The large differences in excise tax rates for various smoking products are prompting consumers with a tobacco habit to shift their smoking habits to pipes and larger cigars, according to a new government study.

A report by the Government Accountability Office attributed the change in smoker preferences to the Children’s Health Insurance Program Reauthorization Act of 2009, or CHIPRA, which created opportunities for tax avoidance and led to significant market shifts by manufacturers and price-sensitive consumers toward 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. 

During 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. 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 all smoking tobacco products from April 2009 through fiscal year 2011 amounted to $40 billion, the GAO report estimated 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 Treasury Department has limited options to respond to these market shifts, the report noted. “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,” said the report. “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 and thus are not subject to the same restrictions on characterizing flavors, sales or distribution, the GAO noted.

In 2011, the FDA indicated that it intended to issue a proposed rule that would deem products meeting the statutory definition of “tobacco product” to be subject to FDA’s regulation. However, the FDA has still not issued the proposed rule as of March 2012. FDA officials told the GAO that developing the rule was taking longer than expected.

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.

Another law passed in 2009, the Family Smoking Prevention and Tobacco Control Act granted the FDA with regulatory authority over tobacco products.

The GAO report recommended that 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 the Treasury, consider options for reducing tax avoidance due to tax differentials between small and large cigars. The Treasury Department generally agreed with GAO’s conclusions and observations.