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entitled 'Tobacco Taxes: Large Disparities in Rates for Smoking
Products Trigger Significant Market Shifts to Avoid Higher Taxes'
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United States Government Accountability Office:
GAO:
Report to Congressional Committees:
April 2012:
Tobacco Taxes:
Large Disparities in Rates for Smoking Products Trigger Significant
Market Shifts to Avoid Higher Taxes:
GAO-12-475:
GAO Highlights:
Highlights of GAO-12-475, a report to congressional committees.
Why GAO Did This Study:
In 2009, CHIPRA increased and equalized federal excise tax rates for
cigarettes, roll-your-own tobacco, and small cigars. Though CHIPRA
also increased federal excise tax rates for pipe tobacco and large
cigars, it raised the pipe tobacco tax to a rate significantly below
the equalized rate for the other products, and its large cigar excise
tax can be significantly lower, depending on price. Treasury collects
federal excise taxes on tobacco products.
Also passed in 2009, the Family Smoking Prevention and Tobacco Control
Act (Tobacco Control Act) granted FDA regulatory authority over
tobacco products. This act directed GAO to report on trade in tobacco
products, including the effects of differing tobacco tax rates. This
report (1) reviews the market shifts in smoking tobacco products since
CHIPRA; (2) examines the impact of the market shifts on federal
revenue and Treasury’s actions to respond; and (3) describes
differences in FDA’s regulation of various smoking tobacco products.
GAO interviewed agency officials, industry members, and public health
representatives. GAO analyzed tax and revenue data and reviewed
relevant literature.
What GAO Found:
Large federal excise tax disparities among tobacco products, which
resulted from the Children’s Health Insurance Program Reauthorization
Act (CHIPRA) of 2009, created opportunities for tax avoidance and led
to significant market shifts by manufacturers and price sensitive
consumers toward the lower-taxed products. Monthly sales of pipe
tobacco increased from approximately 240,000 pounds in January 2009 to
over 3 million pounds in September 2011, while roll-your-own tobacco
dropped from about 2 million pounds to 315,000 pounds. For the same
months, large cigar sales increased from 411 million to over 1 billion
cigars, while small cigars dropped from about 430 million to 60
million cigars (see figure). According to government, industry, and
nongovernmental organization representatives, many roll-your-own
tobacco and small cigar manufacturers shifted to the lower-taxed
products after CHIPRA to avoid paying higher taxes.
Figure: FY 01-11 Monthly Sales for Roll-Your-Own and Pipe Tobacco, and
for Small and Large Cigars:
[Refer to PDF for image: 2 line graphs]
Pounds of tobacco (per month in millions):
October 2000:
Pipe tobacco: 408;
Roll your own tobacco: 670.
November 2000:
Pipe tobacco: 431;
Roll your own tobacco: 713.
December 2000:
Pipe tobacco: 396;
Roll your own tobacco: 868.
January 2001:
Pipe tobacco: 413;
Roll your own tobacco: 697.
February 2001:
Pipe tobacco: 300;
Roll your own tobacco: 726.
March 2001:
Pipe tobacco: 430;
Roll your own tobacco: 701.
April 2001:
Pipe tobacco: 361;
Roll your own tobacco: 695.
May 2001:
Pipe tobacco: 394;
Roll your own tobacco: 770.
June 2001:
Pipe tobacco: 483;
Roll your own tobacco: 677.
July 2001:
Pipe tobacco: 382;
Roll your own tobacco: 720.
August 2001:
Pipe tobacco: 517;
Roll your own tobacco: 853.
September 2001:
Pipe tobacco: 406;
Roll your own tobacco: 704.
October 2001:
Pipe tobacco: 506;
Roll your own tobacco: 817.
November 2001:
Pipe tobacco: 435;
Roll your own tobacco: 593.
December 2001:
Pipe tobacco: 291;
Roll your own tobacco: 699.
January 2002:
Pipe tobacco: 436;
Roll your own tobacco: 1,040.
February 2002:
Pipe tobacco: 356;
Roll your own tobacco: 790.
March 2002:
Pipe tobacco: 402;
Roll your own tobacco: 835.
April 2002:
Pipe tobacco: 385;
Roll your own tobacco: 834.
May 2002:
Pipe tobacco: 430;
Roll your own tobacco: 733.
June 2002:
Pipe tobacco: 411;
Roll your own tobacco: 674.
July 2002:
Pipe tobacco: 388;
Roll your own tobacco: 832.
August 2002:
Pipe tobacco: 359;
Roll your own tobacco: 907.
September 2002:
Pipe tobacco: 381;
Roll your own tobacco: 871.
October 2002:
Pipe tobacco: 402;
Roll your own tobacco: 1,158.
November 2002:
Pipe tobacco: 357;
Roll your own tobacco: 957.
December 2002:
Pipe tobacco: 321;
Roll your own tobacco: 936.
January 2003:
Pipe tobacco: 331;
Roll your own tobacco: 849.
February 2003:
Pipe tobacco: 312;
Roll your own tobacco: 1,050.
March 2003:
Pipe tobacco: 381;
Roll your own tobacco: 951.
April 2003:
Pipe tobacco: 335;
Roll your own tobacco: 1,042.
May 2003:
Pipe tobacco: 403;
Roll your own tobacco: 1,049.
June 2003:
Pipe tobacco: 370;
Roll your own tobacco: 1,030.
July 2003:
Pipe tobacco: 370;
Roll your own tobacco: 976.
August 2003:
Pipe tobacco: 421;
Roll your own tobacco: 1,080.
September 2003:
Pipe tobacco: 320
Roll your own tobacco: 1,143.
October 2003:
Pipe tobacco: 339;
Roll your own tobacco: 1,022.
November 2003:
Pipe tobacco: 269;
Roll your own tobacco: 814.
December 2003:
Pipe tobacco: 305;
Roll your own tobacco: 893.
January 2004:
Pipe tobacco: 309;
Roll your own tobacco: 851.
February 2004:
Pipe tobacco: 339;
Roll your own tobacco: 1,087.
March 2004:
Pipe tobacco: 349;
Roll your own tobacco: 1,044.
April 2004:
Pipe tobacco: 341;
Roll your own tobacco: 1,003.
May 2004:
Pipe tobacco: 328;
Roll your own tobacco: 954.
June 2004:
Pipe tobacco: 341;
Roll your own tobacco: 1,232.
July 2004:
Pipe tobacco: 345;
Roll your own tobacco: 988.
August 2004:
Pipe tobacco: 388;
Roll your own tobacco: 1,149.
September 2004:
Pipe tobacco: 334;
Roll your own tobacco: 1,193.
October 2004:
Pipe tobacco: 274;
Roll your own tobacco: 1,069.
November 2004:
Pipe tobacco: 278;
Roll your own tobacco: 1,193.
December 2004:
Pipe tobacco: 279;
Roll your own tobacco: 936.
January 2005:
Pipe tobacco: 296;
Roll your own tobacco: 1,107.
February 2005:
Pipe tobacco: 331;
Roll your own tobacco: 1,137.
March 2005:
Pipe tobacco: 316;
Roll your own tobacco: 1,200.
April 2005:
Pipe tobacco: 242;
Roll your own tobacco: 1,126.
May 2005:
Pipe tobacco: 329;
Roll your own tobacco: 1,203.
June 2005:
Pipe tobacco: 352;
Roll your own tobacco: 1,346.
July 2005:
Pipe tobacco: 245;
Roll your own tobacco: 1,216.
August 2005:
Pipe tobacco: 395;
Roll your own tobacco: 1,623.
September 2005:
Pipe tobacco: 300;
Roll your own tobacco: 1,381.
October 2005:
Pipe tobacco: 293;
Roll your own tobacco: 1,472.
November 2005:
Pipe tobacco: 366;
Roll your own tobacco: 1,357.
December 2005:
Pipe tobacco: 282;
Roll your own tobacco: 1,273.
January 2006:
Pipe tobacco: 279;
Roll your own tobacco: 1,332.
February 2006:
Pipe tobacco: 217;
Roll your own tobacco: 1,338.
March 2006:
Pipe tobacco: 288;
Roll your own tobacco: 1,485.
April 2006:
Pipe tobacco: 245;
Roll your own tobacco: 1,185.
May 2006:
Pipe tobacco: 216;
Roll your own tobacco: 1,222.
June 2006:
Pipe tobacco: 546;
Roll your own tobacco: 1,496.
July 2006:
Pipe tobacco: 267;
Roll your own tobacco: 1,258.
August 2006:
Pipe tobacco: 311;
Roll your own tobacco: 1,580.
September 2006:
Pipe tobacco: 294;
Roll your own tobacco: 1,453.
October 2006:
Pipe tobacco: 270;
Roll your own tobacco: 1,615.
November 2006:
Pipe tobacco: 292;
Roll your own tobacco: 1,243.
December 2006:
Pipe tobacco: 243;
Roll your own tobacco: 1,290.
January 2007:
Pipe tobacco: 280;
Roll your own tobacco: 1,331.
February 2007:
Pipe tobacco: 231;
Roll your own tobacco: 1,239.
March 2007:
Pipe tobacco: 259;
Roll your own tobacco: 1,311.
April 2007:
Pipe tobacco: 226;
Roll your own tobacco: 1,311.
May 2007:
Pipe tobacco: 326;
Roll your own tobacco: 1,570.
June 2007:
Pipe tobacco: 308;
Roll your own tobacco: 1,578.
July 2007:
Pipe tobacco: 219;
Roll your own tobacco: 1,453.
August 2007:
Pipe tobacco: 292;
Roll your own tobacco: 1,651.
September 2007:
Pipe tobacco: 263;
Roll your own tobacco: 1,420.
October 2007:
Pipe tobacco: 258;
Roll your own tobacco: 1,733.
November 2007:
Pipe tobacco: 297;
Roll your own tobacco: 1,659.
December 2007:
Pipe tobacco: 185;
Roll your own tobacco: 1,043.
January 2008:
Pipe tobacco: 278;
Roll your own tobacco: 1,910.
February 2008:
Pipe tobacco: 251;
Roll your own tobacco: 1,619.
March 2008:
Pipe tobacco: 263;
Roll your own tobacco: 1,496.
April 2008:
Pipe tobacco: 277;
Roll your own tobacco: 1,726.
May 2008:
Pipe tobacco: 250;
Roll your own tobacco: 1,629.
June 2008:
Pipe tobacco: 306;
Roll your own tobacco: 1,618.
July 2008:
Pipe tobacco: 247;
Roll your own tobacco: 1,678.
August 2008:
Pipe tobacco: 269;
Roll your own tobacco: 1,729.
September 2008:
Pipe tobacco: 270;
Roll your own tobacco: 1,832.
October 2008:
Pipe tobacco: 290;
Roll your own tobacco: 2,172.
November 2008:
Pipe tobacco: 274;
Roll your own tobacco: 1,729.
December 2008:
Pipe tobacco: 223;
Roll your own tobacco: 1,697.
January 2009:
Pipe tobacco: 240;
Roll your own tobacco: 2,070.
February 2009:
Pipe tobacco: 233;
Roll your own tobacco: 2,027.
March 2009:
Pipe tobacco: 193;
Roll your own tobacco: 1,501.
April 2009 (begin CHIPRA):
Pipe tobacco: 610;
Roll your own tobacco: 1,087.
May 2009:
Pipe tobacco: 759;
Roll your own tobacco: 1,110.
June 2009:
Pipe tobacco: 1,028;
Roll your own tobacco: 895.
July 2009:
Pipe tobacco: 1,635;
Roll your own tobacco: 601.
August 2009:
Pipe tobacco: 2,019;
Roll your own tobacco: 644.
September 2009:
Pipe tobacco: 1,253;
Roll your own tobacco: 634.
October 2009:
Pipe tobacco: 1,272;
Roll your own tobacco: 533.
November 2009:
Pipe tobacco: 1,164;
Roll your own tobacco: 558.
December 2009:
Pipe tobacco: 1,286;
Roll your own tobacco: 555.
January 2010:
Pipe tobacco: 1,620;
Roll your own tobacco: 465.
February 2010:
Pipe tobacco: 1,590;
Roll your own tobacco: 535.
March 2010:
Pipe tobacco: 2,142;
Roll your own tobacco: 626.
April 2010:
Pipe tobacco: 1,833;
Roll your own tobacco: 526.
May 2010:
Pipe tobacco: 1,646;
Roll your own tobacco: 380.
June 2010:
Pipe tobacco: 1,931;
Roll your own tobacco: 497.
July 2010:
Pipe tobacco: 1,966;
Roll your own tobacco: 438.
August 2010:
Pipe tobacco: 2,043;
Roll your own tobacco: 535.
September 2010:
Pipe tobacco: 2,324;
Roll your own tobacco: 503.
October 2010:
Pipe tobacco: 2,103;
Roll your own tobacco: 478.
November 2010:
Pipe tobacco: 2,063;
Roll your own tobacco: 399.
December 2010:
Pipe tobacco: 2,182;
Roll your own tobacco: 602.
January 2011:
Pipe tobacco: 2,601;
Roll your own tobacco: 357.
February 2011:
Pipe tobacco: 2,542;
Roll your own tobacco: 470.
March 2011:
Pipe tobacco: 2,712;
Roll your own tobacco: 416.
April 2011:
Pipe tobacco: 2,335;
Roll your own tobacco: 395.
May 20101:
Pipe tobacco: 2,524;
Roll your own tobacco: 414.
June 2011:
Pipe tobacco: 2,702;
Roll your own tobacco: 429.
July 2011:
Pipe tobacco: 2,674;
Roll your own tobacco: 418.
August 2011:
Pipe tobacco: 2,981
Roll your own tobacco: 500.
September 2011:
Pipe tobacco: 3,099;
Roll your own tobacco: 316.
Number of cigars (per month in millions):
October 2000:
Small cigars: 281;
Large cigars: 210.
November 2000:
Small cigars: 283;
Large cigars: 191.
December 2000:
Small cigars: 249;
Large cigars: 151.
January 2001:
Small cigars: 225;
Large cigars: 162.
February 2001:
Small cigars: 238;
Large cigars: 178.
March 2001:
Small cigars: 327;
Large cigars: 189.
April 2001:
Small cigars: 296;
Large cigars: 142.
May 2001:
Small cigars: 317;
Large cigars: 173.
June 2001:
Small cigars: 328;
Large cigars: 211.
July 2001:
Small cigars: 325;
Large cigars: 178.
August 2001:
Small cigars: 340;
Large cigars: 199.
September 2001:
Small cigars: 290;
Large cigars: 195.
October 2001:
Small cigars: 323;
Large cigars: 209.
November 2001:
Small cigars: 303;
Large cigars: 183.
December 2001:
Small cigars: 253;
Large cigars: 151.
January 2002:
Small cigars: 274;
Large cigars: 161.
February 2002:
Small cigars: 265;
Large cigars: 163.
March 2002:
Small cigars: 288;
Large cigars: 184.
April 2002:
Small cigars: 330;
Large cigars: 191.
May 2002:
Small cigars: 345;
Large cigars: 186.
June 2002:
Small cigars: 320;
Large cigars: 213.
July 2002:
Small cigars: 334;
Large cigars: 192.
August 2002:
Small cigars: 354;
Large cigars: 212.
September 2002:
Small cigars: 315;
Large cigars: 210.
October 2002:
Small cigars: 322;
Large cigars: 187.
November 2002:
Small cigars: 292;
Large cigars: 169.
December 2002:
Small cigars: 268;
Large cigars: 179.
January 2003:
Small cigars: 274;
Large cigars: 161.
February 2003:
Small cigars: 265;
Large cigars: 163.
March 2003:
Small cigars: 288;
Large cigars: 184.
April 2003:
Small cigars: 330;
Large cigars: 191.
May 2003:
Small cigars: 345;
Large cigars: 186.
June 2003:
Small cigars: 320;
Large cigars: 213.
July 2003:
Small cigars: 334;
Large cigars: 192.
August 2003:
Small cigars: 354;
Large cigars: 212.
September 2003:
Small cigars: 315;
Large cigars: 210.
October 2003:
Small cigars: 358;
Large cigars: 200.
November 2003:
Small cigars: 294;
Large cigars: 160.
December 2003:
Small cigars: 299;
Large cigars: 187.
January 2004:
Small cigars: 327;
Large cigars: 169.
February 2004:
Small cigars: 364;
Large cigars: 162.
March 2004:
Small cigars: 305;
Large cigars: 157.
April 2004:
Small cigars: 386;
Large cigars: 218.
May 2004:
Small cigars: 358;
Large cigars: 204.
June 2004:
Small cigars: 395;
Large cigars: 266.
July 2004:
Small cigars: 353;
Large cigars: 252.
August 2004:
Small cigars: 385;
Large cigars: 265.
September 2004:
Small cigars: 343;
Large cigars: 250.
October 2004:
Small cigars: 349;
Large cigars: 235.
November 2004:
Small cigars: 349;
Large cigars: 231.
December 2004:
Small cigars: 325;
Large cigars: 235.
January 2005:
Small cigars: 293;
Large cigars: 252.
February 2005:
Small cigars: 356;
Large cigars: 248.
March 2005:
Small cigars: 405;
Large cigars: 310.
April 2005:
Small cigars: 390;
Large cigars: 302.
May 2005:
Small cigars: 386;
Large cigars: 270.
June 2005:
Small cigars: 399;
Large cigars: 344.
July 2005:
Small cigars: 386;
Large cigars: 315.
August 2005:
Small cigars: 381;
Large cigars: 353.
September 2005:
Small cigars: 373;
Large cigars: 358.
October 2005:
Small cigars: 371;
Large cigars: 325.
November 2005:
Small cigars: 358;
Large cigars: 324.
December 2005:
Small cigars: 336;
Large cigars: 349.
January 2006:
Small cigars: 362;
Large cigars: 334.
February 2006:
Small cigars: 330;
Large cigars: 304.
March 2006:
Small cigars: 448;
Large cigars: 320.
April 2006:
Small cigars: 382;
Large cigars: 309.
May 2006:
Small cigars: 422;
Large cigars: 340.
June 2006:
Small cigars: 416;
Large cigars: 430.
July 2006:
Small cigars: 354;
Large cigars: 350.
August 2006:
Small cigars: 385;
Large cigars: 384.
September 2006:
Small cigars: 376;
Large cigars: 378.
October 2006:
Small cigars: 333;
Large cigars: 345.
November 2006:
Small cigars: 370;
Large cigars: 358.
December 2006:
Small cigars: 331;
Large cigars: 339.
January 2007:
Small cigars: 332;
Large cigars: 325.
February 2007:
Small cigars: 361;
Large cigars: 333.
