Illegal tobacco sales, made possible by high taxes, are helping fund organized criminal and terrorist activities

by Bob Gatty

There is mounting and virtually inconvertible evidence that trafficking in contraband cigarettes is financing organized criminal activities and international terrorist organizations abroad, unfairly competing with distributors who depend upon legitimate tobacco sales to support their businesses.

It is not a new problem, but one that is growing virtually every day and involves such disparate entities as Indian reservations in some parts of the U.S. and the Internet.

In April, U.S. Rep. Peter T. King (R-NY), ranking Republican member of the House Committee on Homeland Security, called for immediate investigations and Congressional hearings to examine local and national cigarette smuggling operations that are reportedly diverting funds to terrorist organizations overseas.

King’s request followed release of a committee Republican staff report that says illicit cigarette smugglers in New York state and elsewhere are sending large sums of cash to foreigners with terrorist ties. Total funding is estimated to be in the millions of dollars. The report also says that New York’s policy of “forbearance,” or refusing to collect on sales of Native American tax-free cigarettes to non-Native Americans, has created a safe haven for smugglers.

“This is a very serious homeland security issue, one that has gone unnoticed for far too long,” King says. “Cigarette smugglers are able to generate millions of dollars in illegal profits, with a great deal of this wealth being sent to terrorist groups overseas—groups that would like nothing more than to inflict devastating harm on our country and its citizens. Those cigarette smugglers must be stopped, and I call on both New York State and Congress to take immediate action.”

According to the report, a well-organized illicit cigarette operation, smuggling and sales profits included, can generate up to $300,000 per week. The report identifies three cases in which cigarette smugglers were tied to overseas terrorist groups. These closed cases alone cite hundreds of thousands of dollars in cash being funneled to terror groups. Law enforcement officials say the total figure is in the millions of dollars annually.

Further, the report says that New York state is forfeiting anywhere from $436 million to $576 million in tax revenues annually as a result of its policy of forbearance, which it contends has made New York Indian reservations “the chief suppliers of a nationwide Internet-based tax-free cigarette market.”

“Over the past several years, the illicit tobacco trade has reemerged as one of the most lucrative smuggling operations in the United States and around the globe,” the committee staff report asserts, noting that the World Health Organization estimates that illicit cigarettes account for 10.7 percent of the more than 5.7 trillion cigarettes sold globally each year. In North America, experts estimate that 5 percent of the annual cigarette market is illicit.

Exploiting price disparities
Feeding this black market, the report says, is the disparity between state taxes on cigarettes as well as the discounted sale of cigarettes to specific segments of the population, such as Native Americans. Since 1992, cigarette taxes in the U.S. have been increasing, jumping more than 65 percent according to a 2002 report. Obviously, there have been significant state tobacco tax increases since then.

“Exploiting the price disparity for a single pack of cigarettes between individual states has proven lucrative for well-organized criminal networks,” the report says. “For example, a pack of cigarettes that costs $8 in New York and New Jersey will only cost $4 in ‘tobacco states’ like Virginia and North Carolina. The profit on a standard diverted load of 1,500 contraband cartons could be as high as $60,000.”

The report points out that the contraband and counterfeit tobacco trade ranges from large scale smuggling networks to smaller “bootleg” activities, as well as counterfeiting and illegal manufacturing. It says that large scale cigarette smuggling networks in New York state are dominated by “tight-knit, nationality-based networks, primarily families through blood or marriage of Lebanese, Yemeni, Jordanian, and Palestinian descent,” which can control transportation, storage, retail, and remittance.

Federal and New York state law enforcement officials estimate that nearly 60 percent of all convenience retail outlets in New York City “are now Arab-owned, and with the Arab networks compartmentalized by ethnicity and familial ties, the risk of infiltration by law enforcement is minimal.”

“It is possible for these Arab networks to rely on suppliers in lower tax states such as Virginia and North Carolina as well as Hezbollah-linked front companies in various free trade zones around Latin America,” the report points out. “However, sources told the committee that in New York state the smuggling networks rely primarily on access to the Native American Indian reservations for tax-free cigarettes – for obvious financial reasons.”

The report says law enforcement and state taxation officials explain that manufacturers sell a carton of cigarettes to New York wholesalers for $26, who then sell it to Native American Indian reservation smoke shops for $27. New York City retailers, meanwhile, pay an average of $61.77 per carton, after the applicable $18.60 state tax, $15 local tax, and other fees.

“This large disparity has created a tremendous opportunity for criminal enterprise,” the committee report says. “Smugglers can make arrangements with tribal smoke shop owners to purchase an average 1,500 carton load at $30 per carton. The smugglers then add counterfeit tax stamps, which cost them as little as $1 per carton. Once the counterfeit tax stamps are in place, the smugglers may then re-sell the cigarettes to their network retailers for approximately $45 per carton, generating a $14 profit per carton, or $21,000 per load.”

