tobacco tax administrator listing the seller's name, trade name (if any), and address of all business locations. Failure to comply with the Jenkins Act's reporting requirements is a misdemeanor offense, and violators are to be fined not more than $1,000, or imprisoned not more than 6 months, or both. Although the Jenkins Act, enacted in 1949, clearly predates and did not anticipate cigarette sales on the Internet, vendors' compliance with the act could result in states collecting taxes due on such sales. According to DOJ, the Jenkins Act itself does not forbid Internet sales nor does it impose any taxes.
LIMITED FEDERAL INVOLVEMENT WITH THE JENKINS ACT AND INTERNET CIGARETTE SALES
The federal government has had limited involvement with the Jenkins Act concerning Internet cigarette sales. We identified three federal investigations involving such potential violations, and none of these had resulted in prosecution (one investigation was still ongoing at the time of our work). No Internet cigarette vendors had been penalized for violating the act, nor had any penalties been sought for violators.
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FBI Has Primary Investigative Jurisdiction
The Attorney General of the United States is responsible for supervising the enforcement of federal criminal laws, including the investigation and prosecution of Jenkins Act violations.(see footnote 5) The FBI has primary jurisdiction to investigate suspected violations of the Jenkins Act. However, DOJ and FBI officials were unable to identify any investigations of Internet cigarette vendors or other actions taken to enforce the act's provisions regarding Internet cigarette sales. According to DOJ, the FBI could not provide information on actions to investigate Jenkins Act violations, either by itself or in connection with other charges, because the FBI does not have a section or office with responsibility for investigating Jenkins Act violations and does not track such investigations. Also, DOJ said it does not maintain statistical information on resources used to investigate and prosecute Jenkins Act offenses.
In describing factors affecting the level and extent of FBI and DOJ enforcement actions with respect to the Jenkins Act and Internet cigarette sales, DOJ noted that the act creates misdemeanor penalties for failures to report information to state authorities, and appropriate referrals for suspected violations must be considered with reference to existing enforcement priorities. Since September 11, 2001, it is understood that the FBI's priorities have changed, as unprecedented levels of FBI resources have been devoted to counterterrorism and intelligence initiatives.
ATF Has Ancillary Enforcement Authority
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ATF, which enforces federal excise tax and criminal laws and regulations related to tobacco products, has ancillary authority to enforce the Jenkins Act.(see footnote 6) ATF special agents investigate trafficking of contraband tobacco products in violation of federal law and sections of the Internal Revenue Code. For example, ATF enforces the Contraband Cigarette Trafficking Act (CCTA), which makes it unlawful for any person to ship, transport, receive, possess, sell, distribute, or purchase more than 60,000 cigarettes that bear no evidence of state cigarette tax payment in the state in which the cigarettes are found, if such state requires a stamp or other indicia to be placed on cigarette packages to demonstrate payment of taxes (18 U.S.C. 2342).(see footnote 7) ATF is also responsible for the collection of federal excise taxes on tobacco products and the qualification of applicants for permits to manufacture tobacco products, operate export warehouses, or import tobacco products. ATF inspections verify an applicant's qualification information, check the security of the premise, and ensure tax compliance.
To enforce the CCTA, ATF investigates cigarette smuggling across state borders to evade state cigarette taxes, a felony offense. Internet cigarette vendors that violate the CCTA, either directly or by aiding and abetting others, can also be charged with violating the Jenkins Act if they failed to comply with the act's reporting requirements. ATF can refer Jenkins Act matters uncovered while investigating CCTA violations to DOJ or the appropriate U.S. Attorney's Office for charges to be filed. ATF officials identified three investigations since 1997 of Internet vendors for cigarette smuggling in violation of the CCTA and violating the Jenkins Act.
In 1997, a special agent in ATF's Anchorage, Alaska, field office noticed an advertisement by a Native American tribe in Washington that sold cigarettes on the Internet. ATF determined from the Alaska Department of Revenue that the vendor was not reporting cigarette sales as required by the Jenkins Act, and its investigation with another ATF office showed that the vendor was shipping cigarettes into Alaska. After ATF discussed potential cigarette smuggling and Jenkins Act violations with the U.S. Attorney's Office for the District of Alaska, it was determined there was no violation of the CCTA.(see footnote 8) The U.S. Attorney's Office did not want to pursue only a Jenkins Act violation, a misdemeanor offense, and asked ATF to determine whether there was evidence that other felony offenses had been committed. Subsequently, ATF formed a temporary task force with Postal Service inspectors and state of Alaska revenue agents, which demonstrated to the satisfaction of the U.S. Attorney's Office that the Internet cigarette vendor had committed mail fraud. The U.S. Attorney's Office agreed to prosecute the case and sought a grand jury indictment for mail fraud, but not for violating the Jenkins Act. The grand jury denied the indictment. In a letter dated September 1998, the U.S. Attorney's Office requested that the vendor either cease selling cigarettes in Alaska and file the required Jenkins Act reports for previous sales, or come into compliance with the act by filing all past and future Jenkins Act reports. In another letter dated December 1998, the U.S. Attorney's Office instructed the vendor to immediately comply with all requirements of the Jenkins Act. However, an official at the Alaska Department of Revenue told us that the vendor never complied. No further action has been taken.
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Another investigation, carried out in 1999, involved a Native American tribe selling cigarettes on the Internet directly to consumers and other tribes. The tribe was not paying state tobacco excise taxes or notifying states of cigarette sales to other than wholesalers, as required by the Jenkins Act. ATF referred the case to the state of Arizona, where it was resolved with no criminal charges filed by obtaining the tribe's agreement to comply with Jenkins Act requirements.
A third ATF investigation of an Internet vendor for cigarette smuggling and Jenkins Act violations was ongoing at the time of our work.
ATF officials said that because ATF does not have primary Jenkins Act jurisdiction, it has not committed resources to investigating violations of the act. However, the officials said strong consideration should be given to transferring primary jurisdiction for investigating Jenkins Act violations from the FBI to ATF. According to ATF, it is responsible for, and has committed resources to, regulating the distribution of tobacco products and investigating trafficking in contraband tobacco products. A change in Jenkins Act jurisdiction would give ATF comprehensive authority at the federal level to assist states in preventing the interstate distribution of cigarettes resulting in lost state cigarette taxes since ATF already has investigative authority over the CCTA, according to the officials. The officials also told us ATF has special agents and inspectors that obtain specialized training in enforcing tax and criminal laws related to tobacco products, and, with primary jurisdiction, ATF would have the investigative authority and would use resources to specifically conduct investigations to enforce the Jenkins Act, which should result in greater enforcement of the act than in the past.
STATES HAVE TAKEN ACTION TO PROMOTE JENKINS ACT COMPLIANCE BY INTERNET CIGARETTE VENDORS, BUT RESULTS WERE LIMITED
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Officials in nine states that provided us information all expressed concern about Internet cigarette vendors' noncompliance with the Jenkins Act and the resulting loss of state tax revenues. For example, California officials estimated that the state lost approximately $13 million in tax revenue from May 1999 through September 2001, due to Internet cigarette vendors' noncompliance with the Jenkins Act. Overall, the states' efforts to promote compliance with the act by Internet vendors produced few results. 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.
States' Efforts Produced Limited Results
Starting in 1997, seven of the nine states had made some effort to promote Jenkins Act compliance by Internet cigarette vendors. These efforts involved contacting Internet vendors and U.S. Attorneys' Offices. Two states had not made any such efforts.
Six of the seven states tried to promote Jenkins Act compliance by identifying and notifying Internet cigarette vendors that they are required to report the sale of cigarettes shipped into those states. Generally, officials in the six states learned of Internet vendors by searching the Internet, noticing or being told of vendors' advertisements, and by state residents or others notifying them. Five states sent letters to the identified vendors concerning their Jenkins Act reporting responsibilities, and one state made telephone calls to the vendors.
