1 Goldwater Institute 11 you re like a lot of smokers these days, it probably isn t smoking that you want to -..,i give up. It s some of that tar and nicotine you ve been hearing about. (Count 36) As Jonathan Rauch points out, many of the counts essentially redetine fraud and racketeering as publicly disagreeing with the government. The counts exist in a gray area where the distinction between honest disagreement and fraud is not clear. Walter Olson notes: there can scarcely be a better way to silence one side than to concoct a theory that exposes it to charges of racketeering for disseminating views its opponents consider erroneous. What Hath the Settlement Wrought? This leads to the question of whether the provisions of the tobacco settlement can achieve their stated purpose (other than providing state governments with barrels of cash). The terms of the settlement are based on the belief that cigarette advertising, especially that aimed at adolescents, is the cause of the smoking problem, and that bans on forms of advertising and promotion will reduce the number of smokers, creating a healthier population and reducing the cost to the states. Yet, the link between advertising and smoking is weak. Some researchers have found a small effect; others have not. International comparisons are also inconclusive. There are advertising bans in both Sweden and Norway, yet the level of smoking in Sweden is low (although about 15 percent of the population are regular users of snuff),21 while in Norway it is high. The teen-age smoking rate in Finland began to increase after an advertising ban in In addition, any conspiracy by the tobacco companies to downplay to the public the dangers of smoking has not succeeded. The public actually overestimates the risk of smoking. Out of every 100 smokers, 18 to 36 are likely to die due to a smoking related illness. When asked by a survey, respondents put the risk from smoking at 54 deaths per By banning some forms of promotion and advertising, the attorneys general may have unwittingly played the role of Baptists to the big tobacco companies bootleggers. If, as many contend, the main purpose of cigarette advertising 9 U.S. vs. Philip Morris et al. Appendix to Complaint 20 Jonathan Rauch (1999) Bob Dole. Tobacco Racketeer, National Journal, October 2, pp Nicholas George (1999) Swedes consume over 150m tins of snuff a year and about 15% of the population are regular users, Financial Times, USA edition, April Sherman Folland, Allen C. Goodman and Miron Stano (1993) The Economics ofhealth and Health Care, Macmillan, NY, pp ; Sol1 urn supra n. 6 pp ; Dwight R. Lee (1997) Will Government s Crusade Against Tobacco Work? Contemporary Issues Series 86, Center for the Study of American Business, Washington University, St. Louis, csab.wustl.edu/research/73.asp. L-2 23 Jane G. Gravelle and Dennis Zimmerman (1994) Cigarette Taxes to Fund Health Care Reform: An Economic Analysis, Report , Congressional Research Service, Washington. DC.
2 12 CoEdwater Institute c campaigns is to fight over a fixed pool of smokers, then mutual disarmament by reducing promotion expenditures actually benefits the tobacco companies. It especially benefits large companies by helping to freeze into place market shares. It is noteworthy that the current market leaders, R. J. Reynolds and Phillip Morris led the settlement talks and included restrictions on advertising and promotion in their opening offer.2* The agreement provides even more explicit protection to the large tobacco companies. Any other tobacco company that wishes to sign on to the agreement does not have to make payments unless its market share exceeds 125 percent of it market share in Of course any companies that do not want to come into the fold of the agreement are left to the mercy of litigious government officials, plus have to pay an additional tax. (See below) Companies with no market share in 1997, have a stipulated market share of zero. Thus the settlement creates a prohibitive barrier to entry to any company foolish enough to wish to enter the U.S. cigarette market.a5 If the effect of curtailing promotion and advertising is uncertain, will any price increases caused by the settlement have a positive effect?2g Economic studies of the price elasticity of smoking estimate that the elasticity for the participation rate is around That is, a 10 percent increase in the price of cigarettes will. reduce the number of smokers by 3.1 percent. This number is higher for teenagers; i- some estimate it as high as -1.2 (a 10 percent increase leads to a 12 percent ~decrease in teen smoking,)~ although recent, more careful work estimates the participation elasticity for teens to be around -0.5 to Estimates of the effect of price on the number of cigarettes smoked find an elasticity of -0.11, that is a 10 percent increase in the price of cigarettes reduces the number of cigarettes smoked per smoker by 1.1 percent.27 Smoking is also a well-established risk factor in birth outcomes. A high rate of smoking by expectant mothers is associated with a high incidence of low birth weight babies. A study by Evans and Ringel found that a one-cent increase in the t: 2 Sollum. supra n. 6, p, Master Settlement Agreement pp The payments by the tobacco companies are lump sums. which would normally imply that the cost of the settlement would be borne by those unlucky enough to be holding tobacco company stock at the time of the settlement. However, the payments are allocated among the companies by market share. which effectively increases per-unit cost, leading to an increase in price. See Jane G. GravelIe (1998) The Proposed Tobacco Settlement: Effects on Prices, Smoking Behavior, and Income Distribution, report Congressional Research Service, Washington, DC. Indeed on the very day the tobacco settlement was sealed, Philip Morris and R.J. Reynolds announced a the biggest U.S. cigarette price hike ever. The Washington Post (1998) Cigarette Prices Rise Sharply in Wake of States Tobacco Settlement, November 24, p. A Grave& and Zimmerman supra n. 23, p. 27; Gravelle (1998) supra n. 26.
3 Goldwater Institute 1.3 cigarette excise tax associated with a.16 to.21