Point: RYO Cigarette Shops on a Roll

GIRARD, Ohio -- A new generation of roll-your-own (RYO) cigarette machines has been spreading across the country at tobacco shops capitalizing on tax loopholes to deliver low-priced products, reported the Wall Street Journal.

Now lawmakers, backed by tobacco companies and convenience store chains, want to declare such shops to be manufacturers, said the report. That would subject them to the same taxes and regulations as the broader cigarette industry, which the newspaper said would be likely to put them out of business.

Instead of buying ready-made cigarettes, the shops' customers purchase loose tobacco and pour it into an ATM-sized machine that rolls 200 cigarettes in less than 10 minutes.

The cigarettes typically are made with leaves labeled "pipe tobacco'' and can sell for half what major brands cost, depending on state taxes, the report said.

Hundreds of such shops--mostly or entirely focused on the RYO machines--have opened since 2009, when Congress increased the federal excise tax on a carton of 200 cigarettes to $10.066 from $3.90 and hiked the tax on a pound of RYO cigarette tobacco to $24.78 from $1.0969. The tax for a pound of pipe tobacco rose only to $2.8311 from $1.0969.

Under a Senate bill passed Wednesday, any retailers making RYO machines available to customers would be treated like mainstream cigarette manufacturers. The provision was included in a rural school financing amendment tucked inside the federal surface transportation bill, which still needs House approval.

"[RYO] cigarette machines take advantage of an unintended tax loophole, and that isn't right,'' said Senator Max Baucus (D-Mont.), who chairs the Senate Finance Committee and sponsored the amendment. Representative Diane Black (R-Tenn.) introduced a separate bill earlier this month classifying the shops as manufacturers.

Richmond, Va.-based Altria Group Inc. and the National Association of Convenience Stores (NACS) have lobbied for such measures, which are finding support on both sides of the aisle. Governors in Virginia, South Dakota and Wyoming have signed similar bills this month, and legislatures in approximately 20 other states are weighing action.

In New York, state and city authorities filed lawsuits this week against a handful of RYO retailers for allegedly circumventing taxes and regulations. Ready-made cigarettes still have a market share of more than 95%, according to industry estimates cited by the Journal.

RYO Machines LLC, the largest maker of the machines, has hired its own lobbyists and lawyers to try and turn the tide. The company and affected tobacco shops say they have no way of complying with the regulatory requirements of being a cigarette manufacturer. They say they have not broken any laws and that large tobacco companies are trying to extinguish competition.

"I'm David fighting Goliath,'' Phil Accordino, part-owner of Girard, Ohio-based RYO Machines, told the newspaper. The company began manufacturing the machines in 2008. It has sold about 1,900 machines to tobacco shops in more than 40 states, including approximately 1,000 last year.

Stores pay a bit more than $30,000 for each machine, which takes two to three seconds to roll a cigarette. That is several times faster than smaller table-top versions, but still about 1,000 times slower than machines at big cigarette manufacturing plants.

The Alcohol & Tobacco Tax & Trade Bureau declared in 2010 that retailers with the machines are manufacturers, but RYO Machines secured a preliminary injunction in a federal court in Ohio. Oral arguments in that case are expected to begin next month. It also has won injunctions in a handful of states, including Connecticut and Wisconsin.

In the meantime, RYO shops continue to spread in places like Smyrna, Ga., where Tobacco Road opened its doors last November with four machines in a converted KFC fast-food restaurant. A steady stream of smokers filed in this week, drawn by signs touting cigarette cartons for $23.80, which includes the fee to use a machine, said the report.

Critics say such shops unfairly avoid hefty taxes and fees levied on cigarette manufacturers. They also say shops use cigarette tobacco that has been mislabeled as pipe tobacco to gain a further price advantage. Pipe tobacco traditionally is moister than cigarette tobacco with a wider cut.

"We want to see a level playing field,'' Ronald Bernstein, CEO of Mebane, N.C.-based Liggett Group LLC, part of Vector Group Ltd., a large U.S. cigarette company, told the Journal.

Sales of pipe tobacco that end up in pipes have been declining for decades, shrinking by about two-thirds between 1990 and 2008, according to industry estimates cited by the report.

[Editor's Note: For an opposing view, see Counterpoint: Back Taxes Eventually Will Bite Retailers in this issue of CSP Daily News.]