More than 230 years ago, one of the first acts of the First Congress in 1789 included a relatively mundane, but important, tax policy allowing a refund on excise taxes. Unfortunately, this has become a corporate subsidy for the tobacco and alcohol industries.
This, seemingly trivial, provision refunded excise taxes on imports that are later exported. This makes the U.S. a desirable intermediary port for international supply chains, as there is no penalty for shipping through American ports. It is common practice in many countries and is usually entirely uncontroversial, unless something has gone wrong. In the U.S. something has gone wrong with it, as it was modernized, a loophole was introduced.
The loophole resulted from two changes. First, in 1984 the refund, also known as a “drawback,” was expanded to allow companies to export a domestically produced substitute of the imported good, rather than the specific item they had brought in.
Functionally, little changed until 2004 when Congress clarified that the drawbacks could apply to excise taxes that had not been paid yet. Thus the “double drawback” loophole was born.
The double drawback is a tax loophole which allows a company to collect a tax refund on excise taxes it never paid just by deferring them. Here’s how it works: a company imports a product into a bonded warehouse, delaying payment of the excise tax. While the goods sit in the warehouse, the company exports the same amount of that product, and collects the refund as if the taxes were already paid. With the refund in hand the company is free to export the original imports, canceling out the original excise tax with no requirement to return their refund. The company is left with a taxpayer-funded subsidy.
To exploit this loophole effectively, a company needs to produce a standardized, interchangeable product and be large enough to import and export large volumes of the same product. This makes alcohol and tobacco prime industries to take advantage of the loophole.
Wine, and to a lesser degree other alcohols, was industry to capitalize on the double drawback. In 2018, the wine industry used the loophole to drawback the equivalent of 5 percent of total alcohol excise tax collections.
Customs and Border Protection attempted to reign in abuse of the double drawback by alcohol and tobacco companies in 2018, but ultimately fell short. Congress attempted a few years later to limit the double drawback for tobacco companies in particular, but this didn’t go far either.
However, the double drawback is back on the chopping block.
One provision in the budget reconciliation’s One Big Beautiful Bill Act would finally close the loophole for tobacco products. The solution is as simple as it is overdue: cap drawbacks to the amount of excise taxes that have actually been collected. This commonsense fix keeps the excise drawback to facilitate international trade routes through the U.S., while also eliminating a corporate giveaway that costs taxpayers $2.2 billion per year.
Some critics of the reform argue that closing the loophole is a tobacco tax or that it undermines the use of drawbacks in general. But eliminating a tax loophole is not a new tax, and legitimate drawbacks on taxes paid would remain fully intact.
Eliminating the handout for tobacco companies is a good first step but ending the double drawback entirely would restore the excise tax system to what it was for more than two centuries: a neutral, predictable policy—not a corporate ATM. Taxpayers deserve a trade policy that promotes fairness, not subsidies for those best at exploiting technicalities.