March 2007:
Small cigars: 405;
Large cigars: 367.
April 2007:
Small cigars: 386;
Large cigars: 365.
May 2007:
Small cigars: 425;
Large cigars: 411.
June 2007:
Small cigars: 423;
Large cigars: 447.
July 2007:
Small cigars: 370;
Large cigars: 411.
August 2007:
Small cigars: 433;
Large cigars: 481.
September 2007:
Small cigars: 403;
Large cigars: 395.
October 2007:
Small cigars: 395;
Large cigars: 440.
November 2007:
Small cigars: 380;
Large cigars: 441.
December 2007:
Small cigars: 349;
Large cigars: 354.
January 2008:
Small cigars: 334;
Large cigars: 421.
February 2008:
Small cigars: 388;
Large cigars: 430.
March 2008:
Small cigars: 415;
Large cigars: 395.
April 2008:
Small cigars: 388;
Large cigars: 468.
May 2008:
Small cigars: 444;
Large cigars: 474.
June 2008:
Small cigars: 443;
Large cigars: 485.
July 2008:
Small cigars: 387;
Large cigars: 473.
August 2008:
Small cigars: 438;
Large cigars: 455.
September 2008:
Small cigars: 397;
Large cigars: 500.
October 2008:
Small cigars: 409;
Large cigars: 487.
November 2008:
Small cigars: 303;
Large cigars: 414.
December 2008:
Small cigars: 328;
Large cigars: 504.
January 2009:
Small cigars: 411;
Large cigars: 431.
February 2009:
Small cigars: 453;
Large cigars: 508.
March 2009:
Small cigars: 552;
Large cigars: 331.
April 2009 (begin CHIPRA):
Small cigars: 709;
Large cigars: 117.
May 2009:
Small cigars: 680;
Large cigars: 125.
June 2009:
Small cigars: 721;
Large cigars: 122.
July 2009:
Small cigars: 718;
Large cigars: 118.
August 2009:
Small cigars: 772;
Large cigars: 91.
September 2009:
Small cigars: 821;
Large cigars: 101.
October 2009:
Small cigars: 779;
Large cigars: 81.
November 2009:
Small cigars: 700;
Large cigars: 76.
December 2009:
Small cigars: 727;
Large cigars: 74.
January 2010:
Small cigars: 761;
Large cigars: 78.
February 2010:
Small cigars: 736;
Large cigars: 67.
March 2010:
Small cigars: 955;
Large cigars: 72.
April 2010:
Small cigars: 855;
Large cigars: 80.
May 2010:
Small cigars: 797;
Large cigars: 73.
June 2010:
Small cigars: 889;
Large cigars: 80.
July 2010:
Small cigars: 846;
Large cigars: 74.
August 2010:
Small cigars: 909;
Large cigars: 75.
September 2010:
Small cigars: 929;
Large cigars: 78.
October 2010:
Small cigars: 861;
Large cigars: 72.
November 2010:
Small cigars: 832;
Large cigars: 81.
December 2010:
Small cigars: 698;
Large cigars: 68.
January 2011:
Small cigars: 782;
Large cigars: 60.
February 2011:
Small cigars: 783;
Large cigars: 56.
March 2011:
Small cigars: 954;
Large cigars: 73.
April 2011:
Small cigars: 810;
Large cigars: 64.
May 20101:
Small cigars: 846;
Large cigars: 60.
June 2011:
Small cigars: 892;
Large cigars: 74.
July 2011:
Small cigars: 851;
Large cigars: 65.
August 2011:
Small cigars: 902;
Large cigars: 71.
September 2011:
Small cigars: 1,055;
Large cigars: 61.
Source: GAO analysis of Treasury data.
[End of figure]
While revenue collected for all smoking tobacco products from April
2009 through fiscal year 2011 amounted to $40 billion, GAO estimates
that federal revenue losses due to market shifts from roll-your-own to
pipe tobacco and from small to large cigars range from about $615
million to $1.1 billion for the same period. The Department of the
Treasury (Treasury) has limited options to respond to these market
shifts. Treasury has attempted to differentiate between roll-your-own
and pipe tobacco for tax purposes but faces challenges because the
definitions of the two products in the Internal Revenue Code of 1986
do not specify distinguishing physical characteristics. Treasury also
has limited options to address the market shift to large cigars and
faces added complexity in monitoring and enforcing tax payments due to
the change in large cigar tax rates.
Unlike cigarettes and roll-your-own tobacco, pipe tobacco and cigars
are not currently regulated by the Food and Drug Administration (FDA)
and thus are not subject to the same restrictions on characterizing
flavors, sales, or distribution. In 2011, FDA indicated its intent to
issue a proposed rule that would deem products meeting the statutory
definition of “tobacco product” to be subject to FDA’s regulation.
However, FDA had not issued the proposed rule as of March 2012. FDA
officials told GAO that developing the rule was taking longer than
expected.
What GAO Recommends:
As Congress continues its oversight of CHIPRA and Tobacco Control Act
implementation, it should consider equalizing tax rates on roll-your-
own and pipe tobacco and, in consultation with Treasury, consider
options for reducing tax avoidance due to tax differentials between
small and large cigars. Treasury generally agreed with GAO’s
conclusions and observations.
View [hyperlink, http://www.gao.gov/products/GAO-12-475]. View related
video clip. For more information, contact David Gootnick at (202) 512-
3149 or gootnickd@gao.gov.
[End of section]
Contents:
Letter:
Background:
Large Tax Disparities among Similar Tobacco Products Triggered
Significant Market Shifts to Avoid Higher Taxes:
Market Shifts to Avoid Taxes Have Reduced Federal Revenue, and
Treasury Has Limited Options to Respond:
FDA Currently Regulates Cigarettes and Roll-Your-Own Tobacco but Not
Pipe Tobacco and Cigars:
Conclusions:
Matter for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Sales of Smoking Tobacco Products in the United States,
Fiscal Years 2001-2011:
Appendix III: Summary of Treasury's Proposed Rulemaking Actions to
Distinguish between Roll-Your-Own and Pipe Tobacco:
Appendix IV: Comments from the Department of the Treasury:
Appendix V: GAO Contact and Staff Acknowledgments:
Tables:
Table 1: Definitions of Smoking Tobacco Products in the IRC:
Table 2: Federal Excise Tax Rates for Cigarettes, Roll-Your-Own
Tobacco, Pipe Tobacco, and Small Cigars, Before and After CHIPRA:
Table 3: Federal Excise Tax Rates for Large Cigars, Before and After
CHIPRA:
Table 4: Treasury Actions on Roll-Your-Own and Pipe Tobacco following
CHIPRA, Industry Comments, and Status:
Table 5: U.S. Sales of Cigarettes and Other Smoking Tobacco Products,
Fiscal Years 2001-2011 (in Billions of Sticks):
Figures:
Figure 1: Examples of Cigarette and Cigar Products:
Figure 2: Tax Rates for Cigarettes, Roll-Your-Own Tobacco, Pipe
Tobacco, and Small Cigars, 1951-2010:
Figure 3: Changes in Federal Excise Tax Rates as a Result of CHIPRA--
for Cigarettes, Roll-Your-Own Tobacco, Pipe Tobacco, and Small Cigars:
Figure 4: Changes in Federal Excise Tax Rates as a Result of CHIPRA--
for Large Cigars under Three Different Scenarios:
Figure 5: Payment of Federal, State, and Local Excise Taxes in the
Supply Chain for U.S. Tobacco Products:
Figure 6: Monthly and Annual U.S. Sales of Roll-Your-Own and Pipe
Tobacco, Fiscal Years 2001-2011:
Figure 7: Combined U.S. Sales of Roll-Your-Own and Pipe Tobacco,
Fiscal Years 2001-2011:
Figure 8: Number of Companies Producing Roll-Your-Own Tobacco, Pipe
Tobacco, or Both, 2007-2011:
Figure 9: Examples of Maryland Retail Prices for Cartons of Various
Types of Cigarettes:
Figure 10: Monthly and Annual U.S. Sales of Small and Large Cigars,
Fiscal Years 2001-2011:
Figure 11: Combined U.S. Sales of Small and Large Cigars, Fiscal Years
2001-2011:
Figure 12: Estimated Revenue Losses for Roll-Your-Own and Pipe Tobacco:
Figure 13: Estimated Revenue Losses for Small and Large Cigars:
Figure 14: Post-CHIPRA Incentives for Some Manufacturers to Switch
from Small to Large Cigars:
Figure 15: Post-CHIPRA Incentives for Some Manufacturers and Importers
to Lower the Sale Price of Large Cigars:
Figure 16: Basic Phases in FDA's Rulemaking Process:
Figure 17: U.S. Sales of Cigarettes and Other Smoking Tobacco
Products, Fiscal Years 2001-2011:
Abbreviations:
CHIPRA: Children's Health Insurance Program Reauthorization Act of
2009:
FDA: Food and Drug Administration:
IRC: Internal Revenue Code of 1986:
RYO: roll-your-own tobacco:
Tobacco Control Act: Family Smoking Prevention and Tobacco Control Act:
Treasury: Department of the Treasury:
[End of section]
United States Government Accountability Office:
Washington, DC 20548"
April 18, 2012:
The Honorable Tom Harkin:
Chairman:
The Honorable Michael B. Enzi:
Ranking Member:
Committee on Health, Education, Labor, and Pensions:
United States Senate:
The Honorable Fred Upton:
Chairman:
The Honorable Henry A. Waxman:
Ranking Member:
Committee on Energy and Commerce:
United States House of Representatives:
Tobacco use is the leading cause of preventable death, disease, and
disability and a significant contributor to health care costs in the
United States. The Centers for Disease Control and Prevention reports
that smoking and exposure to secondhand smoke account for over 440,000
premature deaths per year and cost the United States an estimated $193
billion annually in health care expenditures and productivity losses.
Federal and state legislation has aimed to discourage tobacco use and
raise revenues by increasing excise taxes on tobacco products. The
most recent federal increase occurred in 2009 when Congress passed the
Children's Health Insurance Program Reauthorization Act of 2009
(CHIPRA),[Footnote 1] which amended the Internal Revenue Code of 1986
(IRC) by raising excise tax rates on tobacco products. The Department
of the Treasury (Treasury) is responsible for collecting these taxes.
In addition, in order to reduce tobacco use and protect public health,
in June 2009, Congress passed the Family Smoking Prevention and
Tobacco Control Act (Tobacco Control Act),[Footnote 2] which granted
the Food and Drug Administration (FDA) authority to regulate the
manufacture, distribution, and marketing of tobacco products.
Title III of the Tobacco Control Act directed GAO to report on various
aspects of trade in tobacco products, including the effects resulting
from the differing tax rates applicable to tobacco products.[Footnote
3] This report examines the federal revenue effects resulting from
different federal excise tax rates on various smoking tobacco products
and differences in FDA's regulation of these products. Specifically,
we (1) review the market shifts among smoking tobacco products since
CHIPRA went into effect on April 1, 2009; (2) examine the impact of
these market shifts on federal revenue and Treasury's actions to
respond; and (3) describe differences in FDA's regulation of various
smoking tobacco products. Our review includes smoking tobacco products
that are subject to federal excise tax: cigarettes and four other
tobacco products--roll-your-own tobacco (sometimes called RYO), pipe
tobacco, small cigars, and large cigars.[Footnote 4] However, in
analyzing the market shifts among these products, we focused solely on
the four smoking tobacco products other than cigarettes.
To address the three objectives in this study, we reviewed documents
and interviewed agency officials from Treasury's Alcohol and Tobacco
Tax and Trade Bureau, FDA, and the Centers for Disease Control and
Prevention, as well as tobacco industry members, representatives of
public health and other nongovernmental organizations, and academics,
to obtain information on tobacco legislation and regulations, tobacco
product sales trends, and consumption patterns. We also reviewed
studies analyzing the relationship between tobacco tax increases and
smoking, including among youth. We analyzed Treasury removals data to
identify sales trends across the different tobacco products. As used
in this report, for smoking tobacco products, "removals" means the
amount removed for distribution in the United States from the factory
or released from customs.[Footnote 5] In this report, we consider
removals to be equivalent to sales and use the term sales. In
addition, we collected and analyzed data on federal excise tax rates
for these tobacco products and the revenues generated from their sale.
We estimated what the effect on tax revenue collection would have been
if the sales trends for roll-your-own and pipe tobacco and for small
and large cigars had not been affected by substitution between the
products but had been affected by the increase in price due to the
tax--in other words, if the market shifts resulting from the
substitution of higher-taxed products with lower-taxed products had
not occurred. In this report, we refer to this estimated effect on
federal tax revenue collection as revenue losses. Our analysis takes
into account the expected fall in quantity demanded due to the price
increases resulting from higher federal excise tax rates that CHIPRA
imposed on all four of these smoking tobacco products. See appendix I
for more information on our objectives, scope, and methodology.
We conducted this performance audit from March 2011 to April 2012 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
Background:
Cigarettes continue to dominate the smoking tobacco product market,
accounting for approximately 91 percent of sales in 2011. However, the
use of other smoking tobacco products has increased over the past 10
years. Between 2001 and 2011, combined sales of roll-your-own tobacco,
pipe tobacco, and small and large cigars grew from 3 percent of the
smoking tobacco market to 9 percent. Although cigarette use in the
United States is declining, it is partially offset by growing use of
other smoking tobacco products. (See appendix II for data on U.S.
sales of smoking tobacco products from fiscal year 2001 through fiscal
year 2011.)
Increasing the price of tobacco products by raising excise taxes is
widely recognized as an effective policy for reducing smoking
prevalence across socioeconomic and racial groups.[Footnote 6] Public
health and economic studies have found that adolescents are more
responsive than adults to tobacco tax and price increases because they
have less disposable income.[Footnote 7] However, the impact of tax
increases on reducing overall smoking prevalence is likely to be
weaker if smokers can turn to tobacco products that can be used as
functional equivalents of factory-made cigarettes and cost
significantly less, according to public health officials and academics.
Tobacco Products Have Broad Definitions:
Smoking tobacco products are broadly defined in the IRC.[Footnote 8]
Roll-your-own tobacco and pipe tobacco are defined by such factors as
the use for which the product is suited and how they are offered for
sale, as indicated by their appearance, type, packaging, and labeling.
Cigars are differentiated from cigarettes by their wrapper and whether
the product is, for a number of reasons, likely to be offered to, or
purchased by, consumers as a cigarette. The tax rate for cigars is
categorized into small and large cigars, which are differentiated by a
weight threshold alone--small cigars are defined as weighing 3 pounds
or less per thousand sticks.[Footnote 9],[Footnote 10] The definitions
found in the IRC characterize five types of smoking tobacco products
that are relevant to our discussion, as shown in table 1.[Footnote 11]
Table 1: Definitions of Smoking Tobacco Products in the IRC:
Product: Cigarette;
Definition: (1) Any roll of tobacco wrapped in paper or in any
substance not containing tobacco or (2) any roll of tobacco wrapped in
any substance containing tobacco which, because of its appearance, the
type of tobacco used in the filler, or its packaging and labeling, is
likely to be offered to, or purchased by, consumers as a cigarette
described in (1).
Product: Roll-Your-Own tobacco;
Definition: Any tobacco which, because of its appearance, type,
packaging, or labeling, is suitable for use and likely to be offered
to, or purchased by, consumers as tobacco for making cigarettes or
cigars, or for use as wrappers thereof.
Product: Pipe tobacco;
Definition: Any tobacco which, because of its appearance, type,
packaging, or labeling, is suitable for use and likely to be offered
to, or purchased by, consumers as tobacco to be smoked in a pipe.
Product: Small cigar;
Definition: Any roll of tobacco wrapped in leaf tobacco or in any
substance containing tobacco (other than any roll of tobacco which is
a cigarette) that weighs 3 pounds or less per thousand.
Product: Large cigar;
Definition: Any roll of tobacco wrapped in leaf tobacco or in any
substance containing tobacco (other than any roll of tobacco which is
a cigarette) that weighs more than 3 pounds per thousand.
Source: 26 U.S.C. §§ 5701, 5702.
[End of table]
Figure 1 shows a sample of different cigarette and cigar products.
Several of the products closely resemble each other in size and shape.
The three on the left are cigarettes. The first is a roll-your-own
cigarette[Footnote 12] made by hand with roll-your-own tobacco. The
second is a roll-your-own cigarette made in a commercial roll-your-own
machine[Footnote 13] with pipe tobacco. And the third from the left is
a factory-made cigarette. The three products on the right are cigars,
which can vary widely in size, shape, flavor, and aroma. According to
industry representatives, a nongovernmental organization, and
government officials, traditionally, cigars are hand-rolled, wrapped
in a tobacco leaf, large in size, and their smoke is not meant to be
inhaled. However, they indicated that many small and large cigars now
have filters, are wrapped in a type of paper made with tobacco, and
can be similar in size and appearance to cigarettes.
Figure 1: Examples of Cigarette and Cigar Products:
[Refer to PDF for image: photograph and descriptions]
1. Roll-your-own cigarette made by hand with roll-your-own tobacco.
2. Roll-your-own cigarette made in a commercial roll-your-own machine
with pipe tobacco.
3. Factory-made cigarette.
4. Small cigar.
5. Filtered large cigar.
6. Traditional large cigar.
Source: GAO.
[End of figure]
Federal Excise Taxes on Tobacco Products Most Recently Increased by
CHIPRA:
While the enactment of CHIPRA in 2009 represents the most recent
increase in federal excise taxes on tobacco products, Congress has
taxed tobacco products since its inception as a means to raise
revenue.[Footnote 14] Of the smoking tobacco products that we discuss
in this report, Congress taxed only cigarettes, small cigars, and
large cigars prior to 1989. Congress began taxing pipe tobacco on
January 1, 1989,[Footnote 15] and roll-your-own tobacco on January 1,
2000.[Footnote 16] As the danger of tobacco became better known,
congressional debates surrounding tobacco taxes expanded from
increasing revenue to protecting the public from health risks of
tobacco. Figure 2 shows the tax rates for four smoking tobacco
products from 1951 to 2010.
Figure 2: Tax Rates for Cigarettes, Roll-Your-Own Tobacco, Pipe
Tobacco, and Small Cigars, 1951-2010:
[Refer to PDF for image: line graph]
Tax rate: dollars per thousand sticks:
Cigarettes: $
Pipe tobacco: $
RYO: $
Year: 1951;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1955;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1960;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1965;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1970;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1975;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1980;
Cigarettes: $4;
Small cigars: $0.75.
Year: 1985;
Cigarettes: $8;
Small cigars: $0.75;
RYO: $0.91.
Year: 1990;
Cigarettes: $8;
Small cigars: $0.75;
RYO: $0.91.