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After contacting the Internet vendors, the states generally received reports of cigarette sales from a small portion of the vendors notified.(see footnote 9) The states then contacted the state residents identified in the reports, and they collected taxes from most of the residents contacted. When residents did not respond and pay the taxes due, the states carried out various follow-up efforts, including sending additional notices and bills, assessing penalties and interest, and deducting amounts due from income tax refunds. Generally, the efforts by the six states to promote Jenkins Act compliance were carried out periodically and required few resources. For example, a Massachusetts official said the state notified Internet cigarette vendors on five occasions starting in July 2000, with one employee working a total of about 3 months on the various activities involved in the effort.
Table 1 summarizes the six states' efforts to identify and notify Internet cigarette vendors about the Jenkins Act reporting requirements and shows the results that were achieved. There was little response by the Internet vendors notified. Some of the officials told us that they encountered Internet vendors that refused to comply and report cigarette sales after being contacted. For example, several officials noted that Native Americans often refused to report cigarette sales, with some Native American vendors citing their sovereign nation status as exempting them from the Jenkins Act, and others refusing to accept a state's certified notification letters. Also, an attorney for one vendor informed the state of Washington that the vendor would not report sales because the Internet Tax Freedom Act relieved the vendor of Jenkins Act reporting requirements.
Jones2.eps
Apart from the states' efforts to identify and notify Internet cigarette vendors, state officials noted that some Internet vendors voluntarily complied with the Jenkins Act and reported cigarette sales on their own. The states subsequently contacted the residents identified in the reports to collect taxes. For example, a Rhode Island official told us there were three or four Internet vendors that voluntarily reported cigarette sales to the state. On the basis of these reports, Rhode Island notified about 400 residents they must pay state taxes on their cigarette purchases and billed these residents over $76,000 (the Rhode Island official who provided this information did not know the total amount collected). Similarly, Massachusetts billed 21 residents for cigarette taxes and collected $2,150 based on reports of cigarette sales voluntarily sent to the state.
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Three of the seven states that made an effort to promote Jenkins Act compliance by Internet cigarette vendors contacted U.S. Attorneys and requested assistance. The U.S. Attorneys, however, did not provide the assistance requested. The states' requests and responses by the U.S. Attorneys' Offices are summarized below.
In March 2000, Iowa and Wisconsin officials wrote letters to three U.S. Attorneys in their states requesting assistance. The state officials asked the U.S. Attorneys to send letters to Internet vendors the states had identified, informing the vendors of the Jenkins Act and directing them to comply by reporting cigarette sales to the states. The state officials provided a draft letter and offered to handle all aspects of the mailings. The officials noted they were asking the U.S. Attorneys to send the letters over their signatures because the Jenkins Act is a federal law and a statement from a U.S. Attorney would have more impact than from a state official. However, the U.S. Attorneys did not provide the assistance requested. According to Iowa and Wisconsin officials, two U.S. Attorneys' Offices said they were not interested in helping, and one did not respond to the state's request.(see footnote 10)
After contacting the FBI regarding an Internet vendor that refused to report cigarette sales, saying that the Internet Tax Freedom Act relieved the vendor of Jenkins Act reporting requirements, the state of Washington acted on the FBI's recommendation and wrote a letter in April 2001 requesting that the U.S. Attorney initiate an investigation. According to a Washington official, the U.S. Attorney's Office did not pursue this matter and noted that a civil remedy (i.e., lawsuit) should be sought by the state before seeking a criminal action. At the time of our work, the state was planning to seek a civil remedy.
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In July 2001, the state of Wisconsin wrote a letter referring a potential Jenkins Act violation to the U.S. Attorney for prosecution. According to a Wisconsin official, this case had strong evidence of Jenkins Act noncompliance—there were controlled and supervised purchases made on the Internet of a small number of cartons of cigarettes, and the vendor had not reported the sales to Wisconsin. The U.S. Attorney's Office declined to initiate an investigation, saying that it appeared this issue would be best handled by the state ''administratively.'' The Wisconsin official told us, however, that Wisconsin does not have administrative remedies for Jenkins Act violations, and, in any case, the state cannot reach out across state lines to deal with a vendor in another state.
States Concerned about Internet Vendors' Noncompliance and Believe Greater Federal Action Is Needed
Officials in each of the nine states expressed concern about the impact that Internet cigarette vendors' noncompliance with the Jenkins Act has on state tax revenues. The officials said that Internet cigarette sales will continue to grow in the future and are concerned that a much greater and more substantial impact on tax revenues will result. One state, California, estimated that its lost tax revenue due to noncompliance with the Jenkins Act by Internet cigarette vendors was approximately $13 million from May 1999 through September 2001.(see footnote 11)
Officials in all nine states said that they are limited in what they can accomplish on their own to address this situation and successfully promote Jenkins Act compliance by Internet cigarette vendors. All of the officials pointed out that their states lack the legal authority necessary to enforce the act and penalize the vendors who violate it, particularly with the vendors residing in other states. Officials in three states told us that efforts to promote Jenkins Act compliance are not worthwhile because of such limitations, or are not a priority because of limited resources.
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Officials in all nine states said that they believe greater federal action is needed to enforce the Jenkins Act and promote compliance by Internet cigarette vendors. Four state officials also said they believe ATF should have primary jurisdiction to enforce the act. One official pointed out that his organization sometimes dealt with ATF on tobacco matters, but has never interacted with the FBI. Officials in the other five states did not express an opinion regarding which federal agency should have primary jurisdiction to enforce the act.
MOST INTERNET CIGARETTE VENDORS DO NOT COMPLY WITH THE JENKINS ACT OR NOTIFY CONSUMERS OF THEIR RESPONSIBILITIES
Through our Internet search efforts, we identified 147 Web site addresses for Internet cigarette vendors based in the United States and reviewed each website linked to these addresses.(see footnote 12) Our review of the Web sites found no information suggesting that the vendors comply with the Jenkins Act. Some vendors cited reasons for not complying that we could not substantiate. A few Web sites specifically mentioned the vendors' Jenkins Act reporting responsibilities, but these Web sites also indicated that the vendors do not comply with the act. Some Web sites provided notice to consumers of their potential state tax liability for Internet cigarette purchases.
Majority of Web sites Indicate that Vendors Do Not Comply with the Jenkins Act
None of the 147 Web sites we reviewed stated that the vendor complies with the Jenkins Act and reports cigarette sales to state tobacco tax administrators.(see footnote 13) Conversely, as shown in table 2, information posted on 114 (78 percent) of the Web sites indicated the vendors' noncompliance with the act through a variety of statements posted on the sites. Thirty-three Web sites (22 percent) provided no indication about whether or not the vendors comply with the act.
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Reasons Cited for Noncompliance with the Jenkins Act
Some Internet vendors cited specific reasons on their Web sites for not reporting cigarette sales to state tax authorities as required by the Jenkins Act. Seven of the Web sites reviewed (5 percent) posted statements asserting that customer information is protected from release to anyone, including state authorities, under privacy laws. Seventeen Web sites (12 percent) state that they are not required to report information to state tax authorities and/or are not subject to the Jenkins Act reporting requirements. Fifteen of these 17 sites are Native American, with 7 of the sites specifically indicating that they are exempt from reporting to states either because they are Native American businesses or because of their sovereign nation status. In addition, 35 Native American Web sites (40 percent of all the Native American sites we reviewed) indicate that their tobacco products are available tax-free because they are Native American businesses.(see footnote 14)
To supplement our review of the Web sites, we also attempted to contact representatives of 30 Internet cigarette vendors, and we successfully interviewed representatives of 5.(see footnote 15) One of the 5 representatives said that the vendor recently started to file Jenkins Act sales reports with one state.(see footnote 16) However, the other 4 said that they do not comply with the act and provided us with additional arguments for noncompliance. Their arguments included an opinion that the act was not directed at personal use. An additional argument was that the Internet Tax Freedom Act(see footnote 17) supercedes the obligations laid out in the Jenkins Act.
