AP IMPACT: Tobacco execs quickly find tax loophole

http://news.yahoo.com/s/ap/20091117/ap_on_bi_ge/us_tobacco_tax_l...

WASHINGTON – With a simple marketing twist, tobacco companies are avoiding hundreds of millions of dollars a year in taxes by exploiting a loophole in President Barack Obama's child health law.

Obama and Congress increased taxes on tobacco products earlier this year to pay for expanded children's health insurance, but tobacco for roll-your-own cigarettes saw a disproportionate leap, from $1.10 to $24.78 per pound. Some predicted the tax would kill the roll-your-own industry, which had offered a cheaper alternative to packaged cigarettes.

But tobacco companies quickly adapted. The Associated Press found that as soon as the tax was on the books, companies all but shut down their roll-your-own brands and reinvented them under a less-restricted, less-taxed category: pipe tobacco. It's still destined to be rolled and smoked, but it's taxed at barely a tenth the rate, $2.83 per pound.

Normally, pipe tobacco is coarser and moister than cigarette tobacco. But nothing says it has to be. In fact, the federal government says the only distinction between the two is how it's labeled. That effectively gives tobacco marketing executives an opportunity to shape the company's tax rate.

Nearly overnight, roll-your-own brands like Criss Cross and Farmers Gold came off the shelves, replaced by pipe tobacco with the same names. The cuts may be slightly different, but they're suitable for rolling. Knowing this, retailers steer customers to the new products, sometimes with a wink and a nod, sometimes with outright advertising.

"They tried to make a product within the elements of the law that they could, in fact, market as pipe tobacco," said Scott Bendett, owner of Habana Premium Cigar Shoppe in Albany, N.Y., which advertises the new pipe tobacco for hand-rolled cigarettes.

Tobacco companies say they're just trying to find a legal way to stay afloat after being saddled with an enormous tax increase.

Because the small, independent companies in the roll-your-own market are often overshadowed by the huge, publicly held cigarette companies, the sudden shift toward pipe tobacco caught researchers by surprise.

Daniel Morris, who tracks tobacco production data at the Oregon Department of Health, thought he had made a mistake when he saw April's figures. Pipe tobacco production had more than doubled in a single month. After years of producing about 270,000 pounds per month, companies put more than 566,000 pounds of pipe tobacco on the market in April.

Morris called the federal Alcohol and Tobacco Tax and Trade Bureau, which collects the data.

There was no mistake.

Over the next several months, the numbers climbed higher. In August, the most recent data available, pipe tobacco reached 1.7 million pounds, enough to roll more than 42 million packs of cigarettes.

The huge spike in production corresponded with a tremendous drop in the roll-your-own industry. Companies produced 660,000 pounds in August, down from an average of 1.5 million pounds before the tax.

"It really shows how the industry is able to respond to changes in the tax environment," Morris said.

Anti-tobacco groups say it's deception, and not just because of the taxes. While flavored cigarettes are now banned in an effort to reduce the appeal of smoking to children, no such ban applies to pipe tobacco, allowing companies to sell black cherry, vanilla and other varieties.

"This is a direct challenge to the federal government," said Matthew Myers, president of the Campaign for Tobacco Free Kids.

The Obama administration says it is working on clearer definitions of pipe and roll-your-own tobacco. Until then, Art Resnick, a spokesman for the Tax and Trade Bureau, said there's no way to know how many companies are reinventing their brands as pipe tobacco, or whether the new offerings are just cigarette tobacco with pipes on the labels.

The tax implications could be huge. As much as $32 million a month could be lost in taxes if the sudden spike in pipe tobacco is just cigarette tobacco in disguise.

Companies say they're just trying to survive within the law. People buy roll-your-own tobacco because it's cheap, so when Washington slapped a 2,000 percent tax increase on the product, producing pipe tobacco became the affordable option. For some companies, it was the only option.

"It allowed companies to stay in business, enough to keep paying the light bills," said Cheryl Turner, vice president of M&R Holdings, a small company in Pink Hill, N.C., that manufactures Farmers Gold.