Year: 1995;
Cigarettes: $12;
Small cigars: $1.13;
RYO: $1.37;
Year: 2000;
Cigarettes: $17;
Small cigars: $1.59;
RYO: $1.94;
Pipe tobacco: $1.94.
Year: 2001;
Cigarettes: $17;
Small cigars: $1.59;
RYO: $1.94;
Pipe tobacco: $1.94.
Year: 2002;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2003;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2004;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2005;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2006;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2007;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2008;
Cigarettes: $19.5;
Small cigars: $1.83;
RYO: $2.23;
Pipe tobacco: $2.23.
Year: 2009;
Cigarettes: $50.33;
Small cigars: $50.33;
Pipe tobacco: $5.75;
RYO: $50.33.
Year: 2010;
Cigarettes: $50.33;
Small cigars: $50.33;
Pipe tobacco: $5.75;
RYO: $50.33.
Year: 2011;
Cigarettes: $50.33;
Small cigars: $50.33;
Pipe tobacco: $5.75;
RYO: $50.33.
Source: GAO analysis of the IRC.
Note: Large cigar tax rates are not included in this figure because
they are taxed at an ad valorem rate--a percentage of the
manufacturer's or importer's sale price--up to a maximum tax per
thousand sticks, rather than a rate based on units or weight.
[A] Roll-your-own and pipe tobacco taxes are shown at an equivalent
tax per stick rate based on the Master Settlement Agreement conversion
rate for roll-your-own tobacco of 0.0325 ounces per stick. We are
applying this conversion rate to pipe tobacco for the purpose of
comparison because Treasury has not yet differentiated the physical
characteristics of roll-your-own and pipe tobacco.
[End of figure]
The federal excise tax rates on different tobacco products are
calculated in different ways. Cigarettes and small cigars are taxed on
a unit basis--number of sticks. Roll-your-own and pipe tobacco are
taxed by weight. Table 2 provides information on the different federal
excise tax rates for cigarettes, roll-your-own tobacco, pipe tobacco,
and small cigars before and after CHIPRA.
Table 2: Federal Excise Tax Rates for Cigarettes, Roll-Your-Own
Tobacco, Pipe Tobacco, and Small Cigars, Before and After CHIPRA:
Tobacco products: Cigarettes[A];
Unit of taxation: thousand sticks;
Before CHIPRA: $19.50;
After CHIPRA: $50.33;
Percentage increase: 158%.
Tobacco products: Roll-Your-Own tobacco;
Unit of taxation: pounds;
Before CHIPRA: $1.10;
After CHIPRA: $24.78;
Percentage increase: 2,159%.
Tobacco products: Pipe tobacco;
Unit of taxation: pounds;
Before CHIPRA: $1.10;
After CHIPRA: $2.83;
Percentage increase: 158%.
Tobacco products: Small cigars;
Unit of taxation: thousand sticks;
Before CHIPRA: $1.83;
After CHIPRA: $50.33;
Percentage increase: 2,653%.
Source: GAO analysis of the IRC.
Note: Although we rounded the tax rates to the nearest cent for this
table, we used the exact tax rate in our calculations.
[A] The federal excise tax rate for large cigarettes up to 6.5 inches
long was $40.95 per thousand sticks prior to CHIPRA and became $105.69
per thousand sticks after CHIPRA. Large cigarettes over 6.5 inches
long are taxed at the rate for small cigarettes, counting each 2.75
inches or fraction thereof of the length of each as one cigarette.
[End of table]
Before CHIPRA, the federal excise tax rate on cigarettes was higher
than the rates on roll-your-own tobacco, pipe tobacco, and small
cigars. However, CHIPRA significantly raised the tax rates on these
four products and equalized the rates on cigarettes, roll-your-own
tobacco, and small cigars (see figure 3). Congress equalized the tax
rates on roll-your-own tobacco and small cigars with the cigarette tax
rate in part in response to concerns that smokers had been using these
two products as substitutes for higher-taxed factory-made cigarettes,
according to nongovernmental organizations. CHIPRA also raised the
federal excise tax rate on pipe tobacco, but to a rate that is
considerably lower. Prior to CHIPRA, the tax rate on roll-your-own
tobacco and pipe tobacco was the same.
Figure 3: Changes in Federal Excise Tax Rates as a Result of CHIPRA--
for Cigarettes, Roll-Your-Own Tobacco, Pipe Tobacco, and Small Cigars:
[Refer to PDF for image: vertical bar graph]
Tax rate: dollars per thousand sticks:
Tobacco product: Cigarettes;
Before CHIPRA: $19.5;
After CHIPRA: $50.33.
Tobacco product: Roll-your-own tobacco[A];
Before CHIPRA: $2.23;
After CHIPRA: $50.33.
Tobacco product: Pipe tobacco[A];
Before CHIPRA: $2.23;
After CHIPRA: $5.7507.
Tobacco product: Small cigars;
Before CHIPRA: $1.83;
After CHIPRA: $50.33.
Source: GAO analysis of the IRC.
[A] The roll-your-own tobacco and pipe tobacco cigarette stick
equivalent is based on the weight of 0.0325 ounces of tobacco per
cigarette stick using the Master Settlement Agreement conversion rate.
[End of figure]
CHIPRA significantly changed the federal excise tax rate on large
cigars. Large cigars are unique among tobacco products in that the tax
rate is ad valorem--a percentage of the manufacturer's or importer's
sale price per thousand sticks--up to a maximum tax per thousand
sticks. Before CHIPRA, large cigars were taxed at 20.72 percent of the
manufacturer's or importer's sale price up to a maximum tax of $48.75
per thousand sticks. After CHIPRA, the ad valorem rate increased to
52.75 percent of the manufacturer's or importer's sale price, and the
maximum tax per thousand sticks increased to $402.60 (see table 3).
According to an industry association, the retail prices of premium
handmade large cigars range from $3 to $20. A public health
organization noted that smaller factory-made cigars that meet the
legal definition of a large cigar can cost as little as $0.07 per
cigar.
Table 3: Federal Excise Tax Rates for Large Cigars, Before and After
CHIPRA:
Tobacco product: Large cigars;
Unit of taxation: Ad valorem rate based on manufacturer's or
importer's sale price up to a maximum tax rate;
Before CHIPRA: 20.72%;
After CHIPRA: 52.75%;
Percentage increase: 155%.
Tobacco product: Large cigars;
Unit of taxation: Maximum tax per thousand sticks;
Before CHIPRA: Before CHIPRA: $48.75;
After CHIPRA: After CHIPRA: $402.60;
Percentage increase: Percentage increase: 726%.
Source: GAO analysis of the IRC.
[End of table]
Figure 4 illustrates the tax structure for large cigars, before and
after CHIPRA and includes three different scenarios. The sloped line
represents the ad valorem rate, which becomes flat when it reaches the
maximum tax per thousand cigars. The following are examples of the
federal excise taxes manufacturers and importers would have to pay for
differently priced large cigars, before and after CHIPRA (see examples
corresponding with figure 4):
A. If the manufacturer's or importer's sale price per thousand large
cigars is $100, before CHIPRA the ad valorem tax rate was $20.72 per
thousand; after CHIPRA it became $52.75 per thousand.
B. If the manufacturer's or importer's sale price per thousand large
cigars is $500, before CHIPRA the tax rate was the maximum tax of
$48.75 per thousand; after CHIPRA it became $263.75 per thousand based
on the new ad valorem tax rate.
C. If the manufacturer's or importer's sale price per thousand large
cigars is $800, before CHIPRA the tax rate was the maximum tax of
$48.75 per thousand; after CHIPRA it became $402.60, which is the new
maximum tax rate per thousand.
Figure 4: Changes in Federal Excise Tax Rates as a Result of CHIPRA--
for Large Cigars under Three Different Scenarios:
[Refer to PDF for image: line graph with tax rates at three different
prince points illustrated]
Dollars per thousand sticks:
Manufacturer's or importer's sale price: $100;
Tax rate:
Before CHIPRA: $20.72;
After CHIPRA: $52.75.
Manufacturer's or importer's sale price: $500;
Tax rate:
Before CHIPRA: $48.75;
After CHIPRA: $263.75.
Manufacturer's or importer's sale price: $800;
Tax rate:
Before CHIPRA: $48.75;
After CHIPRA: $402.60.
Source: GAO analysis of the IRC.
Note: The sloped lines represent the ad valorem rates for large cigars
before and after CHIPRA, with the lines becoming flat when they reach
the maximum rates of $48.75 (before CHIPRA) and $402.60 (after CHIPRA).
[End of figure]
Treasury is responsible for administering and collecting the federal
excise tax on all tobacco products, among other things.[Footnote 17]
In general, federal excise taxes are collected when tobacco products
leave the domestic factory or, in the case of imports, when the
products are released from customs custody.[Footnote 18] Tobacco
manufacturers and importers are required to obtain a Treasury permit
to operate and must comply with Treasury's recordkeeping, reporting,
and other requirements.[Footnote 19] Tobacco product wholesalers and
distributors are responsible for paying state and local excise taxes,
but they are not required to obtain a Treasury permit and are not
subject to Treasury recordkeeping requirements. Figure 5 shows the
major steps in the tobacco supply chain, including the key points at
which taxes are paid.
Figure 5: Payment of Federal, State, and Local Excise Taxes in the
Supply Chain for U.S. Tobacco Products:
[Refer to PDF for image: illustration]
Manufacture/importer:
Federal excise tax;
Wholesaler/distributor;
State/local tax;
Retailer/consumer.
Source: GAO.
Note: Supply chains can differ by manufacturer/importer, and this
figure does not represent all of the steps in the distribution process.
[End of figure]
Tobacco Control Act Gave FDA Broad Authority to Regulate Tobacco
Products to Protect Public Health:
In the Tobacco Control Act passed in June 2009, Congress amended the
Food, Drug, and Cosmetic Act by inserting a chapter governing tobacco
products and granting FDA authority to regulate the manufacture,
distribution, and marketing of tobacco products under that chapter.
[Footnote 20] The act aims to, among other things, reduce the use of
tobacco products to decrease health risks and social costs associated
with tobacco-related diseases. It recognizes that virtually all new
users of tobacco products are adolescents under the age of 18.
According to the law, FDA's regulation of tobacco products is based,
in part, on a public health standard rather than the safety and
effectiveness standard by which FDA regulates pharmaceutical drugs and
medical devices. For example, FDA can issue restrictions on the sale,
distribution, advertising, and promotion of a tobacco product, if the
public health standard is met. This standard requires FDA to
demonstrate that the proposed regulation is appropriate for the
protection of public health, based on a consideration of the risks and
benefits to the population as a whole, including users and nonusers of
tobacco products.
The act specifies that FDA's authority over tobacco products under
Chapter IX of the Food, Drug, and Cosmetic Act shall apply to
cigarettes, roll-your-own tobacco, cigarette tobacco, and smokeless
tobacco, as well as any other tobacco products that the agency deems
by regulation to be subject to such authority.[Footnote 21] FDA does
not at present regulate pipe tobacco and small and large cigars. To
implement the Tobacco Control Act, FDA has established the Center for
Tobacco Products.
Large Tax Disparities among Similar Tobacco Products Triggered
Significant Market Shifts to Avoid Higher Taxes:
Large federal excise tax disparities among tobacco products resulting
from CHIPRA caused sizable market shifts from higher to lower-taxed
products. According to our analysis and interviews with knowledgeable
sources, the tax disparities created incentives for price sensitive
manufacturers and consumers to substitute higher-taxed products with
lower-taxed products. The market for roll-your-own tobacco shifted to
pipe tobacco and the growth rate of the combined market increased
after CHIPRA. Roll-your-own tobacco manufacturers shifted to pipe
tobacco with minimal, if any, changes to the products, and consumers
substituted pipe tobacco for use in roll-your-own cigarettes. At the
same time, the cigar market shifted from small to large cigars, and
the combined cigar market continued to grow after CHIPRA.
Market Shifted from Roll-Your-Own Tobacco to Pipe Tobacco after CHIPRA:
Market trends for roll-your-own and pipe tobacco changed immediately
after CHIPRA, with sales of pipe tobacco rising steeply while sales of
roll-your-own tobacco plummeted. According to government officials and
representatives of industry and nongovernmental organizations,
manufacturers and consumers switched to lower-taxed pipe tobacco to
make roll-your-own cigarettes. After CHIPRA, the federal excise tax on
roll-your-own tobacco was over $20 per pound more than the tax on pipe
tobacco, whereas before CHIPRA, the taxes on both products were the
same. Figure 6 shows the market shift through monthly sales of roll-
your-own and pipe tobacco from fiscal year 2001 through fiscal year
2011. Total annual sales of pipe tobacco grew from approximately 3.2
million pounds in fiscal year 2008, the last year before CHIPRA, to
30.5 million pounds in fiscal year 2011, representing an increase of
about 869 percent. Over the same period, total annual sales of roll-
your-own tobacco declined from approximately 19.7 million pounds to
5.2 million pounds, a decrease of about 74 percent. According to the
representatives of industry and nongovernmental organizations we
interviewed, the shift can be mostly attributed to consumers switching
from using roll-your-own tobacco to pipe tobacco in roll-your-own
cigarettes, rather than to a sudden increase in pipe smoking.
Figure 6: Monthly and Annual U.S. Sales of Roll-Your-Own and Pipe
Tobacco, Fiscal Years 2001-2011:
[Refer to PDF for image: line graph]
Pounds of tobacco (per fiscal year in thousands):
Roll-your-own tobacco:
Fiscal year 2001: 8,793;
Fiscal year 2002: 9,626;
Fiscal year 2003: 12,221;
Fiscal year 2004: 12,230;
Fiscal year 2005: 14,536;
Fiscal year 2006: 16,451;
Fiscal year 2007: 17,010;
Fiscal year 2008: 19,673;
Fiscal year 2009: 16,167;
Fiscal year 2010: 6,152;
Fiscal year 2011: 5,195.
Pipe tobacco:
Fiscal year 2001: 4,921;
Fiscal year 2002: 4,779;
Fiscal year 2003: 4,323;
Fiscal year 2004: 3,987;
Fiscal year 2005: 3,637;
Fiscal year 2006: 3,605;
Fiscal year 2007: 3,208;
Fiscal year 2008: 3,150;
Fiscal year 2009: 8,758;
Fiscal year 2010: 20,817;
Fiscal year 2011: 30,518.
Source: GAO analysis of Treasury data.
[End of figure]
CHIPRA's increase in the federal excise tax for roll-your-own tobacco
did not dampen the overall sales of roll-your-own and pipe tobacco.
Instead, the combined sales of roll-your-own and pipe tobacco
increased because of the rapid growth in pipe tobacco sales following
CHIPRA. Before CHIPRA, from October 2000 through March 2009, the
combined average monthly growth rate was 0.63 percent; after CHIPRA,
the combined average monthly growth rate increased to 2.00 percent.
See Figure 7 for the trends in combined sales of roll-your-own and
pipe tobacco from fiscal year 2001 through fiscal year 2011.
Figure 7: Combined U.S. Sales of Roll-Your-Own and Pipe Tobacco,
Fiscal Years 2001-2011:
[Refer to PDF for image: line graph]
Pounds of tobacco per month in thousands:
January 2001:
RYO and pipe tobacco sales: 1109.71;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1071.37.
January 2003:
RYO and pipe tobacco sales: 1179.92;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1296.85.
January 2004:
RYO and pipe tobacco sales: 1160.44;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1409.6.
January 2005:
RYO and pipe tobacco sales: 1401.19;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1522.34.
January 2006:
RYO and pipe tobacco sales: 1610.55;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1635.08.
January 2007:
RYO and pipe tobacco sales: 1610.65;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1747.83.
January 2008:
RYO and pipe tobacco sales: 2188.4;
Roll-your-own and pipe tobacco sales growth rate, Oct. 2000-Mar. 2009:
1860.57.
April 2008: [Begin CHIPRA]
RYO and pipe tobacco sales: 2002.74;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 1888.76.
May 2008:
RYO and pipe tobacco sales: 1878.74;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 1898.15.
September 2008:
RYO and pipe tobacco sales: 2101.98;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 1935.73.
January 2009:
RYO and pipe tobacco sales: 2310.35;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 1973.31.
May 2009:
RYO and pipe tobacco sales: 1869.44;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 1816.95.
September 2009:
RYO and pipe tobacco sales: 1886.71;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 2001.19.
January 2010:
RYO and pipe tobacco sales: 2085.3;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 2231.5.
May 2010:
RYO and pipe tobacco sales: 2026.4;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 2415.74.
September 2010:
RYO and pipe tobacco sales: 2827.25;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 2599.98.
January 2011:
RYO and pipe tobacco sales: 2958.46;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 2830.29.
May 2011:
RYO and pipe tobacco sales: 2938.81;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 3014.53.
September 2011:
RYO and pipe tobacco sales: 3415.21;
Roll-your-own and pipe tobacco sales growth rate, Apr. 2009-Sept.
2011: 3198.78.
Source: GAO analysis of Treasury data.
[End of figure]
Manufacturers Switched from Roll-Your-Own to Pipe Tobacco, and
Consumers Began to Use Commercial Roll-Your-Own Machines:
According to government officials, representatives of nongovernmental
organizations, and industry, after CHIPRA many manufacturers of roll-
your-own tobacco switched to producing pipe tobacco in order to avoid
higher taxes. According to these representatives and government
officials, the new pipe tobacco products have minimal, if any,
differences from roll-your-own tobacco. Roll-your-own tobacco and pipe
tobacco are defined in the IRC by such factors as the use for which
the product is suited and how they are offered for sale, as indicated
by their appearance, type, packaging, and labeling. To meet the
definition of pipe tobacco in the IRC and Treasury's
regulations,[Footnote 22] a product must be clearly labeled as pipe
tobacco and not indicate other uses. The definitions of tobacco
products in the IRC do not specify physical characteristics that would
differentiate pipe tobacco from roll-your-own tobacco. Representatives
of industry and nongovernmental organizations provided examples of
current pipe tobacco brands that had been roll-your-own brands prior
to CHIPRA, with minimal differences in the packaging and the
appearance of the tobacco itself. We also found examples of Internet
retailers signaling to customers in their marketing that pipe tobacco
was suitable for smoking in roll-your-own cigarettes. One manufacturer
of pipe tobacco had designed its label with three-letter markings, to
indicate to customers the product's similarity to brand-name
cigarettes. For example, the marking MRD indicated Marlboro Red and
CML indicated Camel Light.
