The loophole allowed companies to avoid huge tax increases on loose rolling tobacco by relabeling their product as pipe tobacco. The simple marketing twist lets companies pay $2.83 per pound, rather than the $24.78 per pound levied on rolling tobacco.
That proved an expensive technicality in the way the government pays for health insurance for poor children. Almost immediately, tobacco companies ramped up production of pipe tobacco to record levels and curtailed production of roll-your-own tobacco.
Daniel Morris, who tracks tobacco production data at the Oregon Department of Health, first identified the loophole late last year. In November, The Associated Press highlighted the millions being lost, but it was unclear at the time whether that represented a short-term change in production or a long-term trend.
The trend has not changed. In March, the one-year anniversary of the tax change, companies produced more than 2 million pounds of pipe tobacco. It was a record month for an industry that steadily produced about 270,000 pounds a month before the tax changed.
In a memo to colleagues last week, Morris estimated the U.S. lost more than $250 million in tax revenue in the first year of the law. States are losing money, too, because many base their taxes for roll-your-own and pipe tobacco on the wholesale price, which includes federal taxes.
"The magnitude was larger than I initially expected," Morris said. "I was expecting that once the loophole was identified, there'd be action to fix it."
Such action has stalled. The Obama administration said last year it would release new rules for differentiating roll-your-own tobacco from pipe tobacco, but it has yet to do so.
"We're still studying, from a technical standpoint, how to distinguish between the two products," said Arthur Resnick, a spokesman for the Alcohol and Tobacco Tax and Trade Bureau.
And on Capitol Hill, a bill to raise taxes on pipe tobacco to the same level as loose tobacco has yet to be debated.
"With the money we're losing, the deficits we have and the priority this administration and Congress have put on health care, to not find that revenue is just wrong," said Rep. Steve Cohen, D-Tenn., who wrote the bill to close the loophole.
Pipe tobacco is normally too coarse and moist to roll into a cigarette, but nothing says it has to be. The administration says the only distinction between pipe tobacco and roll-your-own tobacco is how it's labeled.
Norman Sharp of the Washington-based Pipe Tobacco Council said the small, legitimate pipe industry supports regulations distinguishing between traditional pipe tobacco and roll-your-own tobacco, which he said is being mislabeled.
"It's not really a loophole. It's fraud," Sharp said.
Morris said pipe tobacco production, and the lost revenues that go with it, could climb even higher because of a similar technicality in another law. In trying to crack down on tobacco smuggling, lawmakers prohibited shipping cigarettes and roll-your-own tobacco through the mail.
But the law didn't say anything about shipping pipe tobacco.