oversight

Internet Cigarette Sales: Limited Compliance and Enforcement of the Jenkins Act Result in Loss of State Tax Revenue

Published by the Government Accountability Office on 2003-05-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                             United States General Accounting Office

GAO                          Testimony
                             Before the Subcommittee on Courts, the
                             Internet, and Intellectual Property,
                             Committee on the Judiciary,
                             House of Representatives
For Release on Delivery
Expected at 10:00 a.m. EST
Thursday, May 1, 2003        INTERNET CIGARETTE
                             SALES
                             Limited Compliance and
                             Enforcement of the Jenkins
                             Act Result in Loss of State
                             Tax Revenue
                             Statement of Paul L. Jones, Director
                             Homeland Security and Justice




GAO-03-714T
Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss our work on the extent of
compliance by Internet cigarette vendors with the Jenkins Act.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.

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.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.




1
 5 U.S.C. §375-378.
2
 Online Tobacco Sales Grow, States Lose, Forrester Research, Inc. (Apr. 27, 2001). We were
unable to assess the reliability of the estimates because the methodology used in
developing it, including key assumptions and data, is proprietary.



Page 1                                                                     GAO-03-714T
             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.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.

             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
             states4 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.


             Each state, and the District of Columbia, imposes an excise tax on the sale
Background   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.




             3
              Since our report was issued, ATF was transferred from the Department of the Treasury to
             the Department of Justice and is now known as the Bureau of Alcohol, Tobacco, Firearms
             and Explosives.
             4
              We contacted tobacco tax officials in 11 states. Officials in 9 states provided us with
             information, and officials in 2 states did not provide the information we requested in time
             for it to be included in our report. We selected the 10 states with the highest cigarette
             excise tax rates on January 1, 2002, based on the presumption that these states would be
             among those most interested in promoting Jenkins Act compliance to collect cigarette
             taxes. Also, we selected one additional state that appeared to have taken action to promote
             Jenkins Act compliance by Internet cigarette vendors.



             Page 2                                                                       GAO-03-714T
Figure 1: State Cigarette Excise Tax Rates, in Cents, Per Pack of 20 Cigarettes, as of January 1, 2003




                             Wash.                                                                                                                              Maine
                             142.5                                                                                                                              100.0
                                                         Mont.                   N.Dak.
                                                         18.0                     44.0
                         Ore.                                                                    Minn.
                                                                                                                                                               Vt. 93.0
                        128.0                                                                    48.0
                                        Idaho                                    S.Dak.                         Wis.                                    N.Y.   N.H. 52.0
                                         28.0                                     33.0                          77.0                                   150.0
                                                            Wyo.                                                            Mich.                              Mass. 151.0
                                                            12.0                                                            125.0                              R.I. 132.0
                                                                                                   Iowa                                          Pa.
                                                                                  Nebr.            36.0                                         100.0          Conn. 111.0
                                Nev.                                              64.0                                              Ohio
                                35.0                                                                              Ill.    Ind.                                 N.J. 150.0
                                               Utah                                                                                 55.0
                                               69.5              Colo.                                           98.0     55.5                                 Del. 24.0
                    Calif.                                       20.0                 Kans.              Mo.                                    Va.
                                                                                                                                 Ky.                           Md. 100.0
                    87.0                                                              70.0               17.0                                   2.5
                                                                                                                                 3.0                           D.C. 100.0
                                                                                                                                                N.C.
                                                                                                                                                5.0            W.Va. 17.0
                                                                                         Okla.                         Tenn. 20.0
                                           Ariz.            N.Mex.                                       Ark.                                 S.C.
                                           118.0                                         23.0
     Alaska 100.0                                            21.0                                        34.0                                 7.0
                                                                                                                 Miss.    Ala.         Ga.
                                                                                                                 18.0     16.5         12.0
                                                                                    Tex.
                                                                                    41.0                 La.
                                                                                                         36.0
     Hawaii 120.0                                                                                                                              Fla.
                                                                                                                                                33.9




Sources: Developed by GAO based on Federation of Tax Administrators’ data, CorelDraw (map).