We approached 15 pipe tobacco manufacturers to ask about their
companies' actions in response to the CHIPRA tax changes. Each of the
three tobacco manufacturers that agreed to speak with us explained
that their companies switched from selling higher-taxed roll-your-own
tobacco to lower-taxed pipe tobacco in order to stay competitive. One
company changed the cut of its roll-your-own tobacco and labeled it as
pipe tobacco, although a company representative acknowledged that
there was no real difference between its pipe-cut tobacco and its roll-
your-own tobacco. A representative from another company that switched
from selling roll-your-own tobacco to selling pipe tobacco stated that
she was not aware of any difference in the two products other than the
federal excise tax rate.
Data show that the total number of companies exclusively manufacturing
pipe tobacco increased significantly since CHIPRA, while the number of
companies exclusively manufacturing roll-your-own tobacco decreased
sharply. Treasury emphasized that it is unclear whether these
manufacturers modified their roll-your-own tobacco beyond
reclassifying it as pipe tobacco. Data also show the number of
companies producing both roll-your-own and pipe tobacco has slowly
increased since 2007 (see figure 8).
Figure 8: Number of Companies Producing Roll-Your-Own Tobacco, Pipe
Tobacco, or Both, 2007-2011:
[Refer to PDF for image: line graph]
2007, January-March:
RYO tobacco only companies: 28;
RYO and Pipe tobacco companies: 9;
Pipe tobacco only companies: 25.
2007, April-June:
RYO tobacco only companies: 33;
RYO and Pipe tobacco companies: 7;
Pipe tobacco only companies: 35.
2007, July-September:
RYO tobacco only companies: 34;
RYO and Pipe tobacco companies: 7;
Pipe tobacco only companies: 25.
2007, October-December:
RYO tobacco only companies: 34;
RYO and Pipe tobacco companies: 8;
Pipe tobacco only companies: 21.
2008, January-March:
RYO tobacco only companies: 36;
RYO and Pipe tobacco companies: 6;
Pipe tobacco only companies: 30.
2008, April-June:
RYO tobacco only companies: 37;
RYO and Pipe tobacco companies: 8;
Pipe tobacco only companies: 29.
2008, July-September:
RYO tobacco only companies: 35;
RYO and Pipe tobacco companies: 8;
Pipe tobacco only companies: 27.
2008, October-December:
RYO tobacco only companies: 36;
RYO and Pipe tobacco companies: 8;
Pipe tobacco only companies: 24.
2009, January-March:
RYO tobacco only companies: 33;
RYO and Pipe tobacco companies: 10;
Pipe tobacco only companies: 33.
2009, April-June:
RYO tobacco only companies: 20;
RYO and Pipe tobacco companies: 16;
Pipe tobacco only companies: 33.
2009, July-September:
RYO tobacco only companies: 18;
RYO and Pipe tobacco companies: 17;
Pipe tobacco only companies: 36.
2009, October-December:
RYO tobacco only companies: 19;
RYO and Pipe tobacco companies: 15;
Pipe tobacco only companies: 44.
2010, January-March:
RYO tobacco only companies: 15;
RYO and Pipe tobacco companies: 16;
Pipe tobacco only companies: 52.
2010, April-June:
RYO tobacco only companies: 15;
RYO and Pipe tobacco companies: 17;
Pipe tobacco only companies: 50.
2010, July-September:
RYO tobacco only companies: 14;
RYO and Pipe tobacco companies: 17;
Pipe tobacco only companies: 54.
2010, October-December:
RYO tobacco only companies: 14;
RYO and Pipe tobacco companies: 16;
Pipe tobacco only companies: 49.
2011, January-March:
RYO tobacco only companies: 16;
RYO and Pipe tobacco companies: 15;
Pipe tobacco only companies: 52.
Source: GAO analysis of U.S. Department of Agriculture data.
[End of figure]
The rise in pipe tobacco sales coincided with the growing availability
of commercial roll-your-own machines. Treasury officials stated that
there has recently been significant growth in commercial roll-your-own
machines. These machines enable customers to produce a carton of
cigarettes using pipe tobacco and cigarette-paper tubes with filters.
By using pipe tobacco instead of roll-your-own tobacco, customers are
able to save almost $9 per carton in federal excise taxes.[Footnote
23] A common commercial roll-your-own machine can produce a carton of
cigarettes in less than 10 minutes, providing a significant time
saving compared with making roll-your-own cigarettes by hand.
During our visit to a tobacco outlet store in Maryland, we used a
commercial roll-your-own machine to make a carton of 200 cigarettes
using pipe tobacco in about 8 minutes. We made a video showing this
machine being used to make cigarettes (See [hyperlink,
http://www.gao.gov/multimedia/video#video_id=589493]). The carton we
made in Maryland cost about $25, which included state and federal
excise taxes. The total price of $25 for our carton was about half the
price of a carton of discount cigarettes in nearby stores that sold
tobacco[Footnote 24] (see figure 9).
Figure 9: Examples of Maryland Retail Prices for Cartons of Various
Types of Cigarettes:
[Refer to PDF for image: horizontal bar graph]
Types of cigarettes: Premium cigarettes;
Per carton retail price (including federal and state excise taxes)[A]:
$69.50
Types of cigarettes: Discount cigarettes;
Per carton retail price (including federal and state excise taxes)[A]:
$51.50
Types of cigarettes: Roll-your-own cigarettes made with pipe
tobacco[B];
Per carton retail price (including federal and state excise taxes)[A]:
$24.95
Source: GAO.
[A] The retail price does not include sales tax.
[B] These roll-your-own cigarettes were made in a commercial roll-your-
own machine.
[End of figure]
Cigar Market Shifted from Small to Large Cigars after CHIPRA:
CHIPRA's 2009 changes in federal excise tax rates on tobacco products
also resulted in an immediate shift in the cigar market, with sales of
lower-taxed large cigars rising sharply while sales of higher-taxed
small cigars dropped. Figure 10 shows the market shift through monthly
sales of small and large cigars from fiscal year 2001 through fiscal
year 2011. Total annual sales of large cigars increased from
approximately 4.8 billion sticks in fiscal year 2008 to about 10.3
billion sticks in fiscal year 2011, representing an increase of about
116 percent. For the same period, the total annual sales of small
cigars declined from 5.3 billion sticks to 0.8 billion sticks, a
decrease of 85 percent. According to government officials and
representatives of nongovernmental organizations, because weight is
the only characteristic that distinguishes small cigars from large
cigars, many cigar manufacturers made their small cigars slightly
heavier to qualify for the large cigar tax rate and avoid higher taxes
levied on small cigars after CHIPRA. Figure 10 shows an increase in
large cigar sales in the months immediately prior to the tax change.
Treasury officials stated that although they have not specifically
investigated the cause of this increase, there was an incentive for
retailers and wholesalers to purchase and stockpile large cigars after
the date CHIPRA was signed into law (February 4, 2009) and before the
tax increase went into effect (April 1, 2009). In addition, these
officials noted that a floor stocks tax is typically imposed to
prevent stockpiling just before a tax increase, but the floor stocks
tax imposed by CHIPRA did not apply to large cigars.
Figure 10: Monthly and Annual U.S. Sales of Small and Large Cigars,
Fiscal Years 2001-2011:
[Refer to PDF for image: line graph]
Pounds of tobacco (per fiscal year in thousands):
Large cigars:
FY 2001: 3,498;
FY 2002: 3,704;
FY 2003: 3,949;
FY 2004: 4,169;
FY 2005: 4,385;
FY 2006: 4,541;
FY 2007: 4,573;
FY 2008: 4,759;
FY 2009: 6,877;
FY 2010: 9,882;
FY 2011: 10,266.
Small cigars
FY 2001: 2,179;
FY 2002: 2,256;
FY 2003: 2,284;
FY 2004: 2,490;
FY 2005: 3,453;
FY 2006: 4,147;
FY 2007: 4,576;
FY 2008: 5,337;
FY 2009: 3,351;
FY 2010: 908;
FY 2011: 804.
Source: GAO analysis of Treasury data.
[End of figure]
The combined sales for small and large cigars continued to increase
after CHIPRA, though at a slightly lower rate. Before CHIPRA, from
October 2001 through March 2009, the combined average monthly growth
rate was 0.75 percent, compared with a 0.17 percent growth rate from
April 2009 through September 2011. See figure 11 for trends in overall
cigar sales from fiscal year 2001 through fiscal year 2011.
Figure 11: Combined U.S. Sales of Small and Large Cigars, Fiscal Years
2001-2011:
[Refer to PDF for image: line graph]
Number of sales per month in millions:
January 2001;
Small and large total cigar sales: 387.191;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 419.947.
May 2001;
Small and large total cigar sales: 489.597;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 438.603.
September 2001;
Small and large total cigar sales: 485.108;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 457.258.
January 2002;
Small and large total cigar sales: 434.556;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 475.913.
May 2002;
Small and large total cigar sales: 531.162;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 494.568.
September 2002;
Small and large total cigar sales: 525.283;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 513.224.
January 2003;
Small and large total cigar sales: 479.259;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 531.879.
May 2003;
Small and large total cigar sales: 545.611;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 550.534.
September 2003;
Small and large total cigar sales: 561.719;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 569.19.
January 2004;
Small and large total cigar sales: 496.561;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 587.845.
May 2004;
Small and large total cigar sales: 562.548;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 606.5.
September 2004;
Small and large total cigar sales: 593.228;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 625.156.
January 2005;
Small and large total cigar sales: 544.782;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 643.811.
May 2005;
Small and large total cigar sales: 655.876;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 662.466.
September 2005;
Small and large total cigar sales: 731.363;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 681.122.
January 2006;
Small and large total cigar sales: 696.017;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 699.777.
May 2006;
Small and large total cigar sales: 762.45;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 718.432.
September 2006;
Small and large total cigar sales: 753.899;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 737.087.
January 2007;
Small and large total cigar sales: 656.621;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 755.743.
May 2007;
Small and large total cigar sales: 836.344;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 774.398.
September 2007;
Small and large total cigar sales: 797.346;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 793.053.
January 2008;
Small and large total cigar sales: 755.459;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 811.709.
May 2008;
Small and large total cigar sales: 918.125;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 830.364.
September 2008;
Small and large total cigar sales: 897.661;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 849.019.
January 2009;
Small and large total cigar sales: 842.635;
Small and large cigar sales growth rates, Jan. 2000-Mar. 2009: 867.675.
April 2009: [Begin CHIRPA}
Small and large total cigar sales: 826.266;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 881.666.
May 2009;
Small and large total cigar sales: 804.405;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 864.082.
September 2009;
Small and large total cigar sales: 922.639;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 869.897.
January 2010;
Small and large total cigar sales: 838.986;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 877.167.
May 2010;
Small and large total cigar sales: 869.362;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 882.982.
September 2010;
Small and large total cigar sales: 1006.53;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 888.797.
January 2011;
Small and large total cigar sales: 841.813;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 896.066.
May 2011;
Small and large total cigar sales: 905.795;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 901.881.
September 2011;
Small and large total cigar sales: 1116.38;
Small and large cigar sales growth rate, Apr. 2009-Sept. 2011: 907.696.
Source: GAO analysis of Treasury data.
[End of figure]
Market Shifts to Avoid Taxes Have Reduced Federal Revenue, and
Treasury Has Limited Options to Respond:
While tax revenue collected for all smoking tobacco products from
April 2009 through the end of fiscal year 2011 amounted to $40
billion, we estimate that the market shifts from roll-your-own to pipe
tobacco and from small to large cigars reduced federal revenue by a
range of approximately $615 million to $1.1 billion for the same
period. We estimated what the effect on tax revenue collection would
have been if the sales trends for roll-your-own and pipe tobacco and
for small and large cigars had not been affected by substitution
between the products but had been affected by the increase in price
due to the tax--in other words, if the market shifts resulting from
the substitution of higher-taxed products with lower-taxed products
had not occurred. In this report, we refer to this estimated effect on
federal tax revenue collection as revenue losses. Although Treasury
has taken steps to respond to these market shifts, it has limited
options. For example, Treasury has pursued differentiating between
roll-your-own and pipe tobacco for tax collection purposes but faces
challenges because the definitions of the two products in the IRC do
not specify distinguishing physical characteristics. Furthermore,
Treasury also has limited options to address the market shift to large
cigars.
Estimated Federal Revenue Losses from Market Shifts after CHIPRA Range
from $615 Million to $1.1 Billion:
We estimated that federal revenue losses due to the market shifts from
roll-your-own to pipe tobacco and from small to large cigars range
from $615 million to $1.1 billion. This range includes combined tax
revenue losses for the roll-your-own and pipe tobacco markets, as well
as the small and large cigar markets. We conducted analyses of data
from Treasury and the Bureau of Labor Statistics to estimate tax
revenue losses in these markets.[Footnote 25],[Footnote 26] Our
methodology takes into account the expected fall in demand for a
product following a price increase, holding other variables constant.
To calculate the range of federal revenue losses, we included high and
low estimates based on assumptions about the effect of a price
increase on projected sales.[Footnote 27] Economic studies show that,
when the price of a product increases, the quantity demanded for the
product will adjust downward, decreasing at an estimated rate based on
the quantity demanded for the product, that is, price elasticity.
[Footnote 28] Based on our interviews with government officials and
academics and our literature review, we determined that the price
elasticity for the smoking tobacco products ranges from -0.6 to -0.3
for the low and high revenue estimates, respectively. Our projections
also take into account the historic sales trends for these products
and the tax component of the price.[Footnote 29] Appendix I contains
more information on our methodology for developing these estimates.
Tax Revenue Losses in the Roll-Your-Own and Pipe Tobacco Markets:
Treasury collected $573 million in tax revenue from roll-your-own and
pipe tobacco from April 2009 through September 2011.[Footnote 30] We
estimate that during the same period the market shift from roll-your-
own to pipe tobacco reduced federal revenues by between $255 million
and $492 million (see figure 12).
Figure 12: Estimated Revenue Losses for Roll-Your-Own and Pipe Tobacco:
[Refer to PDF for image: stacked line graph]
Dollars per month in millions:
April 2008;
Actual RYO and pipe tobacco tax revenue: $2.19.
June 2008;
Actual RYO and pipe tobacco tax revenue: $2.11.
August 2008;
Actual RYO and pipe tobacco tax revenue: $2.19.
October 2008;
Actual RYO and pipe tobacco tax revenue: $2.70.
December 2008;
Actual RYO and pipe tobacco tax revenue: $2.10.
February 2009;
Actual RYO and pipe tobacco tax revenue: $2.47.
April 2009; [Begin CHIPRA]
Actual RYO and pipe tobacco tax revenue: $28.66;
Low projected roll-your-own and pipe tobacco tax revenue: $23.99;
High projected roll-your-own and pipe tobacco tax revenue: $30.86.
June 2009;
Actual RYO and pipe tobacco tax revenue: $25.08;
Low projected roll-your-own and pipe tobacco tax revenue: $24.44;
High projected roll-your-own and pipe tobacco tax revenue: $31.44.
August 2009;
Actual RYO and pipe tobacco tax revenue: $21.66;
Low projected roll-your-own and pipe tobacco tax revenue: $24.89;
High projected roll-your-own and pipe tobacco tax revenue: $32.02.
October 2009;
Actual RYO and pipe tobacco tax revenue: $16.81;
Low projected roll-your-own and pipe tobacco tax revenue: $25.35;
High projected roll-your-own and pipe tobacco tax revenue: $32.62.
December 2009;
Actual RYO and pipe tobacco tax revenue: $17.38;
Low projected roll-your-own and pipe tobacco tax revenue: $25.82;
High projected roll-your-own and pipe tobacco tax revenue: $33.23.
February 2010;
Actual RYO and pipe tobacco tax revenue: $17.75;
Low projected roll-your-own and pipe tobacco tax revenue: $26.30;
High projected roll-your-own and pipe tobacco tax revenue: $33.85.
April 2010;
Actual RYO and pipe tobacco tax revenue: $18.23;
Low projected roll-your-own and pipe tobacco tax revenue: $26.79;
High projected roll-your-own and pipe tobacco tax revenue: $34.48.
June 2010;
Actual RYO and pipe tobacco tax revenue: $17.78;
Low projected roll-your-own and pipe tobacco tax revenue: $27.29;
High projected roll-your-own and pipe tobacco tax revenue: $35.12.
August 2010;
Actual RYO and pipe tobacco tax revenue: $19.03;
Low projected roll-your-own and pipe tobacco tax revenue: $27.79;
High projected roll-your-own and pipe tobacco tax revenue: $35.78.
October 2010;
Actual RYO and pipe tobacco tax revenue: $17.80;
Low projected roll-your-own and pipe tobacco tax revenue: $28.31;
High projected roll-your-own and pipe tobacco tax revenue: $36.45.
December 2010;
Actual RYO and pipe tobacco tax revenue: $21.09;
Low projected roll-your-own and pipe tobacco tax revenue: $28.84;
High projected roll-your-own and pipe tobacco tax revenue: $37.13.
February 2011;
Actual RYO and pipe tobacco tax revenue: $18.85;
Low projected roll-your-own and pipe tobacco tax revenue: $29.38;
High projected roll-your-own and pipe tobacco tax revenue: $37.83.
April 2011;
Actual RYO and pipe tobacco tax revenue: $16.39;
Low projected roll-your-own and pipe tobacco tax revenue: $29.92;
High projected roll-your-own and pipe tobacco tax revenue: $38.54.
June 2011;
Actual RYO and pipe tobacco tax revenue: $18.28;
Low projected roll-your-own and pipe tobacco tax revenue: $30.48;
High projected roll-your-own and pipe tobacco tax revenue: $39.26.
August 2011;
Actual RYO and pipe tobacco tax revenue: $20.82;
Low projected roll-your-own and pipe tobacco tax revenue: $31.0;
High projected roll-your-own and pipe tobacco tax revenue: $40.0.
High projected revenue loss: $492 million;
Low projected revenue loss: $255[A] million.
Source: GAO analysis of Treasury and Bureau of Labor Statistics data.
[A] Low projected revenue loss is calculated as the difference between
the projected revenue in the low scenario and the actual collected
revenue. When the actual revenue is higher than the low projected
revenue, the estimated figure of $255 million includes the difference.
[End of figure]
Tax Revenue Losses in the Small and Large Cigar Markets:
Treasury collected $1.7 billion in tax revenue from small and large
cigars from April 2009 through fiscal year 2011.[Footnote 31] We
estimate that during that same period the market shift from small to
large cigars reduced federal revenue by between $360 million to $559
million (see figure 13).[Footnote 32],[Footnote 33]
Figure 13: Estimated Revenue Losses for Small and Large Cigars:
[Refer to PDF for image: stacked line graph]
Dollars per month in millions:
April 2008;
Actual small and large cigar tax revenue: $18.18.