After the tax increase, the company cut staff from about 40 employees to about a dozen.

Kevin Altman, who represents a handful of small companies with the Council of Independent Tobacco Manufacturers of America, acknowledged that some companies were exploiting the loophole, packaging cigarette tobacco and marketing it as pipe tobacco.

"What are you going to do? You're trying to save the company," Altman said. "And what they're doing ... , as far as I can tell, is within the limits of the law."

Still, Altman said his companies want the government to make the definition clearer. The ambiguity hurts those companies who didn't make the marketing switch and must sell their tobacco at higher prices.

"Many times our government passes things without first taking an extra few days to say, 'What are the unintended consequences?'" Altman said. "That's what happened here."

A couple lessons here:

1. People respond to incentives.
2. People respond to incentives.
3. Due to 1 and 2, legislation that some claim is 'deficit neutral' probably isn't.
4. People respond to incentives.

good for tobacco.

man i didn't want this in the news. They will be going after this and grow your own now.

Next stop: Prohibition!

What is the point of this thread. Wow - a corporation found a loophole in hastily drafted tax legislation. This is what corporate accountants do for a living. This is nothing new and not really all that noteworthy.

I guess it's good for a cynical chuckle.

Glitch99 said: The focus should be on a tax increase from $1 to $24 overnight, not how a industry has successfully (and legally) managed to avoid succuming to such abuse.I disagree. The bigger issue is why the government charges such different tax rates on basically identical goods. Why is it okay to charge people who roll cigarettes $24 per lb and people who smoke it in a pipe $3 per pound?

Is it because grandpa Jones likes to sit on his porch smoking his pipe (good) and the punk neighbor kid rolls cigarettes (bad)?

Where is the fairness and equality there?

Bring back Joe Camel. That way, the kids get hooked and pay for their own damn health insurance.

Unless there is a table of tax per pound of different tobacco products, it is irreleveant to comment on the tax increase. What if the 2400% increase was to bring parity with cigratte tax and close the roll-your-own loophole?

largeeyes said: Glitch99 said: The focus should be on a tax increase from $1 to $24 overnight, not how a industry has successfully (and legally) managed to avoid succuming to such abuse.

I hate smoking and think that cigarettes are just about the worst legal product out there. However, this is dead on 110% correct. If anything here should be shocking and infurriating, it's a 2400% tax increase overnight.
Imagine the % increase when the government starts taxing something it didn't before, infinity percent!

There are two things here. Big tobacco companies make mostly rolled cigarettes, they likely realized that little tobacco was getting off easy (HumDoHamaraDo's point) so they got their congresspeople to raise the rates on loose tobacco, this gives people who smoke less incentive to roll their own by bringing the pricing up to what rolled cigs cost. Second, the $1.10 rate was likely the rate for a long long time.

theman2 said: The bigger issue is why the government charges such different tax rates on basically identical goods. Apparently roll your own has a lame lobby... Taxes on roll your own should be much less than prepackaged.

Rolling your own would almost certainly cut down on chain smoking... F'ing Washington.

chimeer said: Just another example of why government managed economies fail. No matter how smart the government thinks it is there are always unintended consequences to government actions.Except that in this case, the unintended consequences are that there have been no consequences.

kamalktk said: largeeyes said: Glitch99 said: The focus should be on a tax increase from $1 to $24 overnight, not how a industry has successfully (and legally) managed to avoid succuming to such abuse.

I hate smoking and think that cigarettes are just about the worst legal product out there. However, this is dead on 110% correct. If anything here should be shocking and infurriating, it's a 2400% tax increase overnight.
Imagine the % increase when the government starts taxing something it didn't before, infinity percent!

There are two things here. Big tobacco companies make mostly rolled cigarettes, they likely realized that little tobacco was getting off easy (HumDoHamaraDo's point) so they got their congresspeople to raise the rates on loose tobacco, this gives people who smoke less incentive to roll their own by bringing the pricing up to what rolled cigs cost. Second, the $1.10 rate was likely the rate for a long long time.

Wouldn't that be undefined percent?

Solution: Legalize and tax weed. Something has to pay for this deficit.