                                                                 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.

                                                                 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,


                                                                 Page 3                                                                                        GAO-03-714T
                             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.


                             The federal government has had limited involvement with the Jenkins Act
Limited Federal              concerning Internet cigarette sales. We identified three federal
Involvement with the         investigations involving such potential violations, and none of these had
                             resulted in prosecution (one investigation was still ongoing at the time of
Jenkins Act and              our work). No Internet cigarette vendors had been penalized for violating
Internet Cigarette           the act, nor had any penalties been sought for violators.
Sales

FBI Has Primary              The Attorney General of the United States is responsible for supervising
Investigative Jurisdiction   the enforcement of federal criminal laws, including the investigation and
                             prosecution of Jenkins Act violations.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



                             5
                               28 U.S.C. §533 provides that the Attorney General of the United States may appoint
                             officials “to detect and prosecute crimes against the United States…” except where
                             investigative jurisdiction has otherwise been assigned by law.



                             Page 4                                                                       GAO-03-714T
                        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       ATF, which enforces federal excise tax and criminal laws and regulations
Enforcement Authority   related to tobacco products, has ancillary authority to enforce the Jenkins
                        Act.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).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.




                        6
                         With ancillary authority to enforce the Jenkins Act, if ATF investigates a possible
                        Contraband Cigarette Trafficking Act violation (i.e., cigarette smuggling), for which it has
                        primary jurisdiction, and determines there is a possible Jenkins Act violation, then ATF
                        may also investigate the Jenkins Act violation and refer it to DOJ for prosecution or
                        injunctive relief.
                        7
                          Certain persons, including permit holders under the Internal Revenue Code, common
                        carriers with proper bills of lading, or individuals licensed by the state where the cigarettes
                        are found, may possess these cigarettes (18 U.S.C. 2341).



                        Page 5                                                                          GAO-03-714T
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.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.




8
  The U.S. Attorney’s Office determined there was no CCTA violation because the state of
Alaska did not require that tax stamps be placed on cigarette packages as evidence that
state taxes were paid.



Page 6                                                                      GAO-03-714T
                       •   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.


                       Officials in nine states that provided us information all expressed concern
States Have Taken      about Internet cigarette vendors’ noncompliance with the Jenkins Act and
Action to Promote      the resulting loss of state tax revenues. For example, California officials
                       estimated that the state lost approximately $13 million in tax revenue from
Jenkins Act            May 1999 through September 2001, due to Internet cigarette vendors’
Compliance by          noncompliance with the Jenkins Act. Overall, the states’ efforts to promote
                       compliance with the act by Internet vendors produced few results.
Internet Cigarette     Officials in the nine states said that they lack the legal authority to
Vendors, but Results   successfully address this problem on their own. They believe greater
Were Limited           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.



                       Page 7                                                          GAO-03-714T
States’ Efforts Produced   Starting in 1997, seven of the nine states had made some effort to promote
Limited Results            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.

                           After contacting the Internet vendors, the states generally received reports
                           of cigarette sales from a small portion of the vendors notified.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



                           9
                             Cigarette vendors are not required to report to a state unless they sell and ship cigarettes
                           into the state. Consequently, the states do not know if the Internet vendors that were
                           notified but did not respond had any cigarette sales to report.



                           Page 8                                                                           GAO-03-714T
                                                      Washington that the vendor would not report sales because the Internet
                                                      Tax Freedom Act relieved the vendor of Jenkins Act reporting
                                                      requirements.