June 2008;
Actual small and large cigar tax revenue: $20.69.
August 2008;
Actual small and large cigar tax revenue: $15.89.
October 2008;
Actual small and large cigar tax revenue: $16.17.
December 2008;
Actual small and large cigar tax revenue: $14.99.
February 2009;
Actual small and large cigar tax revenue: $21.65.
April 2009; [Begin CHIPRA]
Actual small and large cigar tax revenue: $68.68;
Low projected small and large cigar tax revenue: $64.21;
High projected small and large cigar tax revenue: $70.46.
June 2009;
Actual small and large cigar tax revenue: $62.68;
Low projected small and large cigar tax revenue: $64.96;
High projected small and large cigar tax revenue: $71.27.
August 2009;
Actual small and large cigar tax revenue: $59.86;
Low projected small and large cigar tax revenue: $65.73;
High projected small and large cigar tax revenue: $72.09.
October 2009;
Actual small and large cigar tax revenue: $53.54;
Low projected small and large cigar tax revenue: $66.51;
High projected small and large cigar tax revenue: $72.93.
December 2009;
Actual small and large cigar tax revenue: $50.32;
Low projected small and large cigar tax revenue: $67.31;
High projected small and large cigar tax revenue: $73.78.
February 2010;
Actual small and large cigar tax revenue: $52.14;
Low projected small and large cigar tax revenue: $68.12;
High projected small and large cigar tax revenue: $74.64.
April 2010;
Actual small and large cigar tax revenue: $65.05;
Low projected small and large cigar tax revenue: $68.94;
High projected small and large cigar tax revenue: $75.52.
June 2010;
Actual small and large cigar tax revenue: $64.38;
Low projected small and large cigar tax revenue: $69.78;
High projected small and large cigar tax revenue: $76.42.
August 2010;
Actual small and large cigar tax revenue: $64.65;
Low projected small and large cigar tax revenue: $70.64;
High projected small and large cigar tax revenue: $77.33.
October 2010;
Actual small and large cigar tax revenue: $56.76;
Low projected small and large cigar tax revenue: $71.51;
High projected small and large cigar tax revenue: $78.26.
December 2010;
Actual small and large cigar tax revenue: $46.23;
Low projected small and large cigar tax revenue: $72.39;
High projected small and large cigar tax revenue: $79.21.
February 2011;
Actual small and large cigar tax revenue: $51.01;
Low projected small and large cigar tax revenue: $73.30;
High projected small and large cigar tax revenue: $80.17.
April 2011;
Actual small and large cigar tax revenue: $55.64;
Low projected small and large cigar tax revenue: $74.22;
High projected small and large cigar tax revenue: $81.15.
June 2011;
Actual small and large cigar tax revenue: $60.22;
Low projected small and large cigar tax revenue: $75.15;
High projected small and large cigar tax revenue: $82.15.
August 2011;
Actual small and large cigar tax revenue: $60.572;
Low projected small and large cigar tax revenue: $76.11;
High projected small and large cigar tax revenue: $83.16.
High projected revenue loss: $559 million;
Low projected revenue loss: $360[A] million.
Source: GAO analysis of Treasury and Bureau of Labor Statistics data.
[A] Low projected revenue loss is calculated as the difference between
the projected revenue in the low scenario and the actual collected
revenue. When the actual revenue is higher than the low projected
revenue, the estimated figure of $360 million includes the difference.
[End of figure]
Developing Standards to Differentiate between Roll-Your-Own and Pipe
Tobacco Presents Challenges to Treasury:
Differentiating between roll-your-own and pipe tobacco for tax
collection purposes presents challenges to Treasury because the
definitions of the two products in the IRC are based on such factors
as the use for which they are suited and how they are packaged and
labeled for consumers and do not specify distinguishing physical
characteristics. Treasury officials and representatives of
nongovernmental organizations we spoke with stated that because the
two products were taxed at the same rate prior to CHIPRA, there was no
revenue-related reason to clarify the differences between the two
products beyond the existing statutory definitions. However, according
to Treasury comments in the Federal Register, the large differences in
tax rates resulting from CHIPRA created an incentive for industry
members to present roll-your-own tobacco as pipe tobacco products,
thus enabling them to pay a lower tax rate.[Footnote 34]
[Side bar: IRC Definitions:
Roll-your-own tobacco: Any tobacco, which because of its appearance,
type, packaging, or labeling, is suitable for use and likely to be
offered to, or purchased by, consumers as tobacco for making
cigarettes or cigars, or for use as wrappers thereof.
Pipe tobacco: Any tobacco which, because of its appearance, type,
packaging, or labeling, is suitable for use and likely to be offered
to, or purchased by, consumers as tobacco to be smoked in a pipe. End
of side bar]
After the CHIPRA tax changes and the market shift from roll-your-own
to pipe tobacco that immediately followed, Treasury took steps through
rulemaking notices in an effort to more clearly differentiate the two
products for tax collection purposes. However, Treasury has not yet
issued a final rule to distinguish the two products based on physical
characteristics. The tobacco industry members' comments on the June
2009 temporary rule and the July 2010 advance notice of proposed
rulemaking highlighted the complexity and difficulties in developing
objective standards that clearly differentiate the two tobacco
products. Treasury also issued a ruling determining that retail
establishments that make cigarette-making machines available for use
by customers are manufacturers of tobacco products.[Footnote 35]
However, a U.S. District Court enjoined Treasury's enforcement of the
ruling pending the outcome of a court case on this ruling, which was
still pending as of March 2012. Table 4 summarizes Treasury's actions
on roll-your-own and pipe tobacco following CHIPRA, the resulting
tobacco industry comments, and the status of Treasury's actions.
Table 4: Treasury Actions on Roll-Your-Own and Pipe Tobacco following
CHIPRA, Industry Comments, and Status:
Date: June 2009;
Treasury action: Temporary rule.[A] Treasury revised regulations on
packaging and labeling of roll-your-own and pipe tobacco to more
clearly differentiate the two products. The temporary rule is set to
expire in June 2012;
Tobacco industry comments[D]:
* New requirements are insufficient to prevent misclassification of
roll-your-own tobacco as pipe tobacco;
* Alternative standards based on physical characteristics are
suggested;
Status:
* Market continued to shift from roll-your-own to pipe tobacco.
Date: July 2010;
Treasury action: Advance notice of proposed rulemaking.[B] Treasury
requested public comments on proposed standards to differentiate
between roll-your-own and pipe tobacco based upon physical
characteristics. Treasury reopened the notice requesting comments in
August 2011[C];
Tobacco industry comments[D]:
* Significant differences in views on proposed standards are expressed;
Status:
* Treasury has not issued a subsequent rulemaking establishing
standards to differentiate roll-your-own and pipe tobacco;
* Market shift from roll-your-own to pipe tobacco continued.
Date: September 2010;
Treasury action: Ruling on cigarette-making machines. Treasury
determined that the owner of a retail establishment who facilitates
the making of cigarettes by or for others by providing the use of
commercial cigarette-making machines for use on the premises is
engaged in the business of a tobacco product manufacturer and must
obtain a Treasury permit to engage in such business;
Tobacco industry comments[D]: [Empty];
Status:
* A manufacturer of these machines sued Treasury, and a U.S. District
Court enjoined Treasury's enforcement of the rule pending the outcome
of the case;
* Use of cigarette-making machines in retail establishments is growing.
Source: GAO analysis of Treasury information.
[A] 74 Fed. Reg. 29,401 (June 22, 2009).
[B] 75 Fed. Reg. 42,659 (July 22, 2010).
[C] 76 Fed. Reg. 52,913 (Aug. 24, 2011).
[D] Treasury received comments from a range of tobacco companies and
associations, and the comments cited in this table do not reflect
industry consensus. Rather, they are intended to summarize key
comments made by companies or associations.
[End of table]
* Temporary rule[Footnote 36] on packaging and labeling requirements:
Following the CHIPRA tax changes that took effect in April 2009,
Treasury published a temporary rule in June 2009, set to expire in
June 2012, that outlined new labeling and packaging requirements for
roll-your-own and pipe tobacco to more clearly differentiate the two
products. The temporary rule required that, to be classified as pipe
tobacco, the packaging must clearly indicate the product type by
bearing the words "pipe tobacco" wherever the brand name appears, and
that the packaging cannot suggest a use other than as pipe tobacco.
Treasury also stated in the temporary rule that it was evaluating
analytical methods and other standards to differentiate between roll-
your-own tobacco and pipe tobacco, and it expected to publish
rulemaking proposals on this subject for comment in the future. In
response to this temporary rule, Treasury received comments from
tobacco industry members indicating that its new labeling and
packaging requirements were insufficient to prevent the
misclassification of roll-your-own tobacco as pipe tobacco and that
standards to further differentiate the products were urgently needed.
Treasury received comments from industry members proposing alternative
standards to distinguish between roll-your-own and pipe tobacco based
on physical characteristics such as moisture content, cut, and variety
of tobacco used. The market shift from roll-your-own to pipe tobacco
continued despite Treasury's issuance of this temporary rule.
* Advance notice of proposed rulemaking[Footnote 37] on standards to
differentiate roll-your-own and pipe tobacco: In July 2010, Treasury
published an advance notice of proposed rulemaking issuing a request
for public comments on standards and characteristics proposed by
commenters to differentiate between roll-your-own and pipe tobacco,
but it has not issued a subsequent rule proposing the standards it
would use. In the notice, Treasury discussed the heightened need for
more regulatory detail to clarify the difference between the two
products and stated its primary concern that the standards be
objective and enforceable. The industry members' comments to Treasury
highlighted the complexity and difficulties in developing objective
standards that clearly differentiate the two tobacco products.
Industry members disagreed on the standards and physical
characteristics that should be implemented, with some commenters
noting that the two products overlap greatly. Some industry commenters
also expressed concerns that proposed standards could easily be
manipulated by consumers. For example, a proposed standard for the cut
width of pipe tobacco could be compromised by a consumer using basic
kitchen or hardware appliances to grind wider cut tobacco into a
smaller width for use in cigarettes.
In August 2011, Treasury issued a second advance notice of proposed
rulemaking, thereby reopening the period for receiving comments on the
proposed standards. Treasury said it did so because it had received an
additional set of proposed standards after the original comment period
closed. Treasury received a number of additional comments, many by the
same companies that commented on the earlier notices, and the comments
continued to reflect significant differences within the industry on
standards that define and distinguish roll-your-own tobacco from pipe
tobacco. This second comment period closed in October 2011. As of
March 2012, Treasury has not issued a subsequent rulemaking based on
the comments received, and no anticipated issuance date has been
communicated. Throughout this period, the market shift from roll-your-
own to pipe tobacco has continued, with negative impacts on federal
revenue. Appendix III contains a more detailed summary of the Federal
Register notices issued by Treasury related to differentiating between
roll-your-own and pipe tobacco and the industry comments in response
to these notices.
* Ruling on commercial cigarette-making machines: Treasury also issued
a ruling in September 2010 determining that retailers who make
commercial cigarette-making machines available for use on their
premises are tobacco product manufacturers and are thus subject to the
permit and tax requirements of the IRC. In October 2010, RYO Machine
Rental LLC, the maker of the RYO Filling Stations, sued Treasury over
this ruling. In December 2010, a federal district court judge in Ohio
ordered a preliminary injunction on the enforcement of the Treasury
rule, and the case is currently on appeal in the U.S. Court of Appeals
for the Sixth Circuit. During the period that enforcement has been
delayed, several organizations told us that businesses continue to
maintain these machines on their premises, and the number of machines
in use has increased. These machines, which cost the retailer about
$30,000 each, have also been the focus of government regulation at the
state level. A number of states are taking action against commercial
roll-your-own machines, including Arkansas, Michigan, New Hampshire,
and West Virginia. For example, Arkansas passed a law prohibiting
tobacco retailers licensed, permitted, appointed, or commissioned
under Arkansas tobacco tax law from possessing or using the machines.
[Footnote 38]
CHIPRA's Changes to Tax Rates on Large Cigars Also Present Challenges
to Treasury:
CHIPRA's changes to the federal excise tax rate on large cigars also
present challenges to Treasury. The first challenge resulted from
CHIPRA's tax rate on the most inexpensive large cigars, which was
significantly lower than its rate for small cigars. This disparity in
tax rates provided an incentive for some small cigar manufacturers to
make minimal changes to their product to meet the legal definition of
a large cigar. The second challenge came about because CHIPRA's rate
for large cigar taxes resulted in more large cigar manufacturers and
importers paying taxes based on the manufacturer's or importer's sale
price rather than simply paying the maximum set tax rate. This added
complexity to Treasury's monitoring and enforcement of large cigar tax
payments and appears to have motivated some manufacturers and
importers of large cigars to restructure their market transactions to
lower the taxes they have to pay.
The first challenge resulted from CHIPRA's changes to the federal
excise tax rate on large cigars, which created an incentive for small
cigar manufacturers to switch to making large cigars when the
manufacturer's or importer's sale price is less than $95.42 per
thousand cigars. Before CHIPRA, there was little incentive for small
cigar manufacturers to alter their product to meet the definition of a
large cigar. Because small cigars are taxed at a fixed rate, and large
cigars are taxed at an ad valorem rate, when CHIPRA raised the small
cigar tax from $1.83 per thousand to $50.33 per thousand,
manufacturers of inexpensive small cigars had an incentive to change
their product to fit the lower-taxed large cigar category. According
to Treasury officials and other industry experts, prior to CHIPRA,
many small cigars weighed close to 3 pounds per thousand sticks, which
is the dividing line between small and large cigars set by the IRC.
[Footnote 39] Small cigars that weighed just under or exactly 3 pounds
per thousand sticks would be able to qualify as large cigars with
minimal changes. After CHIPRA, the same companies could use the same
machines to add a small amount of weight to their product, turning
small cigars into a product legally defined and taxed as large cigars.
For example, manufacturers could add weight by packing the tobacco
more tightly. Some manufacturers then changed their labels from "small
cigars" to "filtered cigars" or "cigars"--often with the same
packaging and design. For example, if a manufacturer sold cigars for
$50 per thousand before CHIPRA, by manufacturing small cigars instead
of large cigars, it would pay $1.83 per thousand in taxes, a tax
savings of $8.53 per thousand. After CHIPRA, the same manufacturer
selling cigars for $50 per thousand would pay $26.38 per thousand in
taxes, a tax savings of $23.95 per thousand, by manufacturing large
cigars instead of small cigars (see figure 14). Treasury officials
stated that the agency lacks the authority to remedy the tax revenue
losses resulting from manufacturers' legitimate modifications of small
cigars to qualify them for the lower tax rate on large cigars.
Figure 14: Post-CHIPRA Incentives for Some Manufacturers to Switch
from Small to Large Cigars:
[Refer to PDF for image: 2 line graphs with examples highlighted]
Dollars per thousand sticks:
Manufacturer's or importer's sale price: $0;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $0
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $0.
Manufacturer's or importer's sale price: $50;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $10.36;
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $26.38.
Manufacturer's or importer's sale price: $100;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $20.72;
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $52.75.
Manufacturer's or importer's sale price: $150;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $31.08;
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $79.13.
Manufacturer's or importer's sale price: $200;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $41.44;
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $105.5.
Manufacturer's or importer's sale price: $250;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $48.75;
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $131.88.
Manufacturer's or importer's sale price: $300;
Before CHIPRA:
Small cigars, tax rate: 1.83;
Large cigars, tax rate: $48.75;
After CHIPRA:
Small cigars, tax rate: 50.33;
Large cigars, tax rate: $158.25.
Source: GAO analysis of the IRC.
Note: The large cigar tax structure before CHIPRA is represented on
the left side of the figure, with the sloped line showing the ad
valorem rate and the line becoming flat upon reaching the maximum rate
of $48.75 per thousand large cigars. For space reasons, the right side
of the figure does not include the maximum rate of $402.60 per
thousand large cigars.
[End of figure]
The second challenge resulting from CHIPRA's changes to tax rates on
large cigars is the complexity that has been added to Treasury's
efforts to monitor and enforce tax payments because many more
manufacturers and importers must now determine the correct tax by
applying the tax rate to the manufacturer's or importer's sale price
per stick (ad valorem) rather than simply paying the maximum set tax
rate. According to Treasury officials, prior to CHIPRA, the majority
of domestic manufacturers of large cigars paid the federal excise tax
at the maximum rate of $48.75 per thousand cigars. Specifically,
manufacturers or importers that sold large cigars priced at $235.30
per thousand and above paid the set maximum tax. The increase in the
large cigar maximum tax after CHIPRA resulted in many more
manufacturers and importers of large cigars paying taxes based on the
ad valorem rate, according to Treasury officials. Currently, the
maximum tax rate does not apply until the manufacturer's or importer's
price is $763.22 per thousand or above, and then, the maximum rate is
$402.60 per thousand. For example, if a manufacturer sold large cigars
for $400 per thousand, before CHIPRA, it would pay $48.75--based on
the maximum tax. After CHIPRA, the manufacturer's tax would increase
to $211 per thousand--based on the ad valorem rate. If the
manufacturer is able to lower its price for the large cigar product
from $400 to $300 per thousand, its tax would decrease to $158.25 per
thousand, a tax savings of $52.75 per thousand. Before CHIPRA, if the
manufacturer had lowered its price from $400 to $300, its tax rate
would have remained at the maximum rate of $48.75 (see figure 15).
Figure 15: Post-CHIPRA Incentives for Some Manufacturers and Importers
to Lower the Sale Price of Large Cigars:
[Refer to PDF for image: line graphs with examples highlighted]
Dollars per thousand sticks:
Manufacturer's or importer's sale price: $0;
Tax rate, before CHIPRA: $0;
Tax rate, after CHIPRA: $0.
Manufacturer's or importer's sale price: $100;
Tax rate, before CHIPRA: $20.72;
Tax rate, after CHIPRA: $52.75.
Manufacturer's or importer's sale price: $200;
Tax rate, before CHIPRA: $41.44;
Tax rate, after CHIPRA: $105.5.
Manufacturer's or importer's sale price: $300;
Tax rate, before CHIPRA: $48.75;
Tax rate, after CHIPRA: $158.25.
Manufacturer's or importer's sale price: $400;
Tax rate, before CHIPRA: $48.75;
Tax rate, after CHIPRA: $211.
Manufacturer's or importer's sale price: $500;
Tax rate, before CHIPRA: $48.75;
Tax rate, after CHIPRA: $263.75.
Manufacturer's or importer's sale price: $600;
Tax rate, before CHIPRA: $48.75;
Tax rate, after CHIPRA: $316.5.
