By Annika McGinnis
WASHINGTON (Reuters) - A 2009 law that raised federal taxes to discourage smoking cost the U.S. government billions of dollars in lost revenue as manufacturers relabeled products and consumers shifted to cheaper pipe tobacco and large cigars, the U.S. Government Accountability Office said in a report released on Tuesday.
The GAO estimated $2.6 billion to $3.7 billion in lost revenue from April 2009 to February 2014 as manufacturers exploited loopholes in the Children's Health Insurance Program Reauthorization Act which raised taxes for smoking-tobacco products.
"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," the congressional watchdog agency said in the report, which was the focus of a Senate hearing on Tuesday.
At the hearing, Liggett Vector Brands LLC Chief Executive Ronald Bernstein urged lawmakers to take action against abuses by manufacturers.
He held up two seemingly identical, but differently labeled non-Liggett bags of tobacco. Showing a third sample, he pointed out that a label saying "all-natural pipe tobacco" covered up a statement that the bag "makes approximately 500 cigarettes."
"Everyone knows this is cigarette tobacco," Bernstein said. "The manufacturer knows. The consumer knows. And I know. I know because I tried smoking it in a pipe and it was not a pleasant experience."
Some manufacturers also add a few ounces of tobacco to small cigars so they qualify as the larger product. Others even mix in clay or kitty litter to increase the weight, Michael Tynan, policy officer at the Oregon Public Health Division, told the hearing.
The GAO said the tobacco market shifted accordingly. Yearly sales of pipe tobacco rose more than eight-fold from fiscal 2008 to 2013, while sales of roll-your-own tobacco declined almost six-fold.
Over the same period, large cigar sales doubled, while small cigar sales dropped to just 700 million from 5.7 billion.
Senate Finance Committee Chairman Ron Wyden, who convened the hearing, criticized the Treasury Department's Alcohol and Tobacco Tax and Trade Bureau (TTB), which is responsible for collecting tobacco taxes and cracking down on evasion, for "footdragging."
In recent years, the agency has pushed to apply "advanced investigative techniques to uncover illicit trade and fraudulent activity," including deploying about 125 auditors and investigators, the TTB wrote in its Senate testimony.
Responding to a push to better differentiate between roll-your-own and pipe tobacco, the agency published an "advanced notice of proposed rule making" in 2010 and 2011. But no rule had yet been issued, the GAO wrote.
In 2015, the TTB will issue a proposed regulation cracking down on the illegal activities, TTB Administrator John Manfreda said on Tuesday.
But Wyden, an Oregon Democrat, said it was not enough. He said the problem reminded him of "the old marquee at the movie house that says: 'Coming soon,' and it never gets there."
(Reporting by Annika McGinnis; Editing by Peter Cooney)