Roll-Your-Own (RYO) cigarettes - using pipe tobacco instead of rolling tobacco..

August 30, 2010 - Scores of tobacco retailers in the U.S. are taking advantage of a federal tax loophole to offer deep discounts on roll-your-own cigarettes. About 150 tobacco outlets in some 20 states are deploying the novel roll-your-own machines to tempt recession-weary smokers, according to an estimate by one maker of the devices. But some regulators say the stores may be violating U.S. and state laws that govern cigarette manufacturing.

"These machines raise a number of questions," said David Rienzo, an assistant attorney general in New Hampshire, which has sued several retailers alleging they are acting as cigarette manufacturers and should pay applicable fees. (New Hampshire - sues 2-retailers that allow customers to roll their own cigarettes..)

Here's where the tax loophole comes into play: At retailers, The Wall Street Journal found, store employees or customers insert into the machines tobacco labeled "pipe tobacco." This substantially reduces the stores' and smokers' costs because the federal excise tax on pipe tobacco is $2.83 a pound—compared with $24.78 a pound (raising the excise tax by more than 2,000%) for the rolling tobacco traditionally used to make hand-rolled cigarettes. Congress in 2009 sharply raised the federal excise tax on rolling tobacco (typically used by smokers with lower incomes) to help finance the expansion of a children's health-insurance program backed by President Barack Obama.

New Hampshire's Mr. Rienzo said that after the tax increase took effect, "numerous manufacturers that sold roll-your-own [tobacco] said, 'Why not just put a pipe-tobacco label on it, and you won't have to pay the increased federal excise tax?'" Other companies created new brands they call pipe tobacco but essentially contain the same tobacco as in their roll-your-own products, said Kevin Altman, an independent tobacco-industry consultant in Richmond, Va.

Some cigarette makers decry the loophole that has created new low-priced competition. "We are complying with the law, but some companies are not doing so in order to gain an unfair advantage," said Ron Bernstein, chief executive of Liggett Vector Brands Inc., a unit of Vector Group Ltd. that is the fifth-largest U.S. cigarette maker by sales.

In the 14 months since the tax increase, the volume of pipe tobacco sold in the U.S. more than tripled to about 21 million pounds, according to data from the U.S. Treasury's Alcohol and Tobacco Tax and Trade Bureau. Rolling-tobacco sales volumes, in contrast, fell about 60%.

The tax loophole cost the U.S. government more than $345 million in the first 15 months since the tax increase, estimated Daniel Morris, who tracks tobacco production data for the Oregon Public Health Division.

Under U.S. Food and Drug Administration regulations, cigarette makers must place health-warning labels on packaging and can't use terms such as "light" in describing cigarettes—a term being used by some retailers selling the roll-your-own cartons, the Journal found. The FDA "is gathering more information about practices related to these machines to determine the appropriate regulatory response," an agency spokeswoman said.

Meanwhile, the Treasury's tobacco-tax bureau is soliciting industry input to help write new rules to clearly differentiate pipe tobacco from rolling tobacco. The process could take months, said an agency spokesman.

Reference: Roll-Your-Own Cigarette Machines Help Evade Steep Tax by DAVID KESMODEL (david.kesmodel@wsj.com), The Wall Street Journal, 8/30/2010.