Table 1: Summary of Six States’ Efforts to Promote Jenkins Act Compliance Since 1997

                                                                        Number of
                                                                 Internet vendors
                                     Number of Internet            that responded            Number of                Number of      Amount of taxes,
                                  vendors identified and            with reports of residents identified          residents that        penalties, and
 State                                           notified           cigarette sales         and notified              responded     interest collecteda
 Alaska                                              15b,c                        2                    3                       1                 $9,850
 California                              167 (approx.) c,d             20 (approx.)     23,500 (approx.)         13,500 (approx.) $1.4 million (approx.)
 Massachusetts                                       262                         13               Nonee                    None                   None
                                                                                   f
 Rhode Island                          Number unknown                         None                None                     None                   None
 Washington                                          186                          8        800 (approx.)            560 (approx.)               $29,898
 Wisconsin                                             21                         6                 696                      696                $80,200
Source: Developed by GAO from states’ data.

                                                      Note: Massachusetts’ data are as of May 2002, Washington’s and Wisconsin’s data are as of April
                                                      2002, Alaska’s and Rhode Island’s data are as of March 2002, and California’s data are through
                                                      September 2001.
                                                      a
                                                        Not all states collected penalties and interest, and some of the amounts paid include sales and use
                                                      taxes in addition to cigarette excise taxes. Some of the amounts paid by residents were for more
                                                      cigarette purchases than the vendors reported to the state.
                                                      b
                                                          Alaska identified 17 vendors, but did not know where 2 were located and could not notify them.
                                                      c
                                                       Alaska and California sent ATF a copy of each letter mailed to Internet cigarette vendors notifying
                                                      them of their Jenkins Act reporting responsibilities.
                                                      d
                                                        California started its Internet/Mail Order Program in May 1999. Through September 2001, 196
                                                      vendors had been identified and notified, of which about 85 percent, or approximately 167, were
                                                      Internet vendors. All 20 vendors that responded were Internet vendors.
                                                      e
                                                       At the time of our work, Massachusetts had not notified the residents identified in reports provided
                                                      by the 13 vendors that responded out of the 262 vendors notified because the state was in the
                                                      process of developing policy regarding Jenkins Act compliance and reports of residents’ Internet
                                                      cigarette purchases.
                                                      f
                                                       No Internet cigarette vendors reported cigarette sales in response to Rhode Island notifying them of
                                                      their Jenkins Act reporting responsibilities.


                                                      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


                                                      Page 9                                                                                 GAO-03-714T
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.

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.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.

•    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


10
 DOJ noted that federal prosecutors generally do not issue advisory opinions about
prosecutive matters, as they may subsequently be presented with the need to make an
actual decision based on specific facts. The issuance of such an opinion might create the
basis for a legal dispute if a subsequent prosecution were undertaken.



Page 10                                                                      GAO-03-714T
                               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    Officials in each of the nine states expressed concern about the impact
Internet Vendors’         that Internet cigarette vendors’ noncompliance with the Jenkins Act has
Noncompliance and         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
Believe Greater Federal   more substantial impact on tax revenues will result. One state, California,
Action Is Needed          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 2001.11

                          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.

                          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.




                          11
                           The Excise Taxes Division, California State Board of Equalization, did not make an
                          official analyses of lost revenue. The $13 million estimate is a projection by the division
                          based on the amount of state excise and use taxes determined as due from cigarette sales
                          reported by out-of-state Internet vendors during the period of May 1999 through Sept. 2001.



                          Page 11                                                                      GAO-03-714T
                           Through our Internet search efforts, we identified 147 Web site addresses
Most Internet              for Internet cigarette vendors based in the United States and reviewed
Cigarette Vendors Do       each website linked to these addresses.12 Our review of the Web sites
                           found no information suggesting that the vendors comply with the Jenkins
Not Comply with the        Act. Some vendors cited reasons for not complying that we could not
Jenkins Act or Notify      substantiate. A few Web sites specifically mentioned the vendors’ Jenkins
                           Act reporting responsibilities, but these Web sites also indicated that the
Consumers of Their         vendors do not comply with the act. Some Web sites provided notice to
Responsibilities           consumers of their potential state tax liability for Internet cigarette
                           purchases.


Majority of Web sites      None of the 147 Web sites we reviewed stated that the vendor complies
Indicate that Vendors Do   with the Jenkins Act and reports cigarette sales to state tobacco tax
Not Comply with the        administrators.13 Conversely, as shown in table 2, information posted on
                           114 (78 percent) of the Web sites indicated the vendors’ noncompliance
Jenkins Act                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.