Manufacturer's or importer's sale price: $700;
Tax rate, before CHIPRA: $48.75;
Tax rate, after CHIPRA: $369.25.
Manufacturer's or importer's sale price: $800;
Tax rate, before CHIPRA: $48.75;
Tax rate, after CHIPRA: $402.6.
Example:
Manufacturer drops price from $400 to $300:
Before CHIPRA: no change is tax rate;
After CHIPRA: Tax rate drops $52.75.
Source: GAO analysis of the IRC.
Note: The sloped lines represent the ad valorem rates for large cigars
before and after CHIPRA, with the lines becoming flat when they reach
the maximum rates of $48.75 (before CHIPRA) and $402.60 (after CHIPRA)
per thousand large cigars.
[End of figure]
After CHIPRA, according to Treasury officials, some large cigar
manufacturers and importers began to restructure their market
transactions to lower the manufacturer's or importer's sale price for
large cigars in order to obtain the tax savings of a lower ad valorem
rate, creating enforcement challenges. These Treasury officials stated
that some manufacturers and importers are "structuring" or "layering"
sales transactions by including an additional transaction at a low
price before the sale to the wholesaler or distributor, and using this
low initial price to calculate the tax. This transaction is conducted
with an intermediary that may have a special contract arrangement with
the manufacturer or importer. A large markup may then be added to the
intermediary's subsequent sale to the wholesaler or distributor. This
added transaction effectively lowers the manufacturer's or importer's
sale price, and thus reduces the taxes collected. According to
Treasury officials, these layered transactions have become more common
after CHIPRA. Treasury officials noted that manufacturers and
importers of large cigars have approached the agency for advice on
different proposals to structure their sales transactions to lower
their taxes and still comply with the law. They also stated that
Treasury has not determined the legality of all of the proposals under
consideration, and that while Treasury can investigate individual
cases, its authority to enforce additional tax collection from these
kinds of large cigar transactions is limited. Officials stated that
Treasury is carefully examining the tobacco importer and manufacturer
pricing arrangements and taking corrective actions where appropriate
on a case by case basis.
The impact of the federal excise tax increases and the resulting
actions by industry to mitigate the CHIPRA tax increase on large
cigars are evidenced by large cigar pricing trends. Prior to CHIPRA,
the average manufacturer's or importer's sale price for large cigars
was $244 per thousand, Treasury officials stated. After the CHIPRA tax
increases, the average manufacturer's or importer's sale price dropped
to $189 per thousand. According to Treasury officials, since large
cigar federal excise taxes increased by a minimum of 155 percent, and
the federal excise tax is included in the sale price, large cigar
manufacturer's and importer's sale prices were expected to increase,
not decrease.
FDA Currently Regulates Cigarettes and Roll-Your-Own Tobacco but Not
Pipe Tobacco and Cigars:
When the Tobacco Control Act amended the Food, Drug, and Cosmetic Act
in June 2009, it granted FDA immediate regulatory authority over four
tobacco products, including cigarettes and roll-your-own tobacco, but
did not specify authority over pipe tobacco and small and large
cigars.[Footnote 40] According to the law, FDA has the authority to
deem by regulation any other tobacco products, including pipe tobacco
and small and large cigars, to be subject to the tobacco provisions in
Chapter IX of the Food, Drug, and Cosmetic Act.[Footnote 41] Deeming
additional products to be subject to these tobacco provisions of the
Food, Drug, and Cosmetic Act requires FDA to go through the process of
developing and issuing a regulation (known as the rulemaking process).
Because FDA does not currently regulate pipe tobacco and small and
large cigars, these products are not subject to the tobacco product
provisions in Chapter IX of the Food, Drug, and Cosmetic Act or
regulations that FDA has issued since June 2009 to implement the
Tobacco Control Act. Some of act's provisions and key FDA regulations
address, for example, (1) the use of characterizing flavors, (2) the
sale and distribution of tobacco products, and (3) the requirements
for new health warnings depicting negative health consequences of
smoking:
* Ban on the use of characterizing flavors: FDA implemented a ban on
cigarettes with characterizing flavors in September 2009 (with the
exception of tobacco or menthol).[Footnote 42] However, pipe tobacco
and small and large cigars--some of which look similar to cigarettes
(see figure 1)--are available in multiple flavors because this Tobacco
Control Act provision does not apply to these products. Smokers can
make roll-your-own cigarettes with flavored pipe tobacco and buy
cigars in candy, berry, fruit, or other flavors. According to the U.S.
Surgeon General, the growing popularity of cigars among younger adults
(those under the age of 30) appears to be linked to the marketing of
flavored tobacco products, including cigars, that might be expected to
be attractive to youth.[Footnote 43]
* Restrictions on the sale and distribution of cigarettes and
smokeless tobacco to protect children and adolescents:[Footnote 44]
Pipe tobacco and small and large cigars are not subject to FDA's rule
containing numerous youth access and marketing restrictions that was
issued in March 2010.[Footnote 45] One restriction generally prohibits
the sale and distribution of individual cigarettes or packs containing
fewer than 20 cigarettes.[Footnote 46] In contrast, cigars can be sold
individually, and filtered cigars are often sold in packs containing
fewer than 20. A second restriction generally requires that retail
sales of cigarettes and smokeless tobacco be conducted in a direct,
face-to-face exchange.[Footnote 47] This restriction does not apply to
pipe tobacco and cigars, and these products are sold on the Internet.
A third restriction bans brand-name sponsorship of sporting and
cultural events by manufacturers, distributors, or retailers of
cigarettes and smokeless tobacco[Footnote 48] and does not currently
apply to pipe tobacco and cigars. A cigar company recently signed a
multiyear sponsorship deal for a major collegiate sporting event, but
the deal was canceled due to public pressure, as has been reported in
the press.[Footnote 49]
* Requirements for new health warnings depicting negative health
consequences of smoking: Pipe tobacco and cigar packs are not subject
to FDA's rule that requires each cigarette pack and advertisement to
bear one of nine new textual warning statements accompanied by color
graphics, issued in June 2011.[Footnote 50] According to the law, the
new warnings must cover the top half of the front and back of
cigarette packs and at least 20 percent of cigarette advertisements
and must contain color graphics depicting the negative health
consequences of smoking.[Footnote 51] FDA selected nine color graphic
health warning messages after reviewing relevant scientific
literature, 1,700 public comments, and the results of its experimental
18,000-person study to assess the effectiveness of the warnings. While
the Tobacco Control Act mandates that the warnings take effect no
later than 15 months after FDA issues regulations, that is, by
September 2012, pending litigation may impact implementation.[Footnote
52]
FDA indicated its interest in deeming additional tobacco products to
be subject to the agency's tobacco product authorities in the four
recent issues of the U.S. government's semiannual regulatory
agenda.[Footnote 53] In the spring and fall 2010 agendas, FDA
announced that it planned to issue a proposed rule that would deem
cigars to be subject to the provisions of the Food, Drug, and Cosmetic
Act.[Footnote 54] In the spring and fall 2011 agendas, FDA announced
that it planned to broaden the proposed rule's scope to encompass all
products that meet the statutory definition of "tobacco product"
[Footnote 55]under Chapter IX of the Food, Drug, and Cosmetic Act.
[Footnote 56] The fall 2011 announcement, the most recent, indicated
that the proposed rule would be issued in December 2011; however, FDA
had not issued the proposed rule as of March 2012, and FDA officials
told us that developing the rule is taking longer than they expected.
A typical rulemaking process consists of three basic phases--
initiation of rulemaking actions, development of proposed rules, and
development of final rules--and involves internal review by the
rulemaking agency, external review by the Office of Management and
Budget, and public comments on proposed rules (figure 16). In
developing the proposed rule deeming additional products, including
pipe tobacco and cigars, to be subject to the agency's regulatory
authority, FDA is in the second phase of the process. FDA officials
told us that, as of March 2012, the proposed rule was undergoing
review by the agency and the Department of Health and Human Services
and that FDA had not yet submitted the proposed rule to the Office of
Management and Budget. In a 2009 report on the federal rulemaking
process, we found--based on an analysis of 16 rules at different
federal agencies, including FDA--that the average time needed to
initiate, develop, and complete a rulemaking was about 4 years, with
considerable variation among agencies and rules.[Footnote 57]
Figure 16: Basic Phases in FDA's Rulemaking Process:
[Refer to PDF for image: illustration]
Initiate rulemaking:
* Congress passes the Tobacco Control Act;
* FDA prioritizes issues for rulemaking.
Develop proposed rule:
* FDA announces intent to issue a proposed rule and develops rule
language;
* FDA, HHS, and OMB review proposed rule;
* Proposed rule is published in the Federal Register.
Develop final rule:
* FDA receives and reviews public comments;
* FDA drafts final rule language;
* FDA, HHS, and OMB review final rule;
* Final rule is published in the Federal Register.
Legend: HHS = Department of Health and Human Services;
OMB = Office of Management and Budget.
Source: GAO.
[End of figure]
FDA will be able to exercise authority over the deemed products once
the rulemaking process is completed and the final rule is published in
the Federal Register. At that time, the deemed products will be
subject to the provisions of Chapter IX the Food, Drug, and Cosmetic
Act that are applicable to tobacco products in general. Examples of
such provisions include a requirement for annual registration with FDA
of establishments engaged in the manufacture of tobacco products,
payment of user fees by manufacturers and importers of specified
classes of tobacco products, as well as restrictions and penalties for
misbranded products. However, if FDA decides to expand the scope of
its existing regulations applicable to cigarettes and roll-your-own
tobacco to encompass the deemed products, it will have to amend those
regulations through the rulemaking process. For example, FDA would
have to amend its rule covering the sale and distribution restrictions
for cigarettes and smokeless tobacco in order to make it applicable to
the deemed products.
Conclusions:
Federal legislation has aimed to discourage tobacco use and raise
revenues by increasing excise taxes on tobacco products. In 2009,
Congress passed CHIPRA, which increased taxation on all smoking
tobacco products, but by different levels for pipe tobacco and for
large cigars. Also in 2009, Congress passed the Tobacco Control Act,
which gave FDA immediate regulatory authority over four tobacco
products, including cigarettes and roll-your-own tobacco, but did not
specify authority over pipe tobacco and small and large cigars.
In equalizing the federal excise tax rates on small cigars and roll-
your-own tobacco with the tax rate on cigarettes, CHIPRA was
responding to concerns that these products were increasingly used as
substitutes to factory-made cigarettes. However, by introducing large
tax disparities between cigarettes, roll-your-own tobacco, and small
cigars, on the one hand, and pipe tobacco and large cigars, on the
other, CHIPRA has contributed to the substitution of higher-taxed
tobacco products with lower-taxed products. Sales of the lower-taxed
pipe tobacco and large cigars saw significant growth following CHIPRA,
as manufacturers and consumers sought to take advantage of lower-taxed
products. We estimate that this tax avoidance has resulted in between
approximately $615 million and $1.1 billion in lost federal revenue
since 2009.
Treasury has not succeeded in addressing the continued tax avoidance
behavior reflected in the market shifts to pipe tobacco and to large
cigars. In the absence of legislative changes, Treasury has limited
options for effective action. First, roll-your-own and pipe tobacco
are similar and, in some cases, may be substitutable products, and the
IRC lacks specificity on how they should be distinguished based on
physical characteristics. Treasury is currently considering and
analyzing various proposals to more clearly and objectively
differentiate the two products based on their physical
characteristics. However, the lack of consensus on which
characteristics or criteria truly define and differentiate roll-your-
own from pipe tobacco reveals the complexity and difficulty in
attempting to develop standards and tests to distinguish the products
from each other. In addition, there is the concern that products could
easily be manipulated to negate any newly established standards or
tests.
Because small and large cigars are distinguished in the IRC only by
weight, and because many small cigars already weighed at or close to
the 3 pounds per thousand threshold for classification as large
cigars, many small cigar manufacturers were able to legally shift to
the lower-taxed large cigar category with minimal changes to their
products. In addition, the large cigar tax structure, which consists
of an ad valorem tax rate up to a maximum rate, is complex and creates
an incentive to lower the manufacturer's or importer's sale price to
avoid paying higher federal excise taxes.
FDA, which implements the Tobacco Control Act, currently regulates
cigarettes and roll-your-own tobacco but does not regulate pipe
tobacco and small and large cigars. These regulatory disparities make
pipe tobacco and small and large cigars more accessible and attractive
to current and potential smokers. While FDA announced its intent to
issue a proposed rule that would subject additional products,
including pipe tobacco and small and large cigars, to its regulation,
it had not issued the proposed rule as of March 2012.
Matter for Congressional Consideration:
Disparities in tax rates on smoking tobacco products have negative
revenue implications because they create incentives for manufacturers
and consumers to substitute higher-taxed products with lower-taxed
products. In light of that fact, as Congress continues its oversight
of CHIPRA and Tobacco Control Act implementation, it should consider
modifying tobacco tax rates to eliminate significant tax differentials
between similar products. Specifically, Congress should consider
equalizing tax rates on roll-your-own and pipe tobacco and, in
consultation with Treasury, also consider options for reducing tax
avoidance due to tax differentials between small and large cigars.
Agency Comments and Our Evaluation:
We provided a draft of this report to the Secretary of the Treasury
and the Secretary of Health and Human Services for their review and
comment. We received technical comments from Treasury and the U.S.
Department of Health and Human Services, which we have incorporated in
the report as appropriate. We also received written comments from
Treasury, which are reprinted in appendix IV.
Treasury generally agreed with our overall conclusion that CHIPRA's
introduction of large tax disparities between similar products
contributed to the substitution of higher-taxed tobacco products with
lower-taxed products. Treasury also agreed with our observation
concerning modifying tobacco tax rates to eliminate significant tax
differentials between similar products, which is consistent with our
Matter for Congressional Consideration.
Treasury noted our use of the term "revenue losses" and commented that
our estimates did not pertain to actual losses of revenues but rather
were estimates of revenue increases that would be realized if Congress
were to change the law to eliminate the tax disparities or had the
market shifts due to the disparities not occurred. We state in the
report that our analysis does not incorporate the hypothetical case of
equal tax rates among smoking products; rather, we estimate the
revenues Treasury would have collected under current law--but in the
absence of the market shifts from higher-taxed products to lower-taxed
products. The difference between the revenues collected under current
law and our estimate of the higher revenues that would have been due
in the absence of the market shifts is what we refer to as "revenue
losses."
In response to Treasury's comment about the use of this term, we note
that Treasury's Alcohol and Tobacco Tax and Trade Bureau developed its
own estimates of what it termed revenue losses stemming from the
market shifts involving these products, and we discuss these estimates
in our report. In addition, the Alcohol and Tobacco Tax and Trade
Bureau's 2011 Annual Report uses the term revenue losses when
estimating the effect of the market shifts since CHIPRA. Appendix I
contains a more detailed discussion of our methodology for developing
our estimates.
We are sending copies of this report to the appropriate congressional
committees and to the Secretaries of Health and Human Services and
Treasury, and other interested parties. This report also is available
at no charge on the GAO website at [hyperlink, http://www.gao.gov].
If you or your staff members have any questions about this report,
please contact me at (202) 512-3149 or gootnickd@gao.gov. Contact
points for our Offices of Congressional Relations and Public Affairs
may be found on the last page of this report. Individuals who made key
contributions to this report are listed in appendix V.
Signed by:
David Gootnick:
Director, International Affairs and Trade:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
The Family Smoking Prevention and Tobacco Control Act (Pub. L. No. 111-
31) directed GAO to report on various aspects of cross-border and
illicit trade in tobacco products, including the effects of differing
tax rates applicable to tobacco products.[Footnote 58] In accordance
with our agreement with Senate Committee on Health, Education, Labor,
and Pensions and House Energy and Commerce Committee staff, this
report provides information on the federal revenue effects of
differing tax rates applicable to tobacco products. Our objectives for
this report are to (1) review the market shifts among smoking tobacco
products since the Children's Health Insurance Program Reauthorization
Act (CHIPRA) of 2009 went into effect on April 1, 2009; (2) examine
the impact of these market shifts on federal revenue and the
Department of the Treasury's (Treasury) actions to respond; and (3)
describe differences in regulation of various smoking tobacco products
by the Food and Drug Administration (FDA). Our review includes smoking
tobacco products that are subject to federal excise tax: cigarettes
and four other tobacco products--roll-your-own tobacco (sometimes
called RYO), pipe tobacco, small cigars, and large cigars.[Footnote
59] However, in analyzing the market shifts among these products, we
focused solely on the four smoking tobacco products other than
cigarettes.
To address the three objectives in this study, we reviewed documents
and interviewed agency officials from Treasury's Alcohol and Tobacco
Tax and Trade Bureau, FDA, and the Centers for Disease Control and
Prevention, as well as tobacco industry members, representatives of
public health and other nongovernmental organizations, and academics
to obtain information on tobacco legislation and regulations, tobacco
product sales trends, and consumption patterns. Tobacco industry
members that we spoke with included industry associations and
individual companies. We identified and contacted 15 pipe tobacco
manufacturers to ask about their companies' actions in response to the
CHIPRA tax changes, and 3 of the manufacturers agreed to speak with
us. We also reviewed studies analyzing the relationship between
tobacco tax increases and smoking, including among youth. We also
collected data from Treasury, the Bureau of Labor Statistics, and the
Department of Agriculture and determined that they were sufficiently
reliable for our purposes.
We analyzed Treasury removals data[Footnote 60] to identify sales
trends across the different tobacco products before and after CHIPRA
took effect. In addition, we collected and analyzed price data and
data on federal excise tax rates for roll-your-own tobacco, pipe
tobacco, small cigars, and large cigars, as well as the federal tax
revenue generated from their sale. We estimated what the effect on
federal tax revenue collection would have been if the market shifts
resulting from substitution of higher-taxed products with lower-taxed
products had not occurred once CHIPRA's higher tax rates went into
effect. In this report, we refer to this estimated effect on federal
tax revenue collection as revenue losses. Our analysis takes into
account the expected fall in quantity demanded due to the price
increases resulting from the higher federal excise tax rates that
CHIPRA imposed on these smoking tobacco products.
To estimate federal tax revenue losses due to market shifts after
CHIPRA, we analyzed Treasury's monthly sales and revenue data from
fiscal year 2001 through fiscal year 2011 for roll-your-own and pipe
tobacco and for small and large cigars. Our analysis compares the
actual tobacco tax revenue collected by Treasury with a counterfactual
scenario. Our counterfactual model draws from one used by Dr. Frank
Chaloupka, an economist who has investigated the effect of prices and
taxes on tobacco consumption in numerous publications. In particular,
we follow the methodology used in a paper from January 2011 in which
Dr. Chaloupka calculates the effect of raising cigarette taxes in the
state of Illinois.[Footnote 61] This methodology projects the effect
of a future tax increase based on the historic sales trend, the amount
of the tax, and the effect of a price increase on projected sales
(that is, price elasticity of demand).[Footnote 62] Our counterfactual
model, then, projects post-CHIPRA sales of roll-your-own and pipe
tobacco and small and large cigars according to the historic sales
trends for these products, adjusted downward to account for the fall
in demand due to the higher post-CHIPRA tax component of the price.