Criminal, terrorist cases cited
In early May, federal prosecutors on Long Island won the conviction of  Rodney Morrison, former owner of a tax-free smoke shop on the Poospatuck Reservation in New York, who had been charged with ordering the firebombing of a woman's car as part of what prosecutors described as a campaign to intimidate owners of competing shops on the reservation. Rodney Morrison was convicted on racketeering conspiracy and weapons charges. He was also under investigation for failing to report at least $9 million in income deposited in banks in his native Costa Rica.

According to published reports, Morrison – who now faces up to 30 years in prison – turned an estimated profit of $35 million per month running the Peace Pipe Smoke Shop. If so, estimates by the Homeland Security GOP staff that “well-organized cigarette smuggling networks generate between $200,000 and $300,000 per week,” are substantially understated.

Morrison’s case is one of those cited in the report, which also points to a criminal enterprise in Charlotte, NC, led by Mohamad Hammoud that smuggled cigarettes from North Carolina, where the tax was 50 cents per carton, to Michigan, where the state tax was $7.50 per carton. Arrested in 2000 and convicted in 2002, Hammoud and his associates made more than $8 million, a sum law enforcement officials estimate took just four years to accumulate. Officials believe more than $100,000 was sent to Hezbollah.

The report also cites a 2003 case involving two women from the Seneca Nation of Indians’ Cattaraugus reservation in New York state that provided tax-free cigarettes from the reservation’s smoke shop to another Hezbollah-linked network in Dearborn, MI. According to prosecutors, the head of the smuggling ring, Elias Mohammad Akhdar, is a native of Lebanon and has direct ties to Hezbollah.

In a case not cited in the report, a federal grand jury in Baltimore, MD, last September indicted 39 individuals and one business on charges arising from money laundering, conspiracy to bribe a public official, operating unlicensed money transmitting businesses and failing to file currency transaction reports. One defendant also was charged with concealment of terrorist financing.

One of the illegal activities involved – international smuggling of counterfeit cigarettes. One of the destinations for at least part of the proceeds – al Qaeda.

The four indictments sought $5,148,000 in criminal forfeitures and ownership interest in two Maryland convenience stores. Five additional defendants were arrested and charged with bribery and one other with money laundering following an undercover sting operation spearheaded by the Federal Bureau of Investigation.

United States Attorney Rod J. Rosenstein said the “Operation Cash-Out” undercover investigation yielded evidence of four separate criminal schemes involving at least 46 defendants in the United States, Spain, Canada and Belgium. He said three of the indictments involved money laundering hawala schemes that illegally transferred millions of dollars to contacts in other countries. One of the defendants, Saifullah Ranjha, was alleged to have laundered money that he believed was to be used by al Qaeda, according to the FBI.

The fourth indictment alleged a scheme in which many defendants conspired to bribe public officials with the U.S. Citizenship and Immigration Services to illegally obtain green cards and, in the Maryland Comptroller’s Office, to receive abatement of taxes owed to the state.

“Illicit money transmittal businesses, coupled with individuals seeking to exploit our immigration system, can pose significant threats to our national security and public safety,” said James A. Dinkins, Special Agent in Charge, of Immigration and Customs Enforcement (ICE), Baltimore.

In April, New York law enforcement authorities announced the arrest of Rafea al-Nablisi for smuggling 12,000 cartons of cigarettes a week. “It was not the first such arrest, and thanks to New York’s latest cigarette tax hike, it will not be the last,” wrote Patrick Fleenor, chief economist of the Tax Foundation, in the May 7 Wall Street Journal.

Fleenor pointed out that on April 23, less than two weeks after Nablisi’s arrest was made public, Gov. David Paterson signed a $1.25 per-pack tax hike on top of the state’s previous $1.50 per-pack tax, and in addition to New York City’s own $1.50 per pack tax. “Come July 1, New York City’s smokers will be paying an average $9 a pack for legal cigarettes,” wrote Fleenor, who is author of “Cigarette Taxes, Black Markets, and Crime: Lessons from New York’s 50-Year Losing Battle,” published by the Cato Institute in 2003.

Unintended consequences
“That is precisely the flaw in efforts to increase tobacco taxes and impose additional burdens on legitimate, law-abiding businesses through unreasonable and unworkable regulatory requirements,” says AWMA President & CEO Scott Ramminger, whose members went to Capitol Hill in May to oppose legislation giving the Food and Drug Administration (FDA) authority to regulate tobacco. “When there is such a tremendous disparity in taxes among individual states, that is when there is opportunity for mischief – and worse.”

He cited as an example the current situation in Canada, where extremely high taxes and government regulatory requirements have resulted in a booming black market trade in tobacco products.