It's all good and fine for tobacco companies, but the article simply ignores that the tax still went up 2.5 times. It's not exactly like Big Tobacco got a tax cut relative to what it was.

HumDoHamaraDo said: Unless there is a table of tax per pound of different tobacco products, it is irreleveant to comment on the tax increase. What if the 2400% increase was to bring parity with cigratte tax and close the roll-your-own loophole?Taxing by the pound is irrelevant.

There might be entirely different tariffs (yeah, I know tariffs are different) on iron ore, pig iron, rolled steel, and car bodies.

To demand that a finished good be taxed at the same per pound rate as its minimally processed components is unrealistic.

Xnarg said: HumDoHamaraDo said: Unless there is a table of tax per pound of different tobacco products, it is irreleveant to comment on the tax increase. What if the 2400% increase was to bring parity with cigratte tax and close the roll-your-own loophole?Taxing by the pound is irrelevant.

There might be entirely different tariffs (yeah, I know tariffs are different) on iron ore, pig iron, rolled steel, and car bodies.

To demand that a finished good be taxed at the same per pound rate as its minimally processed components is unrealistic.
When you put politicians ahead of policy, you can't read right. It would be fair to tax all tobacco products in a similar fashion, irrespective on who is proposing the policy.

I'm 49 years old, and had never heard of flavored cigarettes in my life until the recent ban. How the heck were they being 'marketed to children'? Doesn't policy have to have at least a remote link to reality? Are people such idiots that they think people's taste buds and sense of humor disappear when you turn 21? Why do people allow these mass insanities to exist and flourish? Not liking tobacco is all well and good but to take policy into Alice in Wonderland nonsense is totally unacceptable IMO. </rant>

WalStMonky said: Are people such idiots that they think people's taste buds and sense of humor disappear when you turn 21? </rant>

I'm pretty sure smokers' taste buds disappear within the first year of use

Glitch99 said: chimeer said: Just another example of why government managed economies fail. No matter how smart the government thinks it is there are always unintended consequences to government actions.Except that in this case, the unintended consequences are that there have been no consequences.

A case of much ado about nothing?

Xnarg said: If it were valid to compare the these two product lines solely on the basis of weight, your comparison might be reasonable.

However, raw materials and finished products are not fungible.

There is a huge convenience factor involved with cigarettes over rolling tobacco.

If you disagree, just go into a store and ask cigarette customers if they would like to buy tobacco and papers instead.

Probably NONE of those smokers would agree with the position that finished cigarettes are identical to the raw materials.

Plus, taxing rolling tobacco more probably hurts the poor more than the wealthy, since the poor are more likely to roll their own. This tax is regressive.

I use weight because the material that is "bad" for you, that causes the addiction is the tobacco. You don't see me rolling up pages of the new york times and lighting the end. Far as I understand it, its not a convenience tax but rather a health penalty tax. The real question I have is, why is the pipe tobacco tax so low?

All commodity based taxes are highly regressive. Rich addicted smokers don't smoke considerably more then do low income addicted smokers.

I'm not particulary fond of the tax, considering most kids don't get sick from tobacco smoke, that doctor bill comes later in life. But I am fond of saying, "we're helping the kids", as I light up a Padron.

I should add, I don't disagree that they are fundamentally differnt, but they are substitutes for some. This law is very arbitrary. To think you'd have wide ranges of taxes and not have people find the cheapest option is silly. Its a signifigant tax, about $2 and change on a package of rolling tobacco.

michal1980 said:
What about the fact that tabbaco smokers general die sooner and thus we save all that money on the back end?

One book i read on the subject (written before this ever greater run up on tabbaco taxes) concluded that savings from people dieing early were canceled out by the increased health care costs. Which means smoking was a wash.

It becomes profitable for the government when the government is on the hook for large pensions.

A recent study out of, I believe, Denmark showed that smokers, on average, cost the government much less than non-smokers. The difference was significant enough to nullify the tobacco tax argument of needing to recoup state expenditures.

Perhaps America's insolvent, defined-benefit Ponzi pension scams should begin sending out free cartons.