While cigarettes are the smoking tobacco product preferred by most smokers, the consumption of other smoking tobacco products is growing. Cigarettes continue to dominate the market for domestic and imported smoking tobacco products, accounting for approximately 88 percent of sales in fiscal year 2013. However, sales of other smoking tobacco products increased in fiscal years 2001 through 2013, with combined sales of roll-your-own tobacco, pipe tobacco, and small and large cigars, both domestic and imported, growing from 3 percent of the smoking tobacco market to about 12 percent. Roll-your-own tobacco, pipe tobacco, and small and large cigars are broadly defined in the IRC. Roll-your-own tobacco and pipe tobacco are defined by such factors as the use for which the product is suited and how the products are offered for sale, as indicated by their appearance, type, packaging, and labeling. The definitions in the IRC do not specify the physical characteristics that would differentiate pipe tobacco from roll- your-own tobacco. Cigars are differentiated from cigarettes by their wrapper and whether the product is, for a number of reasons, likely to be offered to, or purchased by, consumers as a cigarette. The IRC distinguishes between small and large cigars only by weight; small cigars are defined as weighing 3 pounds or less per thousand sticks. Figure 1 shows a sample of different smoking tobacco products. The federal excise tax rates on different tobacco products are calculated in different ways. Cigarettes and small cigars are taxed on a per unit basis—the number of sticks. Roll-your-own and pipe tobacco are taxed by weight. Before CHIPRA, the federal excise tax rate on cigarettes was higher than the rates on roll-your-own tobacco, pipe tobacco, and small cigars. 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. 2). Prior to CHIPRA, roll-your-own and pipe tobacco were taxed at the same rate ($1.10 per pound). However, CHIPRA raised the federal excise tax rates for roll-your-own tobacco and pipe tobacco by different amounts, resulting in a $21.95 per pound difference between the higher-taxed roll-your-own tobacco ($24.78 per pound) and the lower-taxed pipe tobacco ($2.83 per pound). As a result, of the three cigarette products shown in figure 1, the cigarette made with pipe tobacco (marked as number 2) is taxed at a much lower rate than either the factory-made cigarette (number 3) or the cigarette made with roll-your-own tobacco (number 1). CHIPRA also significantly changed the federal excise tax rate on large cigars. Large cigars are unique among tobacco products in that the tax rate is ad valorem—calculated as a percentage of the manufacturer’s or importer’s sale price—up to a maximum tax per thousand sticks. While CHIPRA increased the small cigar tax rate from $1.83 to $50.33 per thousand sticks (the same rate as cigarettes), the ad valorem rate for large cigars increased from 20.72 percent to 52.75 percent of the manufacturer’s or importer’s sale price, up to a maximum tax of $402.60 per thousand sticks (see table 1). As a result, cigars with a manufacturer’s price of $50 per thousand, for example, would experience a tax savings of $23.95 per thousand if they qualified as large rather than small cigars. In figure 1, although the small cigar (marked as number 4) and the filtered large cigar (number 5) are similar in appearance, they are likely taxed at significantly different rates, depending on the price of the filtered large cigar. Domestic manufacturers and importers of tobacco products must obtain a permit from Treasury before engaging in business. Treasury collects the federal excise taxes on domestic tobacco products when these products leave manufacturing facilities. CBP collects the federal excise taxes on imported tobacco products when those products are released from customs. According to Treasury, when Treasury investigates or audits an importer of tobacco products and determines liability, Treasury refers the case to CBP for collection of the tax. 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. Specifically, the market for roll-your-own tobacco shifted to pipe tobacco, and the cigar market shifted from small to large 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. Market trends for roll-your-own and pipe tobacco changed immediately after CHIPRA, with sales of pipe tobacco rising steeply while sales of roll- your-own tobacco plummeted. CHIPRA introduced a large disparity in rates on these two products, which had been taxed at the same rate, as shown previously in figure 2. Figure 3 shows the market shift through monthly and annual sales of domestic and imported roll-your-own and pipe tobacco from October 2000 through February 2014. 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. According to government officials, representatives of nongovernmental organizations, and industry, the new pipe tobacco products have minimal, if any, differences from roll-your-own tobacco products. Treasury also emphasized that it is unclear to what extent domestic manufacturers modified their roll-your-own tobacco beyond reclassifying it as pipe tobacco. Representatives of industry and nongovernmental organizations provided examples of current pipe tobacco brands that had been roll-your-own brands prior to CHIPRA, with minimal differences in the packaging and the appearance of the tobacco itself. For both our 2012 report and this testimony, we found examples of Internet retailers signaling to customers in their marketing that pipe tobacco was suitable for smoking in roll-your-own cigarettes. In 2011, we approached 15 pipe tobacco manufacturers based in the United States to ask about their companies’ actions in response to the CHIPRA tax changes. Each of the three tobacco manufacturers that agreed to speak with us explained that their companies switched from selling higher-taxed roll-your-own tobacco to lower-taxed pipe tobacco to stay competitive. One company changed the cut of its roll-your-own tobacco and labeled it as pipe tobacco, although a company representative acknowledged that there was no real difference between its roll-your-own tobacco and its pipe-cut tobacco. A representative from another company that switched from selling roll-your-own tobacco to selling pipe tobacco stated that she was not aware of any difference in the two products other than the federal excise tax rate. As of April 2014, each of the three companies continued to manufacture the same brand of pipe tobacco. We noted in our 2012 report that the rise in pipe tobacco sales after CHIPRA coincided with the growing availability of roll-your-own machines. Treasury officials stated that the use of roll-your-own machines, which enabled customers to produce a carton of cigarettes using pipe tobacco and cigarette-paper tubes with filters, had grown considerably. By using pipe tobacco instead of roll-your-own tobacco, customers were able to save almost $9 per carton in federal excise taxes. In addition, a roll-your- own machine could produce a carton of cigarettes in less than 10 minutes, providing a significant time saving compared with rolling cigarettes by hand. Following the publication of our report in April 2012, the President signed the Moving Ahead for Progress in the 21st Century Act (MAP-21) on July 6, 2012, which clarified the definition of “manufacturer of tobacco products” for tax purposes. The relevant MAP-21 provision amended the IRC and states that the term manufacturer of tobacco products shall include any person who, for commercial purposes, makes available for consumer use a machine capable of making cigarettes, cigars, or other tobacco products. As a manufacturer of tobacco products, such a person is liable for the federal excise tax on the resulting tobacco products. According to Treasury officials and experts, some retailers responded to the MAP-21 legislation by establishing social clubs that make available to their members machines capable of making cigarettes from pipe tobacco. However, according to Treasury’s guidance, the tax liability applies to any person who for commercial purposes makes the machine available for use by consumers of tobacco products regardless of whether the machine is used at a retail premises. The guidance goes on to state that the nonprofit status of the “person” is not relevant in evaluating “commercial purposes.” The statutory and regulatory requirements for manufacturers of tobacco products include obtaining a permit from Treasury before engaging in business; filing tax returns and paying the federal excise tax on a semimonthly schedule; paying a special (occupational) tax; obtaining a bond; and complying with Treasury’s record-keeping, reporting, and inventory requirements. Following the passage of MAP-21, Treasury received 92 applications for tobacco manufacturer permits; it determined that only 4 of these applications involved roll-your-own machines. Of the 4 applicants, none are currently manufacturing under the requested permit: the applicants have either gone out of business, are no longer pursuing their application, or are currently being investigated by Treasury.