[Footnote 63] To calculate the impact on demand due to the higher
taxes on these products, we included high and low estimates for price
elasticity. Based on our interviews with experts and a review of the
relevant literature,[Footnote 64] we assumed that the price elasticity
for the smoking tobacco products in our analysis ranges from -0.6 to
-0.3, which set, respectively, the low and high boundaries of the
estimated revenue losses.[Footnote 65]
Our analysis does not incorporate the hypothetical case of equal tax
rates among smoking tobacco products; rather, we estimate the revenues
that Treasury would have collected in the absence of the market's
substitution of higher-taxed products with lower-taxed products. An
analysis that projected the impact of equal tax rates across all
smoking tobacco products would necessarily produce a much higher
estimate of lost tax revenues. We did not attempt to develop such a
model, however, because doing so was beyond the scope of our analysis.
The reliability of any such model would depend on the assumptions
made, particularly with regard to large cigars--the only tobacco
product for which excise taxes are calculated as a percentage of
price. Compared with determining the tax on all other tobacco
products, according to Treasury, determining the tax on large cigars
is extremely complex. Modeling hypothetical consumption trends for
smoking tobacco products after equalizing tax rates on them would
require a complex set of assumptions not necessarily grounded in
reliable data.
We used data from two sources to build our counterfactual model
projecting post-CHIPRA sales of roll-your-own and pipe tobacco and
small and large cigars. The first source is Treasury's data from
fiscal year 2001 through fiscal year 2011 on smoking tobacco product
tax revenues and removals (the amount of tobacco removed for sale from
the factory or released from customs). The second data source is
tobacco products price data from the Bureau of Labor Statistics, which
it uses to calculate the Consumer Price Index for tobacco products.
The Bureau of Labor Statistics data contain retail price information
collected each month throughout the country; the prices include the
cost of production, markup, and excise taxes from federal, state, and
local governments--shipping, handling, sales tax, and fuel surcharges
have been removed from the data.[Footnote 66]
For roll-your-own and pipe tobacco and for small and large cigars, we
calculated an average taxable manufacturer's or importer's sale price
for the year before CHIPRA was enacted. We then estimated the post-
CHIPRA price by adding the corresponding post-CHIPRA tax to the pre-
CHIPRA price.[Footnote 67] Thus, our counterfactual model includes
only the effect of CHIPRA on tax revenue.
To calculate the average taxable manufacturer's or importer's sale
price for large cigars, we used Treasury's revenue data and removals
data. Treasury collects revenue data for cigars but does not collect
separate revenue data for small and large cigars. However, Treasury's
removals data are separated by small and large cigars, reporting the
number of sticks removed for sale from the factory or released from
customs. After CHIPRA, small cigars are taxed at $50.33 per thousand
sticks, whereas large cigars are taxed at 52.75 percent of the
manufacturer's or importer's price up to a maximum tax rate per
thousand sticks. We calculated small cigar revenue by multiplying the
number of sticks reported in Treasury's removals data in each month by
the tax rate. We then calculated large cigar revenues by subtracting
small cigar revenues from total cigar revenues. Once we had calculated
the large cigar revenues, we estimated the average tax paid by
dividing the large cigar revenues by the number of large cigar sticks
reported in the removals data for each month and calculating the
average price. From March 2007 through March 2009, the average large
cigar tax collected was 4.3 cents per stick. These figures corroborate
Treasury's statement that a majority of manufacturers were paying the
maximum rate. CHIPRA raised this maximum rate from 4.8 cents to 40
cents per stick. We estimated that the average taxable manufacturer's
or importer's sale price before CHIPRA was 20.65 cents. Hence, the
average tax paid after CHIPRA using the new tax rate should be 10.9
cents per cigar, and this is the number we used to estimate post-
CHIPRA tax revenues in our counterfactual model. Treasury does not
maintain records of the manufacturers' and importers' sale prices of
large cigars where the manufacturer or importer paid the maximum rate,
thereby making it impossible to determine the magnitude of
underestimation in our model caused by the maximum rate.
To describe FDA's regulation of tobacco products under Chapter IX of
the Food, Drug, and Cosmetic Act, we examined FDA's regulatory actions
and announcements and interviewed officials from FDA's Center for
Tobacco Products, including the Offices of Compliance and Enforcement,
Policy, Regulations, and Science.
We conducted this performance audit from March 2011 to April 2012 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Sales of Smoking Tobacco Products in the United States,
Fiscal Years 2001-2011:
Treasury's data on taxable removals (sales) show that the decline in
cigarette sales in the last decade has been partially offset by the
combined growth in sales of roll-your-own tobacco, pipe tobacco, small
cigars, and large cigars.[Footnote 68] Table 5 provides annual sales
data for cigarettes, roll-your-own tobacco, pipe tobacco, small
cigars, and large cigars from fiscal year 2001 through fiscal year
2011. Figure 17 uses the same data to depict the concomitant decline
in cigarette sales and growth in combined sales of the other four
smoking tobacco products.
From fiscal year 2001 through fiscal year 2011, sales of the smoking
tobacco products--cigarettes, roll-your-own tobacco, pipe tobacco,
small cigars, and large cigars--in the United States decreased by
about 26 percent. Sales of cigarettes, which continue to dominate the
market, declined by 30 percent from about 414 billion sticks in fiscal
year 2001 to about 289 billion sticks in 2011. However, combined sales
of roll-your-own tobacco, pipe tobacco, small cigars, and large cigars
increased by 131 percent during the same period from about 12 billion
sticks or cigarette stick equivalents (for roll-your-own and pipe
tobacco) in fiscal year 2001 to about 29 billion sticks or cigarette
stick equivalents. The share of these four products grew from 3
percent of the smoking tobacco market in fiscal year 2001 to 9 percent
in fiscal year 2011.
Table 5: U.S. Sales of Cigarettes and Other Smoking Tobacco Products,
Fiscal Years 2001-2011 (in Billions of Sticks):
Fiscal year: 2001;
Cigarettes: 414.17;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 4.33;
Pipe tobacco[A]: 2.42;
Small cigars: 2.18;
Large cigars: 3.50;
Subtotal[B]: 12.42;
Total[B] for cigarettes and other smoking tobacco products: 426.60.
Fiscal year: 2002;
Cigarettes: 406.59;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 4.74;
Pipe tobacco[A]: 2.35;
Small cigars: 2.26;
Large cigars: 3.70;
Subtotal[B]: 13.05;
Total[B] for cigarettes and other smoking tobacco products: 419.61.
Fiscal year: 2003;
Cigarettes: 376.14;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 6.02;
Pipe tobacco[A]: 2.13;
Small cigars: 2.28;
Large cigars: 3.95;
Subtotal[B]: 14.38;
Total[B] for cigarettes and other smoking tobacco products: 390.52.
Fiscal year: 2004;
Cigarettes: 372.24;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 6.02;
Pipe tobacco[A]: 1.96;
Small cigars: 2.49;
Large cigars: 4.17;
Subtotal[B]: 14.64;
Total[B] for cigarettes and other smoking tobacco products: 386.88.
Fiscal year: 2005;
Cigarettes: 367.23;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 7.16;
Pipe tobacco[A]: 1.79;
Small cigars: 3.45;
Large cigars: 4.39;
Subtotal[B]: 16.78;
Total[B] for cigarettes and other smoking tobacco products: 384.01.
Fiscal year: 2006;
Cigarettes: 363.01;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 8.10;
Pipe tobacco[A]: 1.77;
Small cigars: 4.15;
Large cigars: 4.54;
Subtotal[B]: 18.56;
Total[B] for cigarettes and other smoking tobacco products: 381.58.
Fiscal year: 2007;
Cigarettes: 356.05;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 8.37;
Pipe tobacco[A]: 1.58;
Small cigars: 4.58;
Large cigars: 4.57;
Subtotal[B]: 19.10;
Total[B] for cigarettes and other smoking tobacco products: 375.15.
Fiscal year: 2008;
Cigarettes: 337.64;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 9.68;
Pipe tobacco[A]: 1.55;
Small cigars: 5.34;
Large cigars: 4.76;
Subtotal[B]: 21.33;
Total[B] for cigarettes and other smoking tobacco products: 358.98.
Fiscal year: 2009;
Cigarettes: 316.40;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 7.96;
Pipe tobacco[A]: 4.31;
Small cigars: 3.35;
Large cigars: 6.88;
Subtotal[B]: 22.50;
Total[B] for cigarettes and other smoking tobacco products: 338.90.
Fiscal year: 2010[C];
Cigarettes: 296.23;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 3.03;
Pipe tobacco[A]: 10.25;
Small cigars: 0.91;
Large cigars: 9.88;
Subtotal[B]: 24.07;
Total[B] for cigarettes and other smoking tobacco products: 320.29.
Fiscal year: 2011;
Cigarettes: 288.50;
Other smoking tobacco products:
Roll-your-own tobacco[A]: 2.56;
Pipe tobacco[A]: 15.02;
Small cigars: 0.80;
Large cigars: 10.27;
Subtotal[B]: 28.65;
Total[B] for cigarettes and other smoking tobacco products: 317.14.
Source: Treasury.
[A] The roll-your-own tobacco and pipe tobacco cigarette stick
equivalent is based on the weight of 0.0325 ounces. of tobacco per
cigarette stick using the Master Settlement Agreement conversion rate.
[B] The subtotal and total may not add up due to rounding.
[C] 2010 is the first full fiscal year following April 1, 2009, when
the new federal excise tax rates on tobacco products resulting from
CHIPRA took effect.
[End of table]
Figure 17: U.S. Sales of Cigarettes and Other Smoking Tobacco
Products, Fiscal Years 2001-2011:
[Refer to PDF for image: stacked line graph]
Number of sticks per year in billions:
Fiscal year: 2001;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 12.42;
Cigarettes: 414.17.
Fiscal year: 2002;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 13.05;
Cigarettes: 406.56.
Fiscal year: 2003;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 14.37;
Cigarettes: 376.14.
Fiscal year: 2004;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 14.64;
Cigarettes: 372.24.
Fiscal year: 2005;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 16.78;
Cigarettes: 367.23.
Fiscal year: 2006;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 18.56;
Cigarettes: 363.01.
Fiscal year: 2007;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 19.10;
Cigarettes: 356.05.
Fiscal year: 2008;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 21.33;
Cigarettes: 337.64.
Fiscal year: 2009;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 22.49;
Cigarettes: 316.4.
Fiscal year: 2010;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 24.06;
Cigarettes: 296.23.
Fiscal year: 2011;
Roll-your-own tobacco[A], pipe tobacco[A], small cigars, and large
cigars: 28.65;
Cigarettes: 288.49.
Source: GAO analysis of Treasury data.
[A] The roll-your-own tobacco and pipe tobacco cigarette stick
equivalent is based on the weight of 0.0325 ounces. of tobacco per
cigarette stick using the Master Settlement Agreement conversion rate.
[End of figure]
[End of section]
Appendix III: Summary of Treasury's Proposed Rulemaking Actions to
Distinguish between Roll-Your-Own and Pipe Tobacco:
Treasury published a temporary rule and request for public comments in
June 2009 that outlined new labeling and packaging requirements for
roll-your-own and pipe tobacco to more clearly differentiate the two
products on those bases. Treasury also noted the need for additional
rulemaking on other standards and methods to differentiate the
products. In response to its June 2009 rulemaking notice, industry
members proposed standards to distinguish between roll-your-own and
pipe tobacco based on physical characteristics. For example, Treasury
received comments setting forth certain criteria for distinguishing
between the products based on whether the product met a certain number
of factors, including moisture content; cut width; percentage of
weight consisting of reducing sugars; and percentage of weight
consisting of flavoring, casing, or other nontobacco content.
In July 2010, Treasury published an advance notice of proposed
rulemaking issuing a request for public comments on these and other
standards proposed by commenters to differentiate between roll-your-
own and pipe tobacco. The industry members' comments responding to
Treasury's 2010 request highlighted the complexity and difficulties in
developing objective standards based on physical characteristics that
clearly differentiate the two tobacco products. Industry members
disagreed on the number of criteria that should be used and the
specific thresholds for differentiating between the products. For
example, while some industry members generally agreed that pipe
tobacco traditionally has had a thicker cut and greater moisture
content than roll-your-own tobacco, they disagreed on the specific cut
width or moisture content that defines pipe tobacco. Some comments
noted that the physical characteristics of the two products overlap
greatly, emphasizing the numerous types of roll-your-own and pipe
tobacco products on the market and various manufacturing methods, all
of which make it difficult to develop concrete definitions that
clearly differentiate between the two products. Other comments
emphasized the challenges of conducting tests to distinguish the two
products as, for example, test results can be influenced by factors
such as the age of the sample used and the temperature of the
facility, potentially creating different results on tests of the same
tobacco products. Some industry members also proposed that Treasury
take into consideration the preexisting or established pipe tobacco
brands prior to CHIPRA and continue to classify them as pipe tobacco
through a grandfathering clause, regardless of how the tobacco might
fare in any tests based on objective standards. Other industry members
disagreed, however, stating that a grandfathering clause would favor
existing companies, reduce competition, and give some companies the
opportunity to introduce misclassified pipe tobacco into the market
without accountability.
Other industry members expressed concerns that the proposed standards
could easily be manipulated by consumers. For example, the tobacco cut
width standard for pipe tobacco could be compromised by a consumer
using a blender or coffee grinder to obtain a smaller width for use in
cigarettes. Additionally, the moisture content standard could also
prove to be ineffective because end users could dry out the moister
pipe tobacco for use in cigarettes.
After the initial public comment period closed in September 2010,
Treasury did not issue a subsequent rulemaking on clarifying
standards. Treasury said it received an additional proposal after the
close of the comment period and, as a result, issued a second advance
notice of proposed rulemaking in August 2011 reopening the period for
receiving comments on the standards proposed by commenters, including
the new proposal. Treasury received a number of additional comments,
many by the same companies that commented on the earlier notices, and
the comments continued to reflect significant differences within the
industry on standards that define and distinguish roll-your-own
tobacco from pipe tobacco. This second comment period closed in
October 2011, and Treasury has not issued a subsequent rulemaking as
of March 2012.
Within the 2011 notice, Treasury also published the results of the
preliminary analysis conducted by its laboratory on a sample of roll-
your-own and pipe tobacco products. For this analysis, Treasury
purchased a sample of products labeled as roll-your-own and pipe
tobacco from local retail vendors in Maryland. These samples were
purchased just prior to the CHIPRA tax increases going into effect.
Treasury officials emphasized that their sample was not a
representative market sample and thus not generalizable. Treasury
officials stated that the purpose of the preliminary analysis was to
investigate what could be learned about the initial proposed standards
rather than to complete a definitive test differentiating the products
or attempting to determine whether the products were roll-your-own or
pipe tobacco, as they were labeled. Treasury tested for several of the
proposed standards, including total reducing sugars and moisture
content. Treasury's results, in some cases, appeared to show a lack of
a clear distinction between the roll-your-own and pipe tobacco samples.
[End of section]
Appendix IV: Comments from the Department of the Treasury:
Department of the Treasury:
Alcohol and Tobacco Tax and Trade Bureau:
Administrator:
1310 G Street NW, Box 12, Suite 300:
Washington, DC 20005:
April 10, 2012:
Mr. David Gootnick:
Director, International Affairs and Trade:
U.S. Government Accountability Office:
Washington, DC 20548:
Re: Draft Report GAO-12-475, "Tobacco Taxes: Large Disparities in
Rates for Smoking Products Trigger Significant Market Shifts to Avoid
Higher Taxes"
Dear Mr. Gootnick:
Thank you for the opportunity to review and comment on the draft
report. The U.S. Department of the Treasury (Treasury) appreciates the
U.S. Government Accountability Office's (GAO) work in conducting its
review of the impacts of Children's Health Insurance Program
Reauthorization Act (CHIPRA) of 2009 on tobacco tax revenue. We
generally agree with GAO's conclusion that "by introducing large tax
disparities" between similar products "CHIPRA has contributed to the
substitution of higher-taxed tobacco products with lower-taxed
products." We also agree with your observation that "modifying tax
rates to eliminate significant tax differentials between similar
products" would address the market shifts your report identifies.
In this context, it is appropriate to note that the report uses the
term "revenue losses" to Characterize the difference between revenues
due and collected under current law, and revenues that would be
collected if the tax disparities between similar products were
eliminated or had the market shifts due to the disparities not
occurred. These are not actual losses of revenues, but rather your
estimates of the revenue increases if Congress were to change the law
to eliminate the disparities.
With respect to Roll-Your-Own (RYO) and pipe tobacco, the increase in
sales of pipe tobacco from 2008 to 2011 illustrates that disparate tax
rates for like products influences shifts in demand. Given the tax
differentials between using pipe tobacco and higher taxed RYO tobacco,
Treasury expects the increased demand for pipe tobacco to continue.
While CHIPRA ended the disparate tax rates between small cigars and
cigarettes, raising the tax on small cigars means the tax rate on some
large cigars can be substantially less than the rate on other,
slightly smaller cigars. In some cases manufacturers may reduce the
tax on the tobacco used in a cigar, if they adjust the weight to avail
themselves of a lower "large cigar" tax rate and select a low sales
price point. (The tax on large cigars" is based on sales price, so
lower priced tobacco is taxed at a lower rate.) In fact, we have
observed a notable shift in the cigar market since the passage of
CHIPRA. For example, in the year preceding the tax increase on April
1, 2009, of all cigars removed for sale in the United States by
domestic manufacturers, 52 percent were small cigars (cigars weighing
less than 3 pounds per thousand) and 48 percent were large cigars
(cigars weighing over 3 pounds per thousand). In the 2-year period
following April 1, 2009, these numbers were 8 percent for small cigars
and 92 percent for large cigars.
Again, thank you for the opportunity to comment on this draft report.
Signed by:
John J. Manfreda:
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
David Gootnick (202) 512-3149 or gootnickd@gao.gov:
Staff Acknowledgments:
In addition to the individual named above, Christine Broderick,
Assistant Director; Sada Aksartova; Pedro Almoguera; David Dayton;
Etana Finkler; Jeremy Latimer; Grace Lui; and Alana Miller made key
contributions to this report. In addition, Barbara El Osta, Joyce
Evans, Marc Molino, Theresa Perkins, Jena Sinkfield, and Cynthia S.