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Our review of the applicable statutes indicates that neither the Internet Tax Freedom Act nor any privacy laws exempt Internet cigarette vendors from Jenkins Act compliance. The Jenkins Act has not been amended since minor additions and clarifications were made to its provisions in 1953 and 1955; and neither the Internet Tax Freedom Act nor any privacy laws amended the Jenkins Act's provisions to expressly exempt Internet cigarette vendors from compliance. With regard to the Internet Tax Freedom Act, the temporary ban that the act imposed on certain types of taxes on e-commerce did not include the collection of existing taxes, such as state excise, sales, and use taxes.
Additionally, nothing in the Jenkins Act or its legislative history implies that cigarette sales for personal use, or Native American cigarette sales, are exempt. In examining a statute, such as the Jenkins Act, that is silent on its applicability to Native American Indian tribes, courts have consistently applied a three-part analysis. Under this analysis, if the act uses general terms that are broad enough to include tribes, the statute will ordinarily apply unless (1) the law touches ''exclusive rights of self-governance in purely intramural matters;'' (2) the application of the law to the tribe would abrogate rights guaranteed by Indian treaties; or (3) there is proof by legislative history or some other means that Congress intended the law not to apply to Indians on their reservations. Our review of the case law did not locate any case law applying this analysis to the Jenkins Act. DOJ said that it also could not locate any case law applying the analysis to the Jenkins Act, and DOJ generally concluded that an Indian tribe may be subject to the act's requirements. DOJ noted, however, that considering the lack of case law on this issue, this conclusion is somewhat speculative. ATF has stated that sales or shipments of cigarettes from Native American reservations are not exempt from the requirements of the Jenkins Act.(see footnote 18)
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Few Web sites Provide Notice of the Vendors' Reporting Responsibilities, but Some Provide Notice of Customer Cigarette Tax Liability
Only 8 (5 percent) of the 147 Web sites we reviewed notified customers that the Jenkins Act requires the vendor to report cigarette sales to state tax authorities, which could result in potential customer tax liability. However, in each of these cases, the Web sites that provided notices of Jenkins Act responsibilities also followed the notice with a statement challenging the applicability of the act and indicating that the vendor does not comply. Twenty-eight Web sites (19 percent) either provided notice of potential customer tax liability for Internet cigarette purchases or recommended that customers contact their state tax authorities to determine if they are liable for taxes on such purchases. Three other sites (2 percent) notified customers that they are responsible for complying with cigarette laws in their state, but did not specifically mention taxes. Of the 147 Web sites we reviewed, 108 (73 percent) did not provide notice of either the vendors' Jenkins Act reporting responsibilities or the customers' responsibilities, including potential tax liability, with regard to their states.
CONCLUSIONS
Our report concluded that states are hampered in attempting to promote Jenkins Act compliance because they lack authority to enforce the act. In addition, violation of the act is a misdemeanor, and U.S. Attorneys' reluctance to pursue misdemeanor violations could be contributing to limited enforcement. Transferring primary investigative jurisdiction from the FBI to ATF would give ATF comprehensive authority at the federal level to enforce the Jenkins Act and should result in more enforcement. ATF's ability to couple Jenkins Act and CCTA enforcement may increase the likelihood it will detect and investigate violators and that U.S. Attorneys will prosecute them. This could lead to improved reporting of interstate cigarette sales, thereby helping to prevent the loss of state cigarette tax revenues. Transferring primary investigative jurisdiction is also appropriate at this time because of the FBI's new challenges and priorities related to the threat of terrorism and the FBI's increased counterterrorism efforts.
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To improve the federal government's efforts in enforcing the Jenkins Act and promoting compliance with the act by Internet cigarette vendors, which may lead to increased state tax revenues from cigarette sales, our report suggested that the Congress should consider providing ATF with primary jurisdiction to investigate violations of the Jenkins Act (15 U.S.C. §375–378). In view of the fact that ATF was recently transferred from the Treasury Department to DOJ, it may now be possible for the Attorney General to administratively transfer primary Jenkins Act enforcement authority from the FBI to ATF without involving the Congress in the matter. We believe that this possibility deserves further investigation on the part of DOJ.
Mr. SMITH. Thank you, Mr. Jones. Without objection, we will also make the entire GAO report a part of the record as well.
Mr. Armour.
STATEMENT OF HENRY ''HANK'' O. ARMOUR, CHAIRMAN OF THE BOARD, NATIONAL ASSOCIATION OF CONVENIENCE STORES
Mr. ARMOUR. Good morning, Mr. Chairman. My name is Hank Armour and I am a small businessman from Olympia, Washington. As President and CEO of West Star Corporation, I own and operate 24 retail facilities in Washington State and California.
I would first like to thank Representative Green for tackling such an important issue in this legislation, the Youth Smoking Prevention and State Revenue Enforcement Act. I also would like to thank Members of the Subcommittee for inviting me to testify regarding this very important issue facing retailers, States and children across this country. I am testifying today on behalf of the National Association of Convenience Stores, NACS, where I sit as chairman of the board. I am a past president of the Washington Association of Neighborhood Stores and currently serve on its executive committee.
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There are over 134,000 convenience stores operating in the United States and the District of Columbia, and they employ over 1.5 million Americans. Tobacco sales are highly important components of the convenience store industry, and while controversial tobacco is a legal product and one that is very important to our economic viability.
The convenience store industry's position is that minors should not consume tobacco and that no retailer should sell tobacco to minors. That is why the convenience store operators across the country have spent time and money trying to prevent these illegal sales. My company has instituted strict measures to ensure that no minor can purchase an age restricted product. A detailed list is included in my submitted testimony, but I want to take just a few minutes to review some of the measures that we have instituted.
They include training sales associates in the ''We Card'' program on the very first day of employment. We recertify every sales associate every 6 months. We prominently post ''We Card'' signs and decals in all of our stores. We conduct monthly internal sting operations to ensure compliance with our age restricted product sales policies. We have reprogrammed our cash registers to prompt sales associates to check for ID every time an age restricted product is scanned. And finally we have a zero tolerance policy in which we immediately terminate a sales associate if the sales associate sells cigarettes to a minor.
As you can see, we take our responsibility very seriously. While no system is perfect, through these training efforts retailers have been able to significantly increase their compliance rate with regard to age verification at point of sale.
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Brick and mortar retailers such as myself who have spent time and money on these responsible tobacco retailing efforts are at an unfair disadvantage to Internet, mail order, and other remote retailers. I am not asking for a weakening of our enforcement obligation, I am asking for our obligation to apply equally to all tobacco retailers. In my view, these remote retailers are frankly irresponsible. For many of these remote sellers, especially Internet retailers, age verification is simply a joke. As you can see from the Web sites I have submitted with my testimony, all a child has to do is click on a link verifying that he or she is over 18 years old, and the child can buy cigarettes. This lackadaisical age verification wouldn't fly in Washington State and I don't think any other State would allow a convenience store owner to place a sign in the store that says by asking for cigarettes you are verifying that you are 18 years old.
According to Clara York, an employee of cigarette retailers Seneca Cigarettes, the ultimate responsibility for making sure teenagers do not purchase cigarettes lies with parents, who should make an effort to police the Web sites their children are visiting. Unlike Clara York, as a responsible tobacco retailer I believe it is my responsibility and the responsibility of my sales associates to ensure that kids don't purchase cigarettes at my retail locations.
Beyond age verification remote sellers are evading tax obligations. I operate stores in Washington State and California. Both States have high excise taxes. Washington has an excise tax of $14.25 per carton. Because they don't collect State taxes remote sellers can offer their cigarettes for almost $15 less per carton than what I can. When you add in sales tax that amount approaches $20 per carton. And like many other States, Washington is currently considering another $5 per carton increase in State excise taxes. As more and more States raise their State excise taxes, smokers will be driven to these remote sellers for cheaper cigarettes.