                           12
                            The 147 Web site addresses appear to represent 122 different Internet cigarette vendors.
                           We made this determination by comparing information such as vendor names, company
                           names, street addresses, P.O. box numbers, and telephone numbers. For example, some
                           Web sites had the same mailing address and telephone number, suggesting they were
                           separate Web sites being operated by one company.
                           13
                             Two Web sites posted statements indicating that customer information would be released
                           if required; however, both sites also stated that the information would not be given out
                           without the customers’ permission. The Jenkins Act does not require cigarette sellers to
                           notify customers regarding whether or not they comply with the act’s reporting
                           requirements.



                           Page 12                                                                     GAO-03-714T
                     Table 2: Web sites Indicating Internet Cigarette Vendors’ Noncompliance with the
                     Jenkins Act

                         Web site statement indicating noncompliance                           Number             Percent
                         Do not report sales to state tax authorities                              44a                 30
                         Do not comply with the Jenkins Act                                          1                  1
                         Keep customer information private                                         43                  29
                         Silent on reporting, but claim cigarettes are tax-free                    26                  18
                         Total                                                                    114                  78
                     Source: GAO’s analysis of Web site data.
                     a
                      One Web site stated that it does not report to state tax authorities and that it does not comply with
                     the Jenkins Act. In determining the number of Web sites indicating noncompliance with the Jenkins
                     Act, we counted this only as a statement that it does not comply with the act.


Reasons Cited for    Some Internet vendors cited specific reasons on their Web sites for not
Noncompliance with   reporting cigarette sales to state tax authorities as required by the Jenkins
the Jenkins Act      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.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 5.15 One of the 5 representatives said that
                     the vendor recently started to file Jenkins Act sales reports with one
                     state.16 However, the other 4 said that they do not comply with the act and


                     14
                      Fifty-nine percent, or 87, of the 147 Web site addresses reviewed are either Native
                     American-owned or located and/or operated on Native American lands.
                     15
                       We were either unable to reach representatives of the remaining 25 vendors we selected
                     to conduct structured interviews, or they declined to answer questions.
                     16
                      The vendor who said that he does comply with the Jenkins Act told us that he recently
                     started to file reports with the state of Washington after receiving a notice from the state’s
                     Department of Revenue. However, he said Washington is the only state he reports to, and
                     he declined to provide us with evidence of his compliance with the act.


                     Page 13                                                                                 GAO-03-714T
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 Act17
supercedes the obligations laid out in the Jenkins Act.

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.18




17
     P.L. 105-277, Div. C, Title XI, Oct. 21, 1998.
18
     Industry Circular, No. 99-2, Bureau of Alcohol, Tobacco and Firearms, June 6, 1999.



Page 14                                                                        GAO-03-714T
Few Web sites Provide         Only 8 (5 percent) of the 147 Web sites we reviewed notified customers
Notice of the Vendors’        that the Jenkins Act requires the vendor to report cigarette sales to state
Reporting Responsibilities,   tax authorities, which could result in potential customer tax liability.
                              However, in each of these cases, the Web sites that provided notices of
but Some Provide Notice       Jenkins Act responsibilities also followed the notice with a statement
of Customer Cigarette Tax     challenging the applicability of the act and indicating that the vendor does
Liability                     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.


                              Our report concluded that states are hampered in attempting to promote
Conclusions                   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.

                              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



                              Page 15                                                             GAO-03-714T
           matter. We believe that this possibility deserves further investigation on
           the part of DOJ.


           Mr. Chairman, this completes my prepared statement. I would be happy to
           respond to any questions you or other Members of the Subcommittee may
           have at this time.

           For further information, please call me at (202) 512-8777. Other key
           contributors to this testimony were Darryl W. Dutton, Ronald G. Viereck,
           Katherine M. Davis, and Shirley Jones.




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