WOOD DALE, Ill.—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. But the practice is attracting scrutiny from regulators and cigarette manufacturers.
At Smoke Zone, a store in this Chicago suburb, customers one recent afternoon flocked to two high-speed rolling machines that produce a carton of cigarettes in eight minutes. The price: $21—less than half the cost of a carton of Marlboro cigarettes.
“People have waited an hour for these some days,” said Taren DeNicolo, the store’s manager.
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.
Here’s where the tax loophole comes into play: At Smoke Zone and other 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 for the rolling tobacco traditionally used to make hand-rolled cigarettes.
Congress in 2009 sharply raised the federal excise tax on rolling tobacco 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.
Shargio Patel, president of Inter-Continental Trading USA Inc. in Mount Prospect, Ill., confirmed his company began offering pipe tobacco under its OHM brand that is similar to its rolling tobacco due to the tax increase. “We’re just following what other companies are doing,” he said.
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.
Some loose-tobacco makers and retailers say they are doing nothing wrong and that Congress created the problem by raising the excise tax on rolling tobacco—typically used by smokers with lower incomes—by more than 2,000%. “I don’t think the founding fathers of this country meant for taxes that could put companies out of business,” said Jeff Martin, general manager of Rouseco Inc., a pipe and rolling tobacco maker in Kinston, N.C.
Phil Accordino, co-owner of RYO Machine Rental LLC of Girard, Ohio, says his company has sold or leased about 200 of the rolling machines. He said his company, which is about two years old, simply has improved on gadgets some consumers use to roll their own cigarettes.
Jerry Kunz, 39 years old, left a store in Addison, Ill., recently with five cartons of cigarettes made by the machines. “They’re not as good as Marlboro,” he said, but “it’s saving you money.”