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Mr. GREEN. [Presiding.] If you could summarize your testimony. I know your light isn't operating there.
Mr. ARMOUR. While the legislation being considered today will not address every problem relating to cigarette sales, it is a good place to start. We can make a big difference by addressing the egregious violations committed every day by Internet and other remote retailers. All tobacco retailers should have to play by the same rules. And Mr. Green, your legislation will accomplish this goal. This is a fair and balanced approach to a growing problem in our society. I thank you, Mr. Green, for introducing the Youth Smoking Prevention and State Revenue Enforcement Act and would be happy to answer any questions.
[The prepared statement of Mr. Armour follows:]
PREPARED STATEMENT OF HENRY O. ARMOUR
Good morning, Mr. Chairman. My name is Hank Armour, and I am a small businessman from Olympia, Washington. As president and CEO of West Star Corporation, I own and operate twenty-four retail facilities in Washington State and California.
I would first like to thank Representative Green for tackling such an important issue in his legislation, the Youth Smoking Prevention and State Revenue Enforcement Act. I also would like to thank members of the subcommittee for inviting me to testify regarding this very important issue facing retailers, states and children across this country.
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I am testifying today on behalf of the National Association of Convenience Stores (''NACS''), where I sit as Chairman of the Board. I am a Past President of the Washington Association of Neighborhood Stores and currently serves on its Executive Committee.
There are over 134,000 convenience stores operating in the United States and the District of Columbia that employ over 1.5 million Americans. Tobacco sales are a highly important component of the convenience store industry. Convenience stores sell more than half of the single packs of tobacco sold in the United States in more than 20 million transactions per day. Such sales, on average, constituted nearly 40 percent of the in-store sales at retail locations in 2001. While controversial, tobacco is a legal product and one that is important to the economic viability of the convenience store industry.
The convenience store industry's position is that minors should not consume tobacco and that no retailer should sell tobacco to minors. That is why convenience store operators across the country have spent time and money trying to prevent tobacco these illegal sales. These prevention efforts include employee training, signage, company-operated stings, incentives for employees, and enforcement of company policies. Some retailers have even installed electronic age verification (EAV) devices to help eliminate these sales. My company has instituted the following measures to ensure that no minor can purchase an age- restricted product from my stores:
On the first day of employment a sales associate is trained in the We Card program and is fully informed of our zero tolerance policy towards the sale of cigarettes to minors.
Throughout the first two weeks of employment sales associates complete computer based training modules on a daily basis including one on the sales of age-restricted products.
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Every six months sales associates complete a re-certification computer based training module dealing with the sales of age-restricted products.
We Card signs and decals are prominently posted in all of our stores.
We conduct on a monthly basis internal sting operations to insure that sales of age-restricted products are been made appropriately.
We publicize appropriate ID checking during sting operations in our monthly newsletter.
We have programmed our cash registered to prompt the sales associate to check for ID every time an age restricted product is scanned for sale.
And finally, as I mentioned earlier, we have a zero tolerance policy towards the sale of age-restricted products to minor in which we immediately terminate a sales associate if they sell such products to a minor.
As you can see, we take our responsibility very seriously.
In order to assist in the elimination of tobacco sales to minors, retailers, wholesalers and manufacturers formed in 1996 the Coalition for Responsible Tobacco Retailing. This Coalition developed the ''We Card'' training program, which provides education and training to help retailers prevent underage tobacco sales. The program includes development and disseminations of retailer best practices to tobacco retailers across the country. The ''We Card'' training materials include signage, training videos, training guides, posters, interactive on-line training, and daily reminder calendars. Nearly 800,000 ''We Card'' kits were distributed to retailers nationwide between 1996 and 2001. ''We Card'' offers on average 200 classroom training sessions that train almost 10,000 retailers annually. From 1996 to 2001, nearly 60,000 retailers underwent ''We Card'' classroom training and they, in turn, trained more than 700,000 employees. While no system is perfect through these training efforts, retailers have been able to significantly increase their compliance rates with regards to age verification at point of sale.
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Brick-and-mortar retailers, such as myself, who have spent time and money on these responsible tobacco-retailing efforts are at an unfair disadvantage to Internet, Mail order and other remote retailers. We pay to train our employees, we get stung and have to pay fines if an illegal sale is made, and these remote sellers have none of these obligations. I am not asking for a weakening of our enforcement obligation, I am asking for our obligations to apply equally to all tobacco retailers. In my view, these remote retailers are frankly irresponsible. A good majority do not have a consistent or reliable age verification processes and should be made to conform with state tobacco retailing regulations. For many of these remote sellers, especially those Internet retailers, age verification is a joke. As you can see from the websites I've submitted with my testimony, all a child has to do is click on a link verifying and that he/she is over 18 years old and the child can buy cigarettes. This lackadaisical age verification wouldn't fly in Washington State, and I don't think any other state would allow a convenience store owner to place a sign in the store that states, ''By asking for cigarettes you are verifying that you are 18 years old.'' According to Clara York, an employee of cigarette e-tailer Seneca Cigarettes, ''the ultimate responsibility for making sure teenagers do not purchase cigarettes, lies with parents who should make an effort to police the Web sites their children are visiting.'' As a responsible tobacco retailer I believe it is my responsibility and the responsibility of my sales associates to ensure kids don't purchase cigarettes at my retail locations.
Beyond age verification, remote sellers are evading their tax obligations. I operate stores in Washington State and California - two states that have high excise taxes. Both states have excise taxes that are close to $1.50 per pack. Because they don't collect states taxes, remote sellers can offer their cigarettes for $15 less per carton than I can. When you add in sales taxes that such sellers do not collect, the amount approaches $20/carton. And Washington State, as are many other states across the nation, is currently considering another $5/carton increase in the state excise tax. As more and more states raise their state excise taxes, smokers will be driven to these remote sellers for cheaper cigarettes.
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Retailers in the convenience store industry cannot compete with remote sellers who are not complying with their tax obligations—many of which flaunt their ''so called'' tax-free status. It simply is not a level playing field. On its home page, Seneca Smokes states that it does not report to any state taxation or tobacco department. Brand Name Cigarettes' advertising tells smokers to stop paying high taxes and start saving money today by purchasing tobacco products securely online. Just look at some of the website names: NoCigaretteTaxes.com, taxfreecigarettes.com, Cheapsmokesbymail.com, Cigs4free.com, dirtcheapcig.com, and notaxsmokes.com. The problem is not solely with Internet retailers, Big Indian Smoke Shop is buying advertisements in papers highlighting their tax-free cigarettes - the one attached to my testimony ran in a New York City paper right after the tobacco excise tax was increased.
While the legislation being considered today will not address every problem relating to cigarettes sales, it is a good place to start. We can make a big difference by addressing the egregious violations committed everyday by Internet and other remote retailers.
The convenience store industry is not asking for special treatment. We want all tobacco retailers to have to play by the same rules, and Mr. Green's legislation will help accomplish this goal. We want a level playing field. This bill will allow attorneys general to go after those remote sellers, including those that are out-of- state or run by Native Americans, who are violating the law. This is a fair and balanced approach to a growing problem in our society.
I thank Mr. Green for introducing the Youth Smoking Prevention and State Revenue Enforcement Act, and would be happy to answer any questions.
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ATTACHMENT
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Mr. GREEN. Thank you, Mr. Armour, for your testimony.
Mr. Myers, President for the National Center for Tobacco-Free Kids. Welcome.
