HB 429 - TOBACCO TAXATION; LICENSING Number 0892 CHAIR ROKEBERG announced that the next order of business would be HOUSE BILL NO. 429, "An Act relating to certain licenses for the sale of tobacco products; relating to tobacco taxes and sales and cigarette tax stamps; relating to provisions making certain cigarettes contraband and subject to seizure and forfeiture; relating to certain crimes, penalties, and interest concerning tobacco taxes and sales; relating to notification regarding a cigarette manufacturer's noncompliance with the tobacco product Master Settlement Agreement or related statutory provisions and to confiscation of the affected cigarettes; and providing for an effective date." [Before the committee was CSHB 429(L&C).] Number 0915 NEIL SLOTNICK, Deputy Commissioner, Treasury Division, Department of Revenue (DOR), presented HB 429 on behalf of the administration. He said that HB 429 will require adherence of a stamp on cigarette packages, showing that the tax on those cigarettes has in fact been paid. He brought forth a pack of cigarettes with the aforementioned stamp affixed. He relayed that 46 other states require stamps on cigarette packs, and that the reason for this requirement is that without the stamp, one package of cigarettes looks just like another and the departments of revenue in those states have a great deal of difficulty enforcing the tax statutes. He said: If we receive a complaint that a retailer's distributing untaxed cigarettes, and we send our investigators out into the field, they have no way of knowing whether any particular package of cigarettes has had the tax paid or not. They can make a buy, they can ask to look at invoices, but, again, it's very difficult to distinguish because one invoice can list various cigarettes and ... there's no serial number, there's no tracking - obviously - for the kind of volume that we do with cigarettes. And that means that that retailer can either sell those cigarettes at below market price, which then defeats the whole point of having the tax statute, or they can keep the difference, and then the law-abiding retailers are the ones who are hurt as a consequence because their competition can make more money on the cigarettes. Now, do we think that smuggling is a major problem in this state? The answer is no, we don't think so. But, again, we have no way knowing without having the ability to track the cigarettes in which "the stamps have been paid." Well, we do track them; we know how much tax money we're receiving. And ... obviously it's been in steep decline since we had a tax increase back in '97, and we think a great deal of that is due to the fact that fewer cigarettes are being consumed in this state because of the increase in tax. We do know there is some sale of untaxed cigarettes; we have had a couple enforcement actions, ... but it really takes a great deal of luck for those to work without having the ability to trace the tax paid by the stamp. Number 1089 MR. SLOTNICK continued: What we have seen, however, is two other states that recently adopted a stamp Act, and they had a tremendous recovery of additional tax as a consequence of requiring the stamp. One of those was Hawaii, which, like us, doesn't have any contiguous border states where the tax was much cheaper so that there could be influx of either untaxed or lower-tax-paid cigarettes. Hawaii is just like [Alaska]; there is no contiguous border states. And yet after they adopted their tax increase and then subsequently waited a year to adopt the stamp Act, their tobacco-tax stamp increased their collection of revenue by 25 percent. Michigan, which has border states, had a similar experience - not nearly that dramatic; I believe that was about a 12 percent increase in tax revenue when they adopted a requirement of stamping. We do not anticipate - here in this state - anywhere near that level of revenue increase; we don't think we have that level of contraband cigarette problem.... One of the things, though, that I want to emphasize is, we don't want to see that kind of problem develop. Clearly there is an "arbitrage opportunity" here, given that we have a tobacco tax of [$1] a pack; there are states out there that have much lower tobacco tax than that. That creates an "arbitrage opportunity" for the kind of operatives that Hawaii saw or that Michigan saw or [that] were working in their states at the time of their tobacco tax increases. We don't want that to occur here, and we don't think it's occurred yet, and we don't want it to happen. And the only way that we can really enforce our statutes is to have the stamp on the cigarettes. Once we get that, then we can have the assistance of law enforcement personnel, whether it's village public safety officers [VPSOs] or municipal or state police officers, or [the] Department of Health & Social Services [DHSS] has a tobacco inspection program - youth tobacco program; they can be trained to look for the stamp, as well as [others]: our gaming investigators or other state investigators, for example, with the Department of [Community and Economic Development]. Number 1224 MR. SLOTNICK went on to say: One thing I would like to explain ... would be the fiscal note. Now, the way this bill is written, ... [it] does allow for a discount for the wholesalers who would be ... charged with the applying of the stamp; they would have to purchase the stamp from the state, and then they would apply it themselves - they'd open the "package" of cigarettes, apply the stamp - and then ship them out to the various retailers. Obviously that's going to cost them; they're going to have to have personnel to do that. We recognize that, and so we have provided a discount back to them, in this bill, to cover some but not all of their costs, because we think they should share in the cost because they will be the beneficiaries - they are the law- abiding wholesalers ... - if there are additional sales as a consequence of having the stamp. But I will say to it's strictly a policy matter as to how large that discount should be. What we have done here is we've recognized that there are economies of scale, that the larger wholesalers are going to be able to buy more automated equipment, [and] have lower costs for application. And, as a consequence, we don't want to change the market dynamics that exist right now, so what we've done is given a greater discount for all wholesalers on their first purchases, and then it gradually ... lessens down where, at the end, they would have no discount. MR. SLOTNICK concluded: I will point out that Hawaii not only has no discount, they actually charge ... for sale of the stamp. Other states have a more generous discount than what the [DOR] has proposed here, but we think this is a very fair compromise for recognizing that this is going to create a burden on wholesalers, but at the same time there should be a benefit to them. But it's a policy call that this committee could address; the previous committee actually did address that and did change the discount structure to more closely reflect the economies of scale that the larger wholesalers do receive in stamping. Number 1343 REPRESENTATIVE MEYER opined that perhaps tax revenue from tobacco sales is going down because people are now buying their tobacco products from other sources such as the Internet, other states, or military bases. He remarked that applying stamps will only assist the DOR in tracking wholesalers, and that there would still be no way of knowing whether an individual bought cigarettes from other sources. MR. SLOTNICK said he would tend to agree that's accurate. On the other hand, he remarked, the DOR feels that the decline in revenues can be explained, for the most part, by the fact that cigarette consumption has fallen off throughout the United States as a whole, and by the increase in the tobacco tax. These two factors, rather than smuggling, are most likely responsible for the decrease in revenues, although the DOR is aware that there are untaxed cigarette sales taking place, he added. He also said: There is a federal law that doesn't even kick into place unless you have a stamp requirement. There's the federal "contraband cigarette Act," under which the Bureau of [Alcohol, Tobacco and Firearms (ATF)] would come to our assistance and ... enforce a federal law which makes it a felony to transport unstamped cigarettes across a state line. Well, if we don't have a stamp Act, we can't use that [federal] law. MR. SLOTNICK said that the ATF is very good at providing assistance with tobacco-tax law enforcement, but without legislation such as HB 429, the state cannot call upon the ATF for assistance. REPRESENTATIVE MEYER asked what happens when people purchase cigarettes through friends that work on military bases. Would those cigarettes have to be stamped, or would they be exempt from "stamping," he also asked. MR. SLOTNICK indicated that those cigarettes would be exempt from taxation, although military bases are required to price their cigarettes within 90 percent of the prevailing state price. Number 1528 JOHANNA BALES, Revenue Auditor V, Department of Revenue (DOR), testified via teleconference. She said: As far as the military bases are concerned, we do receive information from manufacturers that show the levels of cigarettes that they import and sell in the state, and since the tax increase went into effect in October of '97, they have also seen a decline in the number of cigarettes that they sell, because the military has mandated that their products have to be sold [for] at least 90 percent of the market value in the surrounding community. So, we do not see a problem at all with the military bases. REPRESENTATIVE MEYER expressed interest in receiving information about cigars and smokeless tobacco. He asked whether it would be possible to put stamps on those products as well, noting that it can't be known whether a problem with those products exists unless a stamp is also required for those products. MR. SLOTNICK agreed. He noted, however, that under current law, there is no requirement to pay tax on other tobacco products imported by an individual; thus the DOR is not actually losing revenue on those products. That's not true of cigarettes, however; if an individual imports cigarettes, the tax is still due. REPRESENTATIVE MEYER indicated that he would prefer not to give a discount for applying the stamp, with the understanding that the cost would simply be passed on to consumers. He noted that the discount provision was included in the current version of HB 429 so that individual Alaska wholesalers won't be put at a disadvantage. MR. SLOTNICK agreed. He said that another reason for including the discount provision is that the DOR didn't want to have a tax increase that wasn't clearly labeled as such. "To our mind, it's a policy call that the legislature could make, but we're going to come forward with a bill that's relatively close to tax neutral to the consumer, and then leave it to the legislature to