Taylor provided technical assistance.
[End of section]
Footnotes:
[1] Pub. L. No. 111-3, 123 Stat. 8.
[2] Pub. L. No. 111-31, Div. A, 123 Stat. 1776.
[3] Responding to this mandate, in March 2011, we issued a first
report on illicit tobacco trade and schemes. GAO, Illicit Tobacco:
Various Schemes Are Used to Evade Taxes and Fees, [hyperlink,
http://www.gao.gov/products/GAO-11-313] (Washington, D.C.: Mar. 7,
2011).
[4] Smokeless tobacco products that are subject to federal excise
taxes, such as chewing tobacco and snuff, were outside the scope of
this review. "Processed tobacco" is not subject to federal excise tax
and is defined in the IRC by what it is not: processed tobacco does
not include the farming or growing of tobacco or the handling of
tobacco solely for sale, shipment, or delivery to a manufacturer of
tobacco products or processed tobacco.
[5] 26 U.S.C. § 5702(j).
[6] The World Health Organization, for example, recommends raising
tobacco taxes as one of the six components of its MPOWER framework,
which provides guidance to countries to implement tobacco control
policies. The World Bank recommends that, to curb tobacco use, excise
taxes should account for two-thirds to four-fifths of the retail price
of a pack of cigarettes. In the United States, the Centers for Disease
Control and Prevention, the U.S. Surgeon General, and the Institute of
Medicine of the National Academy of Sciences report that tobacco
excise tax increases are one of the most effective tobacco strategies
for reducing tobacco use. The Centers for Disease Control and
Prevention, which through its Office on Smoking and Health is the lead
federal agency for tobacco control and prevention, recognizes tobacco
excise tax increases as an effective population-based tobacco control
and prevention intervention at the federal and state levels.
[7] In 1989, GAO reviewed studies available at that time; see GAO,
Teenage Smoking: Higher Excise Tax Should Significantly Reduce the
Number of Smokers, [hyperlink,
http://www.gao.gov/products/GAO/HRD-89-119] (Washington, D.C.: June
30, 1989).
[8] 26 U.S.C. § 5702.
[9] 26 U.S.C. § 5701.
[10] As with small and large cigars, the IRC distinguishes between
small and large cigarettes based on weight. Small cigarettes are
defined as weighing 3 pounds or less per thousand sticks. When we
refer to cigarettes in this report, we are discussing small
cigarettes, as defined in the IRC. Treasury data show that no large
cigarettes were manufactured in the United States between fiscal years
2001 and 2011.
[11] The IRC also provides definitions for smokeless tobacco products,
which are not listed here.
[12] In this report, we define roll-your-own cigarettes as cigarettes
made by consumers with loose tobacco, such as roll-your-own tobacco or
pipe tobacco.
[13] Commercial roll-your-own machines are located in some stores that
sell tobacco products. These machines allow customers to make a carton
of cigarettes in less than 10 minutes. They are discussed in more
detail in the next section of the report.
[14] Act of August 10, 1790, ch. 39, §§ 1-2, 1 Stat. 24 (1789).
[15] Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-
647, § 5061(d), 102 Stat. 3342, 3679. This tax became effective after
December 31, 1988.
[16] Balanced Budget Act of 1997, Pub. L. No. 105-33, § 9302(g), 111
Stat. 251, 672. This tax became effective after December 31, 1999.
[17] Treasury's Alcohol and Tobacco Tax and Trade Bureau administers
Chapter 52 of the IRC (26 U.S.C. Chapter 52) pursuant to section
1111(d) of the Homeland Security Act of 2002, codified at 6 U.S.C. §
531(d). The Secretary of the Treasury has delegated various
authorities through Treasury Department Order 120-01 (Revised), dated
January 21, 2003, to Treasury's Alcohol and Tobacco Tax and Trade
Bureau Administrator to perform the functions and duties in the
administration and enforcement of this law. Treasury conducts audits
and investigations to enforce civil and criminal laws relating to
tobacco tax collection, sometimes referring criminal cases to the U.S.
Attorney's Office for prosecution. It also operates a tobacco
laboratory, which conducts analyses to evaluate products for tax
compliance and to support appropriate tax classification of different
tobacco products.
[18] While Treasury collects federal excise taxes from domestic
manufacturers, the U.S. Customs and Border Protection within the
Department of Homeland Security collects federal excise taxes on
imported tobacco products. Where tobacco products are imported for
distribution in the U.S. market and first deposited into a customs
warehouse or foreign trade zone, the federal excise taxes become due
when they are removed from the first warehouse, even when they are
removed for transfer to another warehouse (26 U.S.C. § 5703).
[19] CHIPRA also extended Treasury's permit requirement and related
recordkeeping and reporting requirements to manufacturers and
importers of processed tobacco. Treasury's temporary regulatory
definitions provide that the processing of tobacco includes, but is
not limited to, stemming, fermenting, threshing, cutting, or flavoring
the tobacco, or otherwise combining the tobacco with nontobacco
ingredients. This definition is in effect until June 22, 2012.
[20] Pub. L. No. 111-31. The Tobacco Control Act amended Chapter IX of
the Food, Drug, and Cosmetic Act, the main federal law that governs
FDA's work. Chapter IX provides the primary authority for FDA's
regulation of tobacco products.
[21] Pub. L. No. 111-31, § 101. The act defines cigarette tobacco as
any product that consists of loose tobacco that is intended for use by
consumers in a cigarette and smokeless tobacco as any tobacco product
that consists of cut, ground, powdered, or leaf tobacco and that is
intended to be placed in the oral or nasal cavity.
[22] In June 2009, Treasury revised regulations on packaging and
labeling roll-your-own and pipe tobacco to more clearly differentiate
the two products. See table 4 for more information.
[23] Treasury officials also stated that processed tobacco, which is
not subject to federal excise tax, is being used in these machines to
make roll-your-own cigarettes.
[24] This is not nationally representative because states have varying
tobacco tax rates. According to the Campaign for Tobacco-Free Kids,
state cigarette taxes vary from $0.17 to $4.35 per pack, and pipe tax
rates vary from a tax per ounce to a percent of manufacturer's or
wholesale price. Maryland's cigarette tax is $2.00 per pack, and pipe
tobacco tax is 15 percent of the wholesale price. The price shown for
the roll-your-own cigarettes made in a commercial roll-your-own
machine with pipe tobacco includes a $10 fee charged by the store for
the use of the machine.
[25] In the absence of this market shift due to differential tax
rates, more tax revenue would have been collected because roll-your-
own tobacco and small cigars had historically much higher levels of
sales than pipe tobacco and large cigars, and after CHIPRA these
tobacco products also had a much higher tax rate.
[26] Cigarettes are taxed at the same rate as roll-your-own tobacco
and small cigars, but the analysis does not take into account the
likely impact of a similar market shift from cigarettes to pipe
tobacco and large cigars. See appendix II for information on sales of
cigarettes and other smoking tobacco products.
[27] Using a somewhat similar approach, Treasury estimated that in
2010, over $400 million in revenue was lost due to the shift from roll-
your-own to pipe tobacco. Treasury's estimate did not take into
account the expected decline in demand following a price increase.
[28] For example, a price elasticity of demand of -0.6 means that when
prices go up by 10 percent, demand will decrease by 6 percent.
[29] For a detailed explanation of this methodology, see Frank
Chaloupka and Jidong Huang, "A Significant Cigarette Tax Rate Increase
in Illinois Would Produce a Large, Sustained Increase in State Tobacco
Tax Revenues" (Chicago, IL: University of Illinois at Chicago, Jan. 3,
2011, working paper).
[30] That is about $228 million per year after CHIPRA compared with
$25.5 million for fiscal year 2008.
[31] That is about $680 million per year after CHIPRA compared with
$217.5 million for fiscal year 2008.
[32] Treasury estimates that $723 million in revenue was lost due to
the shift from small to large cigars over the 2 years after CHIPRA was
enacted. Treasury did not include the price elasticity of demand in
their estimate.
[33] As with the roll-your-own and pipe tobacco estimates, the low and
high scenarios are calculated using the price elasticity of demand of
-0.6 and -0.3, respectively. Because cigar taxes are based on price,
our estimate included price data. Small cigar revenues were calculated
by multiplying the number of unit sales in each month by the tax rate.
Large cigar revenues were calculated by subtracting small cigar
revenue from cigar revenue. Once the large cigar revenue was
calculated, the average tax paid was estimated by dividing the large
cigar revenue by the number of large cigar units. From March 2007
through March 2009, this average was 4.3 cents per stick.
[34] 74 Fed. Reg. 29,401 (June 22, 2009).
[35] Treasury refers to the machines as cigarette-making machines
rather than roll-your-own machines. Treasury's position is that the
retailers who make these machines available for use are manufacturers
of cigarettes.
[36] A temporary rule is issued without an advance notice of proposed
rulemaking, but in the publication of the rule the agency may request
comments and state that it may modify the rule in response to the
comments.
[37] An advance notice of proposed rulemaking can announce and explain
agencies' plans to solve problems and accomplish goals and give
interested persons an opportunity to submit comments to improve the
final regulation.
[38] Ark. Code Ann. § 26-57-263.
[39] The IRC does not distinguish small and large cigars by any
characteristic other than weight.
[40] The Food, Drug, and Cosmetic Act and the IRC each maintain their
own definitions of tobacco products, including the smoking tobacco
products discussed in this report. The laws and implementing
regulations of the Food, Drug, and Cosmetic Act utilize the
definitions found at 21 U.S.C. § 387. The laws and implementing
regulations of the IRC utilize the definitions found at 26 U.S.C. §
5702. These statutes have slightly different definitions for
cigarettes and roll-your-own tobacco. The IRC's definition of a cigar
is slightly different from the Food, Drug, and Cosmetic Act's
definition of a little cigar. In addition, while the IRC defines pipe
tobacco, the Food, Drug, and Cosmetic Act does not.
[41] Pub. L. No. 111-31, § 101(b). The law states that "tobacco
products ... shall be regulated by the Secretary [of Health and Human
Services] under this chapter …" and that "[t]his chapter shall apply
to all cigarettes, cigarette tobacco, roll-your-own tobacco, and
smokeless tobacco and to any other tobacco products that the Secretary
by regulation deems to be subject to this chapter."
[42] 21 U.S.C. § 387g. The law states that "a cigarette or any of its
component parts (including the tobacco, filter, or paper) shall not
contain, as a constituent (including a smoke constituent) or additive,
an artificial or natural flavor (other than tobacco or menthol) or an
herb or spice, including strawberry, grape, orange, clove, cinnamon,
pineapple, vanilla, coconut, licorice, cocoa, chocolate, cherry, or
coffee, that is a characterizing flavor of the tobacco product or
tobacco smoke." On April 4, 2012, the World Trade Organization (WTO)
Appellate Body issued a report finding that this restriction is
inconsistent with the United States' WTO obligations. Unless the
Dispute Settlement Body rejects the report by consensus, the United
States has 30 days from the time the report is adopted to state its
intention regarding the implementation of the recommendations of the
Appellate Body.
[43] U.S. Department of Health and Human Services, Preventing Tobacco
Use Among Youth and Young Adults: A Report of the Surgeon General
(Atlanta, GA: U.S. Department of Health and Human Services, Centers
for Disease Control and Prevention, National Center for Chronic
Disease Prevention and Health Promotion, Office on Smoking and Health,
2012).
[44] 75 Fed. Reg. 13,225 (Mar. 19, 2010) (codified in 21 C.F.R. pt.
1140).These restrictions apply to roll-your-own tobacco, and the rule
stipulates that the definition of a cigarette "includes tobacco, in
any form, that is functional in the product, which, because of its
appearance, the type of tobacco used in the filler, or its packaging
and labeling, is likely to be offered to, or purchased by, consumers
as a cigarette or as roll-your-own tobacco."
[45] 21 C.F.R. pt. 1140.
[46] 21 C.F.R. § 1140.14.
[47] 21 C.F.R. § 1140.14. An exception is made for vending machines
and self-service displays that are located in facilities where no
person under the age of 18 is present, or permitted to enter, at any
time.
[48] 21 C.F.R. § 1140.34. The regulation does not ban a manufacturer,
distributor, or retailer from sponsoring sporting and cultural events
in the name of the corporation that manufactures the tobacco product,
provided that, among other things, the corporate name does not include
any brand name used for any brand of cigarettes or smokeless tobacco.
[49] In December 2011, the parent company of Camacho Cigars, according
to a company press release, signed a 3-year sponsorship deal with the
Orange Bowl Committee, a nonprofit organization that stages an annual
football game and the supporting Orange Bowl Festival in South
Florida. The press release stated that under the sponsorship
agreement, Camacho Cigars intended to have a substantial presence at
Sun Life Stadium in Miami Gardens, FL, with cigar lounges for football
fans and a special Camacho Club Lounge at the Orange Bowl Game Day Fan
Zone, the largest pregame event. News organizations reported that the
Camacho Cigars logo had been featured on the official Orange Bowl
website until the sponsorship agreement was canceled in response to
appeals from three U.S. senators and public health groups urging the
Orange Bowl Committee to call off the deal that promoted tobacco use.
[50] Most cigar packs and some individual cigars sold in the United
States are required to display a Surgeon General warning as the result
of an agreement reached in 2000 between the Federal Trade Commission
and seven largest cigar companies. There are no federal requirements
for pipe tobacco packages to display a Surgeon General warning.
[51] Pub. L. No. 111-31, § 201.
[52] In August 2011, several tobacco companies filed a lawsuit to stop
FDA from implementing the new warning requirements. In February 2012,
the U.S. District Court for the District of Columbia granted the
plaintiff's motion for summary judgment and ordered a permanent
injunction to halt FDA from enforcing the rule until 15 months after
resolution of the plaintiff's claim on the merits. As of March 2012,
the case is on appeal before the U.S. Court of Appeals for the
District of Columbia Circuit.
[53] The semiannual agenda, also known as unified agenda, summarizes
the rules and proposed rules that each federal agency expects to issue.
[54] 75 Fed. Reg. 21,791 (Apr. 26, 2010) and 75 Fed. Reg. 79,771 (Dec.
10, 2010).
[55] Section 201(rr)(1) of the Food, Drug, and Cosmetic Act defines
the term "tobacco product" as any product made or derived from tobacco
that is intended for human consumption, including any component, part,
or accessory of a tobacco product (except for raw materials other than
tobacco used in manufacturing a component, part, or accessory of a
tobacco product). By comparison, according to the IRC, "'tobacco
products' means cigars, cigarettes, smokeless tobacco, pipe tobacco,
and roll-your-own tobacco."
[56] 76 Fed. Reg. 40,052 (July 7, 2011) and 77 Fed. Reg. 7,946 (Feb.
13, 2012).
[57] The time needed to complete the 16 rules ranged from 1 to 14
years. One of the recommendations we made in the report was that FDA
routinely track major milestones for significant rules in its
rulemaking process. See GAO, Federal Rulemaking: Improvements Needed
to Monitoring and Evaluation of Rules Development as Well as to the
Transparency of OMB Regulatory Reviews, [hyperlink,
http://www.gao.gov/products/GAO-09-205] (Washington, D.C.: Apr. 20,
2009). However, FDA does not generally track rulemaking milestones
during the early phases of rule development, that is, before the
agency prepares proposed rules for publication in the Federal
Register. FDA informed us that it takes several actions to track major
milestones, such as maintaining the Federal Register Document Tracking
System database to track the progress of all its Federal Register
documents through the agency's rule development and clearance process
and holding monthly and quarterly meetings where senior agency
officials discuss major milestones in the rulemaking process for
potentially significant regulations.
[58] Responding to this mandate, in March 2011, we issued a first
report on illicit tobacco trade and schemes, [hyperlink,
http://www.gao.gov/products/GAO-11-313].
[59] Smokeless tobacco products that are subject to federal excise
taxes, such as chewing tobacco and snuff, were outside the scope of
this review. "Processed tobacco" is not subject to federal excise tax
and is defined in the Internal Revenue Code of 1986 by what it is not:
processed tobacco does not include the farming or growing of tobacco
or the handling of tobacco solely for sale, shipment, or delivery to a
manufacturer of tobacco products or processed tobacco.
[60] As used in this report, for smoking tobacco products, "removals"
means the amount removed for distribution in the United States from
the factory or released from customs, as measured in pounds for roll-
your-own and pipe tobacco or in the number of sticks for cigarettes
and small and large cigars. 26 U.S.C § 5702(j). In this report, we
consider removals to be equivalent to sales and use the term sales.
[61] For a detailed explanation of this methodology, see Frank
Chaloupka and Jidong Huang, "A Significant Cigarette Tax Rate Increase
in Illinois Would Produce a Large, Sustained Increase in State Tobacco
Tax Revenues" (Chicago, IL: University of Illinois at Chicago, Jan. 3,
2011, working paper).
[62] Economic theory states that when the price of a product
increases, the quantity demanded for the product will decrease at a
rate that is computed from the underlying demand curve.
[63] Hence, it is assumed that the actual change in revenue is based
on the new tax differential. If changes in sales were due to other
market forces, such as changes in the prices of other products or
changing demand, this would cause our estimates to be over or under
stated.
[64] For an extensive literature review of tobacco price elasticity
studies, see Qiang Li, The Effects of Cigarette Price and Tax on
Smokers and Government Revenue. Unpublished doctoral dissertation
(Buffalo, NY: The State University of New York, 2007).
[65] In our counterfactual scenario, a lower decrease in demand
results in a higher estimate of revenue losses. A price elasticity of -
0.6 means that when prices go up by 10 percent, demand will decrease
by 6 percent; a price elasticity of -0.3 for the same price increase
means that demand will decrease by 3 percent.
[66] The price data for cigars, pipe tobacco, and roll-your-own
tobacco are subsets of the sample used to calculate the Consumer Price
Index for Tobacco products other than cigarettes. The Bureau of Labor
Statistics cautioned that these data be interpreted with care because
they do not meet its standard publication criteria.
[67] Using an average post-CHIPRA price from the Bureau of Labor
Statistics would be misleading as it would include increases in state
and local taxes and would artificially inflate the effect of CHIPRA on
prices.
[68] As used in this report, for smoking tobacco products, "removals"
means the amount removed for distribution in the United States from
the factory or released from customs, as measured in pounds for roll-
your-own and pipe tobacco or in the number of sticks for cigarettes
and small and large cigars. 26 U.S.C. (§ 5702(j). In this report, we
consider removals to be equivalent to sales and use the term sales.
[End of section]
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