STATEMENT OF MATTHEW MYERS, PRESIDENT, NATIONAL CENTER FOR TOBACCO-FREE KIDS
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Mr. MYERS. Thank you. I want to start out by thanking Congressman Green for introducing this legislation and prompting this important dialogue. I also want to thank Congressman Meehan for his long time leadership on these issues and his effort to find realistic solutions to a serious problem. I am hoping that today's hearing can in fact be the kickoff to a dialogue that will lead to the enactment of legislation that will make a real difference. We ought to be able to get there.
It is clear from the discussion this morning that we agree on goals, that we need to do more to prevent youth access to tobacco products over the Internet and that we need to do something to give the State officials the tools to make sure that State taxes on tobacco products are in fact collected, both because if we fail to do so it undercuts efforts to reduce youth tobacco use and at this time more than any time in our recent past States need the funds if they are going to succeed.
That is critically important.
We agree on the problem.
We agree that State taxes are currently being evaded on a rampant basis and that unless State officials are given new tools that nothing they can do will make a significant difference.
We agree on the need for action.
We agree that the twin problems of youth access and tax evasion need to be addressed, preferably in one bill, but if not in one bill, then in two bills with realistic solutions.
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We agree that the Jenkins Act has been a failure, not that it was not well intended, but it simply didn't give the Federal and State officials the tools they need.
We agree that there is a desire not to create a new bureaucracy, unfunded mandates or unnecessary burdensome provisions.
We also agree that if we are going to pass legislation we must give the State attorneys general the tools they actually need to make a real difference.
In that area, our testimony is designed to focus on what we think needs to be added to this bill so that the State attorneys general will be able to do the jobs, so they will be able to stop the hemorrhaging of State revenues.
Let me tick off in the limited time available the key areas that we think need to be addressed.
First, it is essential that this bill deal with all tobacco products. By leaving out some tobacco products we unintentionally encourage the sale over the Internet of others.
We should create an even playing field. We are not talking about adding new taxes, we are only talking about making sure that people who sell tobacco products comply with the tax laws that are already in existence.
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Second, it is absolutely clear talking to law enforcement officials around the country that unless the bill clearly and unambiguously makes it the responsibility of the seller to collect and pay the taxes, then enforcement efforts will inevitably fail. We cannot go after every kid or person who purchases a tobacco product. No law enforcement official in the Nation has those kinds of resources. I believe it is the intent of this bill to do so. But when you compare the provisions of this bill with what is needed it is clear that there needs to be an amendment. It is a simple process to make explicit that it is the obligation of the seller to collect and remit those taxes to the State officials prior to shipping the tobacco products into the State if we are going to succeed. If we don't include that kind of explicit language, everything else we do is doomed to failure.
Third, we have to make sure that the State officials are given the tools they need to enforce those provisions. What do we mean? Record keeping provisions on the part of sellers, the kind of things that the people in state, the bricks and mortar people have to comply with. The authority of State officials to block the shipment of cigarettes in from repeat offenders. It won't be enough if you simply go after the taxes time and time again. Just as you would with a repeat seller who violates the law, you need the authority to prohibit those people from selling tobacco products. And third, this bill already contains a notice provision. What it needs to make clear is that out of State sellers shouldn't be allowed to sell in State until they have filed with the State, so that the State officials don't have to go on a search for a needle in a haystack to figure out who is violating the law.
Next, the enforcement provisions have to be adequate. Otherwise State officials won't have the incentive to do so. What that means is significant enough minimum penalties just as retailers face so that people will have an incentive both to obey the law and the law enforcement officials will have the incentive to enforce the law. The bill I think unintentionally strips the Federal officials of its Federal authority. We should be adding to those.
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Last, let me just add something that Congressman Meehan said. We need to make sure that the criminal penalties here are real and that they can be enforced both by Federal and State officials. If we do those things, this is a law enforcement bill that can have a significant public health impact on our children and can help States prevent the continued hemorrhage from the illegal sale of tobacco products.
Thank you. Congressman Green, we are very sincere in our offer that we would like to work with you to have a bill that can pass this Congress with bipartisan support in an overwhelming vote.
[The prepared statement of Mr. Myers follows:]
PREPARED STATEMENT OF MATTHEW MYERS
Good morning Mr. Chairman, and members of the Committee. My name is Matthew Myers. I am the President of the National Center for Tobacco-Free Kids, a national organization created to protect children from tobacco by raising awareness that tobacco use is a pediatric disease, by changing public policies, and by actively countering the special interest influence of the tobacco industry.
Mr. Chairman, I want to thank you for inviting me to testify on draft legislation by Congressman Green. While we support the concept of providing the State Attorneys General with authority to enforce violations of this Act, regrettably, we must oppose the legislation as drafted.
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Current Internet sales of tobacco raise two serious issues: uncontrolled sales to youth and evasion of state sales and tobacco related excise taxes. The twin problems of youth access and tax evasion need to both be addressed, preferably in one bill, but if not in one bill in two bills that contain adequate provisions to make a real difference. This bill as currently drafted does not deal with the problem of sales to young people at all; and it is our assessment that its limited proposal to address the problem of the evasion of state sales and tobacco related excise taxes will be ineffective. If its enactment prevents or forestalls the passage of legislation that effectively addresses these problems, it will do more harm than good. Even worse, it would undermine the longstanding, bipartisan efforts of Congressman Meehan, former Congressman Hansen and others to enact a comprehensive solution by giving the false impression that the problems had been effectively addressed.
There are currently about 200 U.S. websites and 200 foreign-based websites that sell cigarettes to U.S. smokers. Effective safeguards against kids being able to purchase cigarettes via the Internet are almost non-existent. While many Internet websites post notices that sales to persons under 18 are illegal or not allowed, very few do anything at all to make sure such sales do not occur.
Tax evasion via Internet sales of tobacco products is rampant. Internet tobacco prices are much lower than those in regular bricks-and-mortar retail outlets because Internet prices almost never include the taxes charged by retail stores. These low prices make Internet tobacco products attractive to both adult and underage smokers, and help to boost overall smoking levels. In addition, states lose millions of dollars each year in uncollected tax revenues. All of these problems have been compounded by the inadequacy of the enforcement tools available, the most serious of which is caused by the fact that under current law responsibility for paying the state taxes is normally the responsibility of the purchaser rather than the Internet seller.
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We have been skeptical about whether these problems can be fully resolved by any action short of a ban such as that imposed recently by the State of New York, but we have endorsed H.R. 5724, the Meehan/Hansen bill introduced in the last Congress. The Meehan/Hansen bill offered a comprehensive solution to the problems arising from Internet sales of tobacco products by addressing both parts of the problem: youth access and tax evasion. The American Cancer Society, the American Heart Association and the American Lung Association also endorsed H.R. 5724. To protect against Internet sales to youth, H.R. 5724 would have required the verification of age and identity both at the time of sale and the time and place of delivery.
We understand that this Committee wants to focus exclusively on legislation within its jurisdiction that addresses the fact that states are illegally losing millions of tax dollars. To accommodate that desire, we undertook to provide Congressmen Green and Meehan with a draft of such legislation. We strongly urge the Committee to adopt its provisions.
I would now like to outline the seven specific areas in which the legislation offered by Congressman Green fails to meet what we believe are the minimum standards necessary for any effective legislation dealing with Internet tobacco sales.
1. The legislation should apply to all tobacco products, not just cigarettes.
If the legislation applies only to cigarettes it will do nothing to reduce illegal sales and tax evasion over the Internet or through mail order on other tobacco products. By focusing only on cigarettes, the legislation could have the unintended consequence of encouraging use of other tobacco products such as smokeless tobacco. There can be no justification for the different treatment of different tobacco products.
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2. The legislation should explicitly impose the burden of either paying or insuring that applicable state taxes are paid on the Internet seller rather than on the purchaser.
State tobacco taxes on tobacco products sold at retail are collected at the distributor level. The products arrive at the retail outlet with a tax stamp already on them and the applicable tobacco related taxes already paid. This enables law enforcement officials to easily monitor compliance and insures that violations will involve a sufficient amount of money to warrant enforcement.
