* For 'roll-your-own' cigarette machines, a brief boom
* Big Tobacco and health group form rare alliance
* One couple's story: unexpected riches, and then despair
By Andy Sullivan
AUBURN, Washington, Sept 8 Jean and Larry Wood
weren't thinking about politics when they opened Butt's Tobacco
in a tidy strip mall south of Seattle in February 2011.
They weren't aware that a federal children's health law had
inadvertently turbocharged their discount-cigarette business,
and they didn't know that a federal highway law soon would
Washington, D.C., was on the other side of the continent,
and it felt even more distant.
Over the next 2-1/2 years, Butt's Tobacco would shower Jean
and Larry with unexpected riches before eating up their life
savings. Along the way, it would deliver a harsh lesson in the
ways of American politics.
The story of Butt's Tobacco, and the hundreds of similar
"roll-your-own" cigarette retail operations that briefly
flourished across the United States, illustrates the unintended
consequences that can ripple out from Washington as seemingly
minor elements of complex legislation change lives and upend
It also illustrates the difficulty of closing a tax loophole
once it has been opened.
The solution adopted by Congress effectively shuttered many
mom-and-pop tobacco retailers, but the tax disparities that
first made the business attractive remain in place.
As she struggles to stay afloat, Jean Wood has drawn a
bitter lesson from the experience.
"The guy with the most money wins," she says.
THE ACCIDENTAL LOOPHOLE
As one of his first acts in office in February 2009,
President Barack Obama signed a law that extended health
insurance to children who lacked coverage. The Children's Health
Insurance Program Reauthorization Act raised cigarette taxes
from 39 cents to $1.01 per pack.
To discourage smokers from switching to other forms of
tobacco to avoid the tax, loose cigarette tobacco and small,
cigarette-like cigars were taxed at the same rate.
Lawmakers thought cigarette smokers weren't likely to switch
to pipe tobacco and large cigars, so they taxed those forms of
tobacco at a lower rate.
They were wrong.
Shortly after the law took effect, tobacco manufacturers
changed their product lines to avoid the higher tax rates,
according to internal company documents obtained by the U.S.
House of Representatives Energy and Commerce Committee.
Cigar makers increased the size of their small cigars to
meet the federal definition of a "large cigar" and thus qualify
for the lower tax rate, according to the committee.
Companies that sold loose cigarette tobacco had it easier -
in some cases, they simply relabeled their existing product as
"pipe tobacco," documents show. That subjected them to taxes of
$2.83 per pound, rather than $24.78 per pound they would have to
collect for cigarette tobacco.
Meanwhile, an Ohio manufacturer had developed a machine that
would make loose tobacco more appealing to many consumers. The
RYO Filling Station could turn a bag of loose tobacco into a
carton of 200 finished cigarettes in about 15 minutes, compared
with the hours it would take someone to roll that many smokes by
The machine wasn't built to exploit the loophole. It hit the
market in 2008, well before the new taxes took effect.
Developer Phil Accordino required retailers to use the
machine in a way that would minimize their exposure to a
separate set of taxes. By requiring customers, not store
employees, to operate the $32,000 machine, shop owners could
argue that they were not liable for taxes on pre-made cigarettes
because they were providing a service for customers who
otherwise would roll their smokes by hand.
Together, the new machine and the low-tax "pipe" tobacco
made a compelling value proposition, enabling consumers to walk
out the door with a carton of cigarettes at one-third the cost
of premium, factory-made cigarettes such as Marlboro and Camel.
"I thought, 'Wow, that's an equation that makes sense in a
bad economy - people are saving money for a product they're
addicted to,'" said entrepreneur Joe Baba, who sold 120 RYO
machines in the Pacific Northwest as a distributor for the
Jean and Larry Wood, both 51, were among his customers. They
cashed out Larry's $75,000 pension from his former job as a
sprinkler-system installer, bought an RYO machine and opened up
Butt's Tobacco in Edgewood, Washington, a blue-collar city near
their hometown of Auburn.