decide whether you should pass that cost on or not," he added. Number 1702 REPRESENTATIVE JAMES recalled that she raised many of these same issues during the original hearings on the tobacco tax increase. She mentioned that one of those issues dealt with requiring the stamp to be applied in such a way that it could not be salvaged and applied to a different pack of cigarettes. She asked whether it would be possible to have the stamp applied by the cigarette manufacturers before the product is sold to the wholesalers. She indicated that what she has heard is that although cigarette use in general is down, cigarette use among youth is increasing, particularly among young girls. She then asked for a response to her comments. MS. BALES said: As far as the stamping is concerned, the way that works is, manufactures do not stamp. That would be [Philip Morris U.S.A. ("Philip Morris"), Brown & Williamson Tobacco Corporation ("Brown & Williamson"), R.J. Reynolds Tobacco Company ("R.J. Reynolds")]. What they do is they sell their product to the distributors, and then wherever that distributor is conducting business or wherever they're shipping cigarettes, they will stamp for each particular state. We do have distributors in Alaska who purchase direct from the manufacturer, and so those distributors in the state would be required to do the stamping for Alaska. Or, if it was a distributor that's licensed in Alaska to do business that has a presence or does business in other states, they would be stamping as well for Alaska, possibly out of state, maybe in Washington or wherever they have their stamping equipment right now. I have been told by [Costco Wholesale Corporation ("Costco")] that if we were to have a stamp, that they would more than likely stamp within the state. Now, one of the reasons ... it wouldn't be good for a distributor ... in the state to try to purchase from someone out of state that's already stamping, is because then you've already inserted another middleman in the whole process, and our distributors, then, wouldn't be buying direct from the manufacturers, and the price of their cigarettes would go up for them as well. So that's the way the stamping works. Number 1891 REPRESENTATIVE JAMES remarked that they oughtn't to care how much it costs distributors to buy cigarettes. On the issue of requiring a stamp, she noted that the state doesn't subsidize other businesses in their efforts to meet state requirements regarding product identification; therefore, the state shouldn't subsidize the cigarette [industry] either. MS. BALES, on that point, added that Hawaii actually charges their distributors 1.7 percent to pay for the costs that the state incurs to have those stamps manufactured. So that always is an option, she noted. On the issue of who is smoking, she said it is hard to tell; she added that the DOR doesn't have any demographic data that would show which age groups are smoking more and which are smoking less. She remarked that [the DOR] occasionally gets information from out of state companies regarding individuals within the state who get their cigarettes shipped to them, and with that information, the DOR attempts to collect tax from those individuals. She mentioned that the DHSS has conducted surveys which indicate that in many cases, people have either quit smoking or have cut back. She relayed that from information obtained from a few vendors that comply with federal reporting laws, the DOR is aware of approximately 1,000 individuals who have purchased cigarettes through the mail. She pointed out that one of the advantages of requiring a stamp, as is proposed in HB 429, is that the DOR would then be able to confiscate unstamped cigarettes on the spot, whereas currently, even if the DOR knows and can prove that the tax has not been paid, it has no ability to seize the cigarettes. REPRESENTATIVE JAMES said she supports requiring a stamp on cigarettes, adding that she did not know why such a provision was not instituted at the time of the tax increase. She remarked that she doesn't have any interest in allowing a discount for affixing the stamps. "If that's the rule, they should just do it," she opined. She mentioned that her staff has done research and found that cigarettes can be purchased by the case on the Internet, and that she is aware that when people travel outside of Alaska, they purchase cigarettes and bring them back home. She also surmised that since the military is required to charge close to market value, the military probably makes a fair amount of money reselling cigarettes. Number 2037 JAYNE ANDREEN, Tobacco Prevention and Control Program, Division of Public Health, Department of Health & and Social Services (DHSS), said simply that she is available to answer questions, and then shared an anecdotal story about someone's cat who ordered cigarettes over the Internet, didn't even use the cat's own credit card to pay for the cigarettes, and did receive those cigarettes. Number 2055 JOHN AYERS, Chairman, Chief Executive Officer, Keystone Distribution Service, Inc. ("Keystone"), testified via teleconference. He explained that Keystone is a public warehouse that currently houses the cigarette inventory from R.J. Reynolds, Philip Morris, and Brown & Williamson for a number of distributors in Anchorage including Costco. On the issue of how allowing the stamp to be applied out of state would affect his company, he said that contrary to what Ms. Bales has indicated, Costco provides the stamping in Kirkland [Washington] for five states and has specifically told Keystone that it would stamp cigarettes destined for Alaska in Kirkland rather than Alaska. This could result in a yearly loss of revenue for Keystone of approximately $250,000, and, hence, Keystone would have to reduce staff. MR. AYERS suggested amending HB 429 to include a requirement that stamping be done in Alaska. He opined that such a requirement would add both revenue and jobs in the state. In response to a question, he indicated that with such a requirement, he would not expect the state to provide a discount for the cost of stamping. Number 2150 TOMAS T. ANDERSON, Owner, Alaska Strategic Consultants, testified via teleconference noting that he is "working with Jan's Distributing [Inc.] on this issue." He remarked that HB 429 appears to be unwarranted, since the DOR cannot provide any statistics to substantiate its concerns. He said that statements made by the DOR - that it "has no way of knowing" - alarm distributors and suggest that the problems are just speculative. He opined that the approach taken via HB 429 will cost more money than it will generate. Referring to AS 43.50.090(c), which exempts military "exchange, commissary, or ship's stores" from taxes, he remarked that this still provides people with a way to avoid paying taxes when purchasing bulk cigarettes. MR. ANDERSON also pointed out that proposed Sec. 43.50.580 offers an exemption to certain entities such as Indian tribal organizations, and opined that such a potential loophole might enable a Native corporation to take undue advantage. He reiterated his belief that claims by the DOR are merely speculation, adding that many of the variables are undefined. After mentioning that he is not in favor of HB 429, he said he agrees with Mr. Ayers's suggestion that the bill should require that the stamps be applied in Alaska. In response to a question, he indicated that he is in favor of the discount provision. Number 2353 BOBBY SCOTT, Jan's Distributing, Inc. ["Jan's"], testified via teleconference. He noted that his company is a "direct buy customer" serving Anchorage, Wasilla, Eagle River, Fairbanks, Homer, Nikiski, and some Bush communities. He said that he is concerned about whether the two additional employees mentioned in the DOR's fiscal note will be sufficient for enforcement of the stamp program, and if not, then the fiscal note needs to reflect more personnel. TAPE 02-56, SIDE B Number 2400 MR. SCOTT remarked that although his company experienced a decline in sales when the tax increase first took effect, sales have since improved to the point that last year Jan's paid just under $2 million in taxes on tobacco products and yet, in comparison, Jan's is one of the smaller distributors in Alaska. He indicated that he questions whether there has really been such a decline in tax revenue that it warrants legislation such as HB 429. In response to a question, he confirmed that he would rather HB 429 did not become law. REPRESENTATIVE JAMES questioned whether, particularly during a budget crunch, hiring two additional people to enforce a stamp program will engender additional revenues for the state. She opined that the provisions of HB 429 ought to have been instituted at the same time as the tobacco tax increase. She indicated that she, too, has concerns about potential loopholes. MR. AYERS pointed out that one of the hidden costs to Alaskan distributors and wholesalers "is the time to pay" and is tied in with whether Keystone continues to be a warehouse on behalf of the manufacturers. He said, "Like liqueur, you don't get a lot of float on how long you can take to pay for the product; typically on cigarettes it's ten days." Thus, when a company places an order with a manufacturer, that order gets sent to Keystone, for example, which then delivers the product to the distributor, whose "clock starts when that order" gets to Keystone; if, on the other hand, the cigarettes are stamped out of state, "the clock starts" that much sooner, and the distributor would loss anywhere from five to seven of those ten days. He warned that although the cash flow implications have not yet been quantified, they will affect distributors financially. REPRESENTATIVE JAMES asked whether insurance costs for wholesalers have risen because of the increase in tobacco tax. MR. AYERS said that Keystone did not experience any increase in insurance costs as a result of that tax increase, but mentioned that perhaps distributors or transportation companies might have. MR. SCOTT indicated that his insurance costs did go up, adding that he would have to research that information and get the exact figures to the committee at a later date. He also mentioned that bonding costs have increased as well because of the increase in tobacco tax. Number 2154 REPRESENTATIVE MEYER said he did not like HB 429; he said, however, that if it is adopted, he would like it to contain a requirement that the stamping be done in Alaska. He asked whether it would be possible to institute such a requirement. MR. SLOTNICK said that both the DOR and the Department of Law (DOL) have looked at that issue and have concluded that, legally, it would be a very tenuous proposition. He posited that the courts would view such a requirement as "protectionist legislation in violation of the commerce clause," which will not allow a state to use its taxing authority to favor in-state commerce over out-of-state commerce. CHAIR ROKEBERG closed the public hearing. [HB 429 was held over.]