At present Internet sellers based outside the United States and/or on Indian lands pay no state taxes and Internet sellers based in low tax states only pay the tax from the state in which they are based. The responsibility for paying the tax on the tobacco products they sell then falls to the individual consumer/purchaser, making enforcement difficult and costly. Unless the responsibility for paying the tax is clearly and unquestionably switched to the Internet seller, it doesn't matter who is given the authority to enforce the law—it will not happen.
Despite our requests that a provision be added that explicitly switches the responsibility to the Internet seller, the bill before the Committee does not do so. As written, the draft legislation offered by Congressman Green in Sec. 2(a) only requires that the Internet seller ''comply with all the sales tax and use tax and other laws, applicable to the distribution and sale of cigarettes.'' This could be interpreted to give states only a federal right of action to enforce existing state laws that apply to Internet sellers. Very few states have laws that explicitly apply to Internet sellers.
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Even a broader interpretation would be difficult to implement because states have numerous ''sales and use tax and other laws applicable to the sale of cigarettes.'' Some apply to manufacturers, distributors, and wholesalers; others apply to retailers, vending machine operators, etc. In most states, state laws place no tobacco tax collection or payment obligations on retailers because these responsibilities are placed on others. If the goal is to require the Internet seller to pay the tax or to insure that it is paid, then the legislation should be explicit on this point. If legislation is ambiguous as to whether the burden to pay the tax falls on the Internet seller or purchaser or some third party, then it will be wholly ineffective in curtailing tax evasion.
3. The legislation should apply to all remote sales of tobacco products.
As written, the legislation exempts sales that are not ''outside the State or Indian lands where the order is processed.'' While the impact is probably unintended, this could be read to exempt sales from Indian lands to consumers outside the Indian reservation but within the same state. This could be a substantial loophole in states with large populations with in-state tribal Internet sellers.
4. The legislation should include an enforcement mechanism that will assure that the states can actually enforce the legislation and block Internet and mail-order sales of tobacco products for which state taxes have not been paid.
Internet sellers are often based out of state, on Tribal lands, or even offshore or overseas. Some are fly-by-night operations. Even if this legislation gives states authority to bring civil actions against any person who violates the Act, bringing state lawsuits against distant vendors is an inevitably costly, cumbersome, complicated, and ultimately uncertain enforcement procedure.
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To be effective, legislation must require that Internet sellers maintain records of their sales for several years, prohibit anyone from shipping tobacco products into the state who has not registered and give the state the authority to block the delivery of tobacco products who have not complied with the law. The current draft does not adequately include any of these tools.
5. The Civil Action section of the legislation should provide for civil fines and give the federal government the right to seek civil fines and civil damages.
As drafted, Sec. 3. entitled ''Civil Action'' says that a State Attorney General may ''obtain appropriate relief, including money damages,'' but does not provide for any specific or minimum penalties or fines for violating the provisions of this Act, nor does it include the authority to withdraw a repeat violator's right to sell tobacco products into the state in the future.
We support the proposal to provide state Attorneys General with the authority to bring civil actions to enforce violations of the law, but it should not at the same time strip the federal government of authority to bring a civil enforcement action and allow the federal government only to seek criminal penalties. As drafted, the federal government would not be allowed to seek any civil or monetary damages or fines from Internet or mail order sellers who break the law. Federal authorities have not to date exercised their current enforcement authority, in part, because individual enforcement cases were deemed to be too small to warrant the effort. If the law imposed the burden to pay the taxes on the Internet seller, rather than the purchaser, federal enforcement could potentially become an important complement to any state enforcement prompted by the Act.
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6. The criminal penalties should be increased beyond the inadequate penalties established in the original Jenkins Act in 1949.
This legislation provides only a misdemeanor penalty with no minimum fine and a maximum fine too small to have a deterrent effect, along with up to 6 months in jail, or both. These penalties are inadequate. The penalties in the original Jenkins Act failed to deter violators or to encourage federal enforcement of the law and the provisions in the bill now before the Committee will not correct this problem. To be effective, the criminal penalty provisions should make violations of the act a felony, provide for significant, minimum criminal fines, and provide for larger criminal fines and possible imprisonment for flagrant and repeated violations.
7. The legislation does not require Internet and mail-order sellers to keep any records of their sales and deliveries into a state.
While the legislation, like the original Jenkin's Act, requires Internet and mail-order sellers to register with state tax administrators and make monthly sales reports to those officials, it does not require them to keep their own records of these sales and deliveries over time. This omission could be a major impediment to enforcement efforts and to the calculation of monetary damages, such as unpaid taxes. A provision should be added to the legislation requiring sellers to maintain specific records for not less than five years.
In sum, this bill addresses a legitimate problem, but does not do so effectively. If the goal is to insure that state tobacco taxes are collected on Internet tobacco sales, the bill as drafted will not accomplish its purpose. We in the public health community are prepared to and would welcome the opportunity to work with the Committee to produce effective legislation that would make a reality of our common goal to reduce tax evasion and eliminate youth access to tobacco products in remote sales of tobacco products.
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ATTACHMENT
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Mr. GREEN. I look forward to it. Thank you for your testimony. The final witness today is Mr. Patrick Fleenor, Chief Economist with Fiscal Economics. Welcome.
STATEMENT OF PATRICK FLEENOR, CHIEF ECONOMIST, FISCAL ECONOMICS
Mr. FLEENOR. Mr. Chairman, Members of the Committee, as you know, over the last 5 years the retail price of cigarettes in the United States has soared. Buoyed by the rash of recent State and local excise tax hikes as well as the implicit taxes which were part of the Master Settlement Agreement, the average retail price of cigarettes has risen nearly $4 per pack, almost twice the level of just 5 years ago. In high tax jurisdictions such as New York City cigarettes can cost more than $7.50 a pack. Consumers have responded to the rising prices by increasingly searching out low cost sources of cigarettes.
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One source that has experienced considerable growth over the last several years has been online tobacco retailers who sell cigarettes acquired from low-tax jurisdictions. In the year 2000 it was estimated that there were roughly 40 U.S. based Web sites selling cigarettes. Today this figure has risen to nearly 200. An equal number of foreign sites also sell cigarettes into the U.S. market.
A September 2002 study by Prudential Securities estimated that 2 percent of the cigarettes consumed in the United States, or more than 400 million packs were purchased online. The report projected this figure would triple by 2005. Another study by Forrester Research forecast that Internet sales would claim 14 percent of the market by 2005.
With State and local governments frequently collecting more than $1 in excise and sales tax revenue on each pack of cigarettes sold, Internet cigarette sales can have significant fiscal effects. I estimated—using a sophisticated economic model which first allocates Internet sales to the States and then estimates their effect on State and local revenue. The model basically applies State and local excise taxes as well as sales taxes to the number of packs sold, during the current fiscal year under the assumption that Internet sales would supply about 2 percent of the market I estimated that Internet sales would collectively cost State and local governments about $552 million in excise and sales tax revenue. This impact, however, will vary significantly by State. In New York, home of the Nation's highest cigarette taxes, Internet sales will cost State and local governments more than $150 million. It will also be high in California and New Jersey and Michigan.
On the flip side, some States will experience very little losses. Montana, for example, will lose about $41,000 this year in sales tax as well as cigarette excise taxes. Losses will also be relatively light in Wyoming, Delaware, and Colorado.
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Even in the absence of additional State and local excise tax hikes, many observers feel that the share of the U.S. cigarette market supplied by Internet retailers will continue to expand over the next several years unless the tax advantage that online retailers enjoy over traditional brick and mortar retailers is significantly narrowed.