According to the Canadian Tobacco Manufacturers’ Council, 22 percent of cigarettes smoked in Canada are illegal, up from 16.5 percent in 2006, a 30 percent increase. A recent study produced by AWMA points out that in Ontario, 31.6 percent of cigarettes smoked there are illegal, up from 23.5 percent in 2006, a 35 percent increase. Ontario accounts for 55.5 percent of illegal smokers and 53.8 percent of illegal cigarettes in Canada.

The study points out that the contraband situation contributed to a rollback of tobacco taxes in 1994, but on concerns of underage smoking and the impact on health, they were later increased to rates higher than pre-cutback levels.

“Compounding the problem is the fact that tobacco products sold on First Nations Reserves are exempt from provincial taxes, although it is illegal to sell these products to non-Native consumers without collecting the appropriate taxes,” the study says. “However, many non-Native consumers who smoke are able to purchase untaxed Native cigarettes at about one-third of the price of taxed cigarettes.”

“Competition in Canada from illegal sales parallels that in the U.S., where the sale of untaxed cigarettes on the Internet is a growing problem and where distributors in some states, such as New York, are experiencing unfair competition from tax-free cigarettes purchased on Indian reservations and then resold,” the report points out.

Opposing Internet tobacco sales
On May 1, Ramminger submitted testimony to the House Judiciary Committee in support of HR 4081, the Prevent All Cigarette Trafficking Act of 2007, designed to address the widespread problem of illegal Internet sales of cigarettes.

“From our industry’s perspective, every sale of an illegal tobacco product over the Internet translates into a loss for responsible, legitimate, law-abiding distributors and retailers across the country,” Ramminger told lawmakers. “And, it is not just our industry that’s impacted – states are losing millions of dollars each year in unpaid excise taxes and enforcement expenses. And, more important, many of the cigarettes sold over the Internet are ending up in the hands of underage smokers because of the lack of safeguards inherent in these types of remote sales.”

The legislation would impose shipping and recordkeeping requirements on delivery sellers of cigarettes and smokeless tobacco products, including Internet businesses, and establish age verification requirements for recipients.

Meanwhile, the House Subcommittee on Federal Workforce, Postal Service and the District of Columbia on April 29 approved legislation that would restrict shipment of tobacco products through the U.S. mail, despite objections from the Postal Service. AWMA also supports this bill, introduced by Rep. John McHugh.

The fox in the chicken coop
AWMA Chairman Dick Dunham, Stephenson Wholesale Company, Inc., stressed during AWMA’s Day on the Hill event in Washington that because the FDA has publicly expressed its support for banning tobacco, “having that agency in charge of regulating tobacco cannot possibly be good.”

“We need less, not more, bureaucracy when it comes to running our day-to-day businesses,” he declared. “We need to let our legislators know that what they do will have an impact on distributors, and we need to let them know the value that we bring to their local communities.”

The House Commerce Committee in early April approved a bill that would give FDA sweeping regulatory authority over the tobacco industry. “The bill is meant to severely curtail tobacco marketing, to emphasize health warnings on tobacco products, to ban many flavored cigarettes, and to prohibit labeling of cigarettes as ‘light’ or ‘low tar’. Dozens of health groups have supported the bill as potentially life-saving,” reported The New York Times on April 3.

AWMA will continue to firmly oppose the bill, Ramminger says, pointing out that the FDA should concentrate its efforts on ensuring the safety of the nation’s food, prescription drugs and medical device supplies, and not be given additional responsibility for tobacco.

“These bills give overly broad authority to the FDA and even the chief of the FDA has expressed his opposition to this measure, indicating that that agency is ill-suited to police the heavily regulated tobacco industry,” he adds.

“Many of our association members have small, family-owned businesses and the burdensome recordkeeping requirements and regulations that would result from this legislation would work a tremendous hardship on them with little, or no real benefit. There are also real concerns that this legislation could create a ‘back door’ ban on tobacco products through these onerous restrictions on the approval, sale, distribution, advertising and promotion of these products. Tobacco is a legal and important product that our members distribute to convenience stores.”

Opposing excise tax hikes
Ramminger also stressed AWMA’s opposition to increased federal excise taxes on cigarettes and other tobacco products, pointing out that the most recent proposal to increase the current federal 39-cent tax by 61 cents would have brought the total federal excise tax to $1 per pack of cigarettes.

“AWMA opposes any increase in cigarette excise taxes because of the unintended consequences of such action,” Ramminger says. “Increases in these taxes provide additional incentives for smokers to find alternative avenues to purchase cigarettes – many of which are illegal, such as over the Internet where taxes are avoided. And, excessive excise taxes can lead to increased traffic in other forms of illegal cigarette activity.”

…And more money for al Qaeda and Hezbollah to do their dirty work, according to Congressman King.

Bob Gatty is a food industry consultant and writer based in Sykesville, MD, and founder of Gatty Edits.