Cigarettes continue to dominate the market for domestic and imported  smoking tobacco products, accounting for approximately 88 percent of  sales in fiscal year 2013. In 2009, CHIPRA significantly raised the tax rates on these four  products. The act equalized the rates for cigarettes, roll-your-own  tobacco, and small cigars, but not for pipe tobacco (see fig. CHIPRA also significantly changed the federal excise tax rate on large  cigars. Treasury collects the  federal excise taxes on domestic tobacco products when these products  leave manufacturing facilities. 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 created opportunities for tax avoidance and led to  significant market shifts by manufacturers, importers, and price-sensitive  consumers toward the lower-taxed products. 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. Total annual sales of pipe tobacco grew from  about 5.2 million pounds in fiscal year 2008, the last year before CHIPRA,  to 43.7 million pounds in fiscal year 2013, representing an increase of  about 740 percent. Over the same period, total annual sales of roll-your- own tobacco declined from about 21.3 million pounds to 3.8 million  pounds, a decrease of 82 percent. Cigar Market Shifted from Small to Large Cigars after CHIPRA

CHIPRA’s 2009 changes in federal excise tax rates on tobacco products  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. Over the same period, total annual sales  of small cigars declined from about 5.7 billion sticks to 0.7 billion sticks, a  decrease of 88 percent. Market Shifts to Avoid Taxes Have Reduced Federal Revenue, and Treasury Has Limited Options to Respond

		Estimated Federal Revenue Losses from Market Shifts after CHIPRA Range from $2.6 Billion to $3.7 Billion

While tax revenue collected for domestic and imported smoking tobacco  products, including cigarettes, from April 2009 through February 2014,  amounted to about $77 billion, we estimate that federal revenue losses  due to the market shifts from roll-your-own to pipe tobacco and from small  to large cigars range from approximately $2.6 billion to $3.7 billion for the  same period. 5). Treasury  and CBP collected about $4.2 billion in tax revenue from domestic and  imported small and large cigars from April 2009 through February 2014. 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 do not specify distinguishing physical  characteristics and are based on such factors as the use for which the  products are suited and their packaging and labeling. The  federal excise tax on imported large cigars is based on the price for which  they are sold by the U.S. importer upon release from customs. We maintain that 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.
Why GAO Did This Study

In 2009, CHIPRA increased and equalized federal excise tax rates for cigarettes, roll-your-own tobacco, and small cigars. Although 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 the large cigar excise tax can be significantly lower, depending on price. Treasury collects federal excise taxes on domestic tobacco products. Customs and Border Protection (CBP) collects federal excise taxes on imported tobacco products.
This testimony highlights and provides selected updates to key findings from GAO's April 2012 report ( GAO-12-475 ) by examining (1) market shifts among smoking tobacco products since CHIPRA, and (2) the impact of the market shifts on federal revenue and Treasury's actions to respond to these shifts. GAO analyzed Treasury and CBP data to identify sales trends for domestic and imported smoking tobacco products and to estimate the effect of the market shifts to lower-taxed products on federal tax revenues.

What GAO Found

Large federal excise tax disparities among smoking 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 toward lower-taxed products by manufacturers, importers, and price-sensitive consumers. From fiscal year 2008, the last year before CHIPRA, to fiscal year 2013, annual sales of domestic and imported pipe tobacco increased from about 5.2 million pounds to 43.7 million pounds, while sales of domestic and imported roll-your-own tobacco declined from about 21.3 million pounds to 3.8 million pounds. Over the same period, annual sales of domestic and imported large cigars increased from about 5.8 billion sticks to 12.4 billion sticks, while sales of domestic and imported small cigars declined from about 5.7 billion sticks to 0.7 billion sticks. 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.
While revenue collected for domestic and imported smoking tobacco products, including cigarettes, from April 2009 through February 2014, amounted to about $77 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 $2.6 to $3.7 billion for the same period. GAO found that the Department of the Treasury (Treasury) has limited options to respond to these market shifts. 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 Internal Revenue Code do not specify distinguishing physical characteristics and are based on such factors as the use for which the products are suited and their packaging and labeling. GAO also found that Treasury continues to have limited options to address the market shift from small cigars to large cigars—which are differentiated in the Internal Revenue Code only by weight—and faces added complexity in monitoring and enforcing tax payments due to the change in large cigar tax rates.

What GAO Recommends

GAO is not making any new recommendations in this testimony. In its 2012 report, GAO suggested that Congress 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.