Estimates of market penetration vary significantly, so I estimated State and local revenue losses under two scenarios. The first assumed the Internet retailers would capture about 6 percent of the market by 2005. In that scenario I estimated that total excise and sales tax revenue losses by the States would equal around $1.7 billion, again the impact varying significantly by State. New York, I estimated would lose about $435 million while other States would lose as little as about $115,000.
In the second scenario I assumed Internet retailers would capture about 14 percent of the market by 2005. In that case you have losses of about $4 billion, again significant variation among the States in terms of revenue loss. Some States like New York will lose as much as a billion, others will lose around $268,000.
Proponents of a larger role for State governments in the enforcement of tobacco statutes, as we are talking about today, frequently argue that in addition to the fact that State and local governments have a greater incentive to collect their tax revenue than do Federal authorities, the widely varying impact that avoidance causes on the States calls for something more than a one-size-fits-all approach. Therefore my research tends to support the bill.
Thank you, Mr. Chairman and Members of the Committee, for the opportunity to testify this morning. I will submit a copy of my full statement for the record and be happy to take any questions.
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[The prepared statement of Mr. Fleenor follows:]
PREPARED STATEMENT OF PATRICK FLEENOR
Mr. Chairman and Members of the Committee, my name is Patrick Fleenor. I am the chief economist of Fiscal Economics, a consulting firm specializing in the economic analysis of fiscal policy. Prior to my current position I was a senior economist with the Joint Economic Committee of the United States Congress. I have also served as chief economist of the Tax Foundation, one of the nation's oldest and most respected think tanks. It is an honor for me to appear before you today to discuss the impact of Internet cigarette sales on state and local government budgets.
INTRODUCTION
Over the last 5 years, the retail price of cigarettes has soared. Buoyed by the rash of recent state and local excise tax hikes as well as the implicit tax hikes which are part of the Master Settlement Agreement, the average retail price of a pack of cigarettes has risen to nearly $4.00 per pack, almost twice the level just 5 years ago. In high-tax jurisdictions such as New York City, cigarettes can cost as much as $7.50 per pack.
Consumers have responded to these rising prices by increasingly searching out low-cost sources of cigarettes. One source that has experienced considerable growth over the last several years has been online tobacco retailers who sell cigarettes acquired from low-tax jurisdictions.
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In 2000, it was estimated that there were roughly 40 U.S.-based websites selling cigarettes on the Internet. Today, this figure has risen to more than 200 with an equal number of foreign sites also selling cigarettes in the U.S. market. A September 2002 study by Prudential Securities estimated that 2 percent of the cigarettes consumed in the U.S.—more than 400 million packs annually—were purchased online.(see footnote 19) The report projected that this figure would triple by 2005. Another study by Forrester Research forecast that Internet cigarette sales would claim 14 percent of the U.S. market by 2005.(see footnote 20)
ESTIMATING THE EFFECT OF INTERNET CIGARETTE SALES ON STATE & LOCAL SALES AND EXCISE TAX REVENUES BY STATE
With state and local governments frequently collecting more than $1.00 in excise and sales tax revenue on each pack of cigarettes sold, Internet cigarette sales can have significant fiscal effects. It is possible to calculate these effects by employing an economic model that apportions Internet cigarette sales by state and then uses information on sales and excise taxes as well as average price data to calculate revenue losses by jurisdiction.
This type of analysis was used to prepare the estimates presented in Table 1. Here it was assumed that Internet purchases accounted for 2.0 percent of total cigarette sales in FY 2003. Under this assumption, which is generally consistent with the estimate made in the Prudential Securities report, 413.9 million packs of cigarettes will be sold over the Internet during the 2003 fiscal year.
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The allocation module of the model uses population data, smoking rates, sales and excise tax levels, and other information to calculate the demand for cigarettes as well as incentive to purchase cigarettes online. Consequently, states with similar populations can have widely differing levels of Internet sales. Total Internet sales in New York, for example, are estimated to be more than three times the level in Texas even though smoking rates in the two states are similar. This occurred in large part because the incentive to purchase cigarettes online—i.e. sales and excise taxes levied on cigarettes—were, on average, more than 3 times higher per pack in New York.
Once total Internet sales have been apportioned among the states the model calculates state and local excise and sales tax revenue lost as a result of Internet cigarette sales. The model estimates that in FY 2003 state and local governments in the U.S. will lose $552.4 million due to online cigarette sales. The bulk of these funds, $399.4 million or 72.3 percent of the total, will be due to lost excise tax collections. The balance will result from lost sales taxes.
Tables 2 and 3 present projections of state and local government revenue losses under current law for FY 2005 under two scenarios. The analysis underlying Table 2 assumes that Internet sales will capture 6 percent of the U.S. cigarette market by FY 2005, a forecast similar to that made by Prudential Securities. Under this scenario state and local governments will lose $1.7 billion in excise and sales tax revenue during that fiscal year.
The results of the analysis presented in Table 3 assume that Internet cigarette sales climb to 14 percent of the market by FY 2005, a forecast generally consistent with that made by Forrester Research. Under this assumption, state and local governments would lose roughly $4.0 billion in excise and sales tax revenue during FY 2005.
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CONCLUSION
The ability of Internet retailers to sell low-tax cigarettes at a time of rapidly rising cigarette taxes has resulted in that sector supplying an ever increasing share of the nation's cigarette market in recent years. This has cost state and local governments billions of dollars in lost excise and sales tax revenue at a time of widening budget gaps. Even in the absence of additional tax hikes, many industry observers feel that the Internet sector will continue to expand over the next several years, with commensurate revenue losses for state and local governments, unless the tax advantage Internet retailers currently enjoy over traditional brick-and-mortar retailers is significantly narrowed.
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Mr. GREEN. Thank you for your testimony. I thank again all the witnesses for testifying. I will begin with questions.
Mr. Jones, in your research you came across a large number of Web sites that sell so-called tax free cigarettes. Did your research show who the operators of those Web sites are?
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Mr. JONES. For the most part it had indications of the owners. We identified, as I say, 147 sites. The majority of those sites were Native American sites, 87 out of the 147 were Native Americans. Some of the others listed addresses and names. It was for the most part Native Americans, 87 out of 147.
Mr. GREEN. Okay. Thank you. And if you will take a look, I hope you have had a chance, as all the witnesses I know have had a chance, to take a look at this color handout that we have given here which shows just some of the Web sites that are there. Mr. Jones, can you tell me as you look at those, was that sort of characteristic of the Web sites that you researched?
Mr. JONES. Yes. We searched terms such as cheap cigarettes, free taxes, and so forth. And we also came up with a set of Internet sites similar to the ones shown here. I think the interesting thing is that when you search on these sites it becomes very obvious that the selling point is the lack of taxes and that is what draws the seller to those sites. I think, too, that in some cases that the site also will lure you on with buying one cigarette and then talk you into buying one that they can make more money on such as a generic brand versus premium brand. We found some of those cases also.
While we didn't specifically look at this in terms of the issue of youth smoking, our review didn't specifically look at that issue, but looking at some of the sites in terms of how you would order cigarettes there were some indications that youth could buy cigarettes with very little identification. Although they asked for verification of age it would just require certification in the statement that I am of age. And of course if you want to buy a cigarette, you certify.
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Mr. GREEN. Every high school student's dream.
Mr. JONES. My son had an ID card that had a false age, too. So I think it is very easy if a youth wanted to falsify his age via the Internet because as I said in my statement the Internet is anonymous, you can use the Internet without being physically there. So to an extent it is anonymous, it also makes it very easy for people who might be ashamed to go to stores to buy cigarettes because of the social issues, they also find its another avenue to procure cigarettes over the Internet.
Mr. GREEN. Interesting. Mr. Armour, could you comment on or expound upon the threat that these remote sellers present to brick and mortar stores?