Customers could get a carton of cigarettes made from pipe
tobacco for $36, compared to $80 or so that other retailers
charged for a carton of Marlboros. The Woods cleared $15 on each
Butt's Tobacco was an immediate success. The Woods took in
$312,000 in revenue during their first year, enough to open up a
second store in Auburn. Customers would gossip or watch TV while
they waited to use the rolling machine, which often was booked
days in advance. Their kids got free coloring books and candy.
"It was really fun," Jean said. "Smokers are really relaxed
people, more so than nonsmokers."
Baba had warned the couple that their business might suffer
if lawmakers decided to raise taxes on pipe tobacco. But they
figured that wouldn't happen for at least five years or so.
AN UNLIKELY ALLIANCE
By early 2012, the impact of the children's health law on
the tobacco market was clear.
Congressional researchers said it had shifted
price-sensitive consumers toward lower-taxed forms of tobacco,
depriving the U.S. government of up to $1.1 billion in lost
revenue in the 18 months after the law was enacted.
Meanwhile, 2,000 RYO Filling Stations were humming away in
smoke shops across the nation. The U.S. Alcohol and Tobacco
Trade and Tax Bureau estimated that each machine cost the
government $156,000 a year in lost cigarette-manufacturer taxes,
on top of the money lost to the pipe tobacco loophole.
That agency had ruled in September 2010 that roll-your-own
operators like the Woods should have to pay the taxes levied on
conventional cigarette manufacturers. But a federal judge
suspended the rule while the issue played out in court.
The new landscape created allies among powerful groups that
more often squared off as adversaries.
Convenience-store operators said the new competitors were
unfairly exploiting a tax loophole.
Public-health advocates worried that the roll-your-own shops
were undermining their goal of curbing the top preventable cause
of death in the country.
Big cigarette makers saw a threat to their core business.
"These low-priced alternatives are clearly affecting the
reported decline of cigarette industry volume," RJ Reynolds
president Andrew Gilchrist told investors in November 2011.
As cigarette sales had fallen steadily during the past
decade, tobacco giants had fiercely fought the tax increases
that they feared would prompt more smokers to quit.
The tobacco companies had been unable to block the 2009
federal tax increase, but they have had more success in recent
years as dozens of conservative Tea Party Republicans won
legislative office on small-government, anti-tax platforms.
Altria, the owner of Marlboro cigarettes maker Philip
Morris, says it helped defeat 25 proposed tax increases in 2011
In Congress, Democrats proposed eliminating the tax loophole
by equalizing tax rates across all forms of tobacco. But
Republicans blocked the measure on the grounds that it would
amount to a tax increase, Democratic aides say.
So tobacco companies and public-health advocates, usually
fierce adversaries, agreed on a solution: They would not try to
raise taxes on pipe tobacco, but would press lawmakers to write
a law that would require roll-your-own tobacco sellers to pay
the manufactured-cigarette taxes that they had managed to fend
off in court. Roll-your-own retailers would not be liable for
back taxes on the sales they had already made.
"Every now and then there are things (tobacco companies)
happen to support that we know will improve public health," said
Danny McGoldrick, a vice president at the Campaign for
Convenience-store trade groups, representing 150,000 stores
in all 435 congressional districts, led the effort.
The coalition launched a state-by-state lobbying effort and
pressed Congress to take up the issue.
Roll-your-own cigarette sellers fought back at the state
level. In Washington state, Jean Wood testified before the
legislature, arguing that imposing a manufacturers' tax would
eliminate 1,900 jobs across the state. She and her husband
helped to collect 300,000 signatures to bolster their argument.
But in the halls of the U.S. Congress, the retailers were
"I lobbied in Washington multiple times, and everyone I
talked to said the same thing: 'You're going to get screwed here
and there's nothing you can do about it because there's too much
money against you,'" said Accordino, the RYO manufacturer.
Federal lobbying records show that Accordino's company spent
$250,000 to make its case in 2011 and 2012.
