From the U.S. Government Accountability Office, www.gao.gov

Transcript for: The Effects of Disparate Rates on Tobacco Products

Audio interview by GAO staff with David Gootnick, Director,
International Affairs and Trade

Related GAO Work: GAO-12-475: Tobacco Taxes: Large Disparities in Rates
for Smoking Products Trigger Significant Market Shifts to Avoid Higher
Taxes

Released: April 2012

[ Background Music ]

[ Narrator: ] Welcome to GAO's Watchdog Report, your source for news and
information from the U.S. Government Accountability Office. It's April
2012. Recent excise tax increases on certain tobacco products, including
roll-your-own tobacco and small cigars, have resulted in dramatic shifts
by tobacco manufacturers and consumers toward lower tax products such as
pipe tobacco and large cigars. A group led by David Gootnick, a Director
in GAO's International Affairs and Trade Team, recently reviewed these
shifts in the market for tobacco products and their potential affect on
federal revenues. GAO's Jeremy Cluchey sat down with David to learn
more.

[ Jeremy Cluchey: ] To start off, can you talk about the 2009
legislation that prompted these market shifts?

[ David Gootnick: ] Yeah, well, it's well established that smoking is a
public health problem and a cause of preventable death and disease in
the United States, and a significant contributor to healthcare costs.
And the federal government has taxed tobacco products for many, many
decades, primarily to raise revenue but also, more recently, to reduce
tobacco use. So most recently, in 2009, in the Children's Health
Insurance Reauthorization Act—known by its acronym CHIPRA—in this act
Congress increased the federal excise taxes on cigarettes but also on
roll-your-own tobacco, pipe tobacco, and cigars. But importantly CHIPRA
taxed pipe tobacco and large cigars at much lower rates, creating large
disparities in tobacco taxation.

[ Jeremy Cluchey: ] There are some figures in your report that
demonstrate pretty clearly the dramatic changes that took place after
this law was implemented. Can you describe what you found?

[ David Gootnick: ] Yeah. Well, we looked at nationwide data on sales
for roll-your-own pipe tobacco and cigars spanning the implementation of
CHIPRA and we found that when the tax increases went into effect, this
was in April of 2009, the sales of roll-your-own and small cigars—these
are the high tax products—dropped significantly, and at the same time
sales of pipe tobacco and large cigars—these are the low tax
products—spiked upwards. In particular, sales of pipe tobacco increased
from about 250,000 pounds to over 3 million pounds between January and
September; and this is monthly sales. And during the same period, sales
of large cigars more than doubled, and at the same time small cigars
plummeted from roughly 430 million to about 60 million sticks per month.

[ Jeremy Cluchey: ] How easy was it for manufacturers and consumers of
these products to make this adjustment?

[ David Gootnick: ] Yeah, well the key here is that according to
industry experts and government officials and nongovernmental
organizations, a manufacturer shifted their products to take advantage
of the lower tax rate and smokers actually changed their purchasing
behavior in response to these price shifts. So manufacturers could shift
their products because the tax code differentiates roll-your-own and
pipe tobacco only by their appearance, their packaging, and labeling,
which allows manufacturers to simply relabel their products. And the tax
code distinguishes between small and large cigars solely by their
weight, so at 3 pounds per 1,000 sticks—that's the break point—a
manufacturer can modestly change the weight of their cigar. And we have
a photograph in our report of a small cigar and a filtered large cigar
and we can show that they're essentially indistinguishable. And likewise
for roll-your-own and pipe tobacco, they look and taste the same so
they're really substitutes.

[ Jeremy Cluchey: ] Your team also looked at the potential loss in
revenue to the federal government that resulted from these market
shifts. What did you find there?

[ David Gootnick: ] Right, we found that the shift to the lower tax
products, because of this shift, Treasury loss between $615 million and
$1.1 billion since CHIPRA went into effect; that's about 18 months of
data. And Treasury is well aware of this problem but the tax code
defines these products in the way that does not really give Treasury
direct or swift options by the regulatory or enforcement options to
differentiate them for the purposes of taxation.

[ Jeremy Cluchey: ] Finally, what steps is GAO recommending to address
the issues you outlined in this report?

[ David Gootnick: ] Ultimately because tobacco is taxed really both for
revenue purposes and to reduce, to discourage tobacco use and because
the tax differentials are incentives for manufacturers and consumers to
shift to the lower tax substitutes and with both health and revenue
implications there and because Treasury's options are limited, we
recommended that Congress consider equalizing the tax rates among these
products.

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