Mr. ARMOUR. I think the largest one, going back to what I said in my testimony, you look at Washington State. By not collecting State excise and sales taxes it is $20 a carton. That is an enormous price advantage. And while in Washington State I can't quantify the instances of Internet or mail order sales into the State because we have so many Indian reservations in urban areas that already are siphoning off a great deal of excise taxes, our State Department of Revenue estimated 3 years ago that the loss of State excise taxes in Washington State due to Indian reservation sales exceeded $130 million a year.
So I think that is indicative of the wide discrepancy in prices that retailers that don't collect taxes have.
Mr. GREEN. Interesting.
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Mr. Myers, what do you think is the best way that Internet sales can verify age, Internet sellers can verify age? Do you have any suggestions on how that might be accomplished?
Mr. MYERS. We do. And Congressman Meehan's bill that he introduced previously represents our thinking as well on that. What you need to do is require a Government database checked photo ID both at the time of the initial transaction over the Internet and then second at the point of delivery. If you don't do both, then you have opened up a path either way. If you do do both, then you can get a real clamp on these issues.
We would be happy to work on the specific detailed provisions about how to do that. But I think it is essential if we are going to really put a clamp on illegal sales to children all across the country.
Mr. GREEN. Thank you. Now the Chair recognizes Mr. Meehan for his questions.
Mr. MEEHAN. Thank you, Mr. Chairman. Mr. Jones, thank you for appearing at this hearing and also for an excellent GAO report that both Congressman Conyers and I had requested. I may be going over some of your testimony you have already presented, but I want to make the Subcommittee record clear on some points.
Mr. Jones, both the Department of Justice and the Bureau of Alcohol, Tobacco and Firearms commented on your draft report, is that correct?
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Mr. JONES. That is correct.
Mr. MEEHAN. What did the Department of Justice state in regards to the fact that the Jenkins Act only contained misdemeanor penalties in terms of the U.S. attorney's willingness to prosecute cases?
Mr. JONES. Both the Justice Department and the Treasury Department commented on the draft report, suggested that felony as a penalty would increased compliance with the Jenkins Act. They also made some other suggestions in terms of getting more enforcement by States, allowing States more authority to take Jenkins Act enforcement to State courts and Federal district courts. The concern with the——
Mr. MEEHAN. So that was the input that you got from the Justice Department?
Mr. JONES. Yes. The concern was that by making it a felony you would get more U.S. attorneys to take the cases to Federal court. As you know, U.S. attorneys have a limited staff and they can't take every Federal case to Federal court. They have a certain—I guess it is pretty well known they have thresholds that they use to take cases to Federal court, and they very rarely take misdemeanors to a Federal court. And because these are misdemeanors, very little attention is given to these cases because Federal law enforcement knows that they won't be able to get U.S. attorneys to take these cases to Federal court.
So I think the reason that the Federal Government doesn't enforce the law; that is, the FBI and the ATF, is because they can't get U.S. attorneys to take the cases to court.
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Mr. MEEHAN. It is your testimony as well, you mention the Treasury Department, the ATF, the agency that you recommend to have jurisdiction over this matter, that now potentially we could accomplish administratively. They made the same representations in the comments?
Mr. JONES. Yes. And they went—ATF when a step further and offered to take over the responsibility of enforcement. As you know, ATF now enforces the Cigarette Contraband Trafficking Act, which is a smuggling act, and it also carries a felony penalty. So they feel by having the comprehensive authority to enforce the Jenkins Act and CTA act that they will have the whole issue in one court. And since ATF has been transferred now from Treasury to the Justice Department, we think that Justice can handle that issue and Congress doesn't need to worry about that right now.
Mr. MEEHAN. Excellent.
Mr. Myers, your testimony mentioned the growing problem of kids buying cigarettes over the Internet in the absence of safeguards to prevent these types of sales. Massachusetts Attorney General Tom Reilly and I actually conducted our own sting operation on two separate occasions and we were astounded at how easily it was for young children who participated in the sting, how easy it was for them to buy cigarettes over the Internet with the click of the mouse.
Do you think this new legislation addresses the growing problem with youth access to tobacco over the Internet, and how specifically can we better address this problem that I think it is clear that we all agree it is, certainly Congressman Green and I are in strong agreement on?
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Mr. MYERS. It is a vitally important problem. And State attorney generals have done more to stop illegal sales at the brick and mortar retailers. Then it becomes even more important to address the issue here. There are a number of things we have to do. First, strong enforcement of tax evasion is a component of the issue. If the cigarettes aren't cheaper kids will be less likely to buy them. But, second, we have to have a meaningful set of provisions for age verification, as Congressman Green and I discussed earlier. We need to make sure it hits both at the point of sale and at the point of delivery. We need to hold the people in that line of process accountable for it. That includes adequate record keeping. So this bill by itself does not solve that problem.
Mr. MEEHAN. Will giving States attorneys general the right to bring a case to Federal court help reduce the problem with youth access?
Mr. MYERS. Giving State attorneys general the right to sue along with the tools they need to do so will make a difference. This bill needs to be beefed up to accomplish it. Unless it is clear that it is the out-of-state sellers who have the obligation to collect and pay the tax, unless the State attorneys general have the authority to actually block sales by a seller who is not living up to the law and to ban future sales, and unless you have penalties that include felony penalties, then you will not accomplish the goal that I think we all agree upon.
Mr. MEEHAN. Thank you.
Mr. GREEN. I thank the gentleman. The Chair recognize Mr. Keller, the gentleman from Florida.
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Mr. KELLER. Thank you very much, Mr. Green. Mr. Myers, let me begin with you. And I want to thank you so much for coming before our Committee today and taking time to educate us on your issues. I know all of us share your concern about underage children smoking. Let me just tell you one thing in the interest of States, if I had somebody from the National Center for Tougher Sentences for Child Abusers here before us and we had a bill to make dramatically tougher sentences for child abusers and they were saying they weren't supportive of it, I would think to myself what in the hell are these people thinking. I would think that they would be almost marginalizing themselves by saying we are not going to support it unless you make different changes that we uniquely would do.
So my question is now, faced with the situation where we have a very real problem with underage children smoking because these remote Web sites are failing to do adequate age verifications and they are making it easier and cheaper for kids to buy cigarettes and this bill would in fact ensure that the age verification and tax collection would take place for remote sales of cigarettes at least better than it is now, why are you not supporting this legislation as written?
Mr. MYERS. I am glad you asked that question. Because the answer is straightforward. The Jenkins Act was passed with the best of intentions and failed because it didn't have adequate teeth. It doesn't have adequate enforcement provisions. Our goal, like yours, is to come up with a piece of legislation that will actually make a difference. We don't move our ball forward if we don't give the State attorneys general the actual tools they need. Based on a lot of conversations with a lot of law enforcement officials, it has been our conclusion that without making the changes we suggest, none of which are radical, none of which are extraordinary, that you won't in fact make the difference that both you and I want to see made.
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This isn't a matter of the perfect being the enemy of the good. It is a matter of making sure that you pass a piece of legislation that will actually do what you and I want. As drafted, we have been told by lots of people this bill won't get us there. I am convinced that working with Congressman Green and Congressman Meehan we can get there with a reasonable bill.
Mr. KELLER. Thank you for that. That is fair. I want to give you your side of that. I would encourage reasonableness on both sides.
Mr. MYERS. That is why one of the things we first did was in fact go out to the people who have to enforce the law and ask them about the adequacy of these provisions. Will it make a real difference because I know that is what you want? What we were told is that unless you take a number of the steps that we have described here, that all we are doing is kidding ourselves and no one here intends to do that.
Mr. KELLER. Mr. Jones, turning to you, does Native American status as far as you know serve as a valid defense for noncompliance with State laws regulating the sale and distribution or possession of cigarettes? In other words, can an Indian tribe by virtue of their own sovereignty say if I want to sell to a 12-year-old I can sell to a 12-year-old; is that legal on their part?
Mr. JONES. Our legal staff has found that is not true, that Native Americans do not have auto