The National Association of Convenience Stores, by contrast,
spent $8.1 million on lobbying during that period.
Tobacco companies spent more than $80 million, on everything
from trade agreements to health regulations.
They found a sympathetic ear in Republican Representative
Diane Black of Tennessee, who introduced a bill that would
require roll-your-own cigarette retailers to pay the
manufacturers' tax. It drew the support of 75 other lawmakers in
the U.S. House.
It also drew the attention of Democratic Senator Max Baucus
The powerful chairman of the Senate Finance Committee had
written the tobacco tax increases into the health law, and he
was unhappy with the way they were playing out.
He also was looking to find a way to help local governments
pay for roads and schools in rural areas where the federal
government owns large swaths of land. Budget analysts said
Black's measure would boost federal tax revenue by $94 million
over 10 years.
As the Senate debated a sweeping transportation bill in
early 2012, Baucus proposed using Black's approach to partially
offset the cost of the rural-government funding. His amendment
passed the Senate by a vote of 82-16 and was added to the
transportation bill, which easily passed the Senate and House.
Roll-your-own operators felt blindsided. They had made their
case at the state level but said they were not prepared to fight
a provision that was tucked into an unrelated law with little
"We were outmuscled and outspent by Big Tobacco," said Baba,
the RYO distributor.
Those on the other side of the fight say convenience stores,
not tobacco companies, did most of the heavy lifting.
"Big Tobacco did not crush them. Main Street crushed them,"
said Corey Fitze, a lobbyist with the National Association of
Convenience Stores (NACS).
JOBS GONE, LOOPHOLE REMAINS
The new law required Butt's Tobacco to collect an additional
$30.66 in federal and state taxes on each carton of cigarettes
it sold. Price-conscious smokers could find cheaper smokes at
the nearby Muckleshoot Indian reservation.
Jean and Larry Wood sold 49 cartons in June, roughly what
they used to sell in one day. They returned their manufacturing
license last month, and their RYO machine now sits unused in the
back of the store. The retirement fund that Larry built up over
25 years is gone. With one store shuttered, they hope electronic
cigarettes and marijuana pipes can generate enough income to
cover their $1,000 monthly lease at their remaining location.
"I never knew a lot about politics until this, and I can
tell you it is so crooked," Jean said. "Anything can be bought."
A year after the rule took effect, the roll-your-own
industry has been nearly wiped out. Baba, the machine
distributor, estimates that the change has eliminated 10,000
retail jobs across the country.
It's not clear whether the new requirement has led to more
tax revenue, as Baucus promised. The Treasury Department has
collected $12.7 billion in taxes from smokable tobacco products
so far this year, down 6 percent from the same period last year.
The government now collects less revenue from pipe tobacco
and roll-your-own cigarette tobacco. Regulators have been unable
to come up with a formal definition that would specifically
define the difference between the two types of tobacco.
Although roll-your-own retailers now face the same
manufacturers' tax imposed on factory-made cigarettes, the
loophole that taxes pipe tobacco and small cigars at a lower
rate remains in place.
That benefits the small manufacturers who produce loose pipe
tobacco, as well as retailers that sell the product to
cost-conscious cigarette smokers who now have to roll their own
It also helps giants such as Altria, which makes the Black
and Mild cigars that account for 30 percent of the low-tax
"large cigar" market.
Efforts to equalize tobacco taxes have gone nowhere in
Altria and RJ Reynolds, the maker of Camel
cigarettes, issued identical statements in response to questions
from Reuters and declined further comment.
"We supported the retail coalition led by NACS to correct
this issue and were pleased when Congress closed a loophole it
had created," both companies said.
Phil Accordino, the RYO manufacturer, says the legal and
lobbying battles around his business ate up all of his profits.
With a bare-bones operation, he is now trying to crack the
market in Europe, where hand-rolled tobacco is more prevalent
and popular brands such as Marlboro are available in pouch form.
The tobacco makers who drove him out of business in the
United States are eager to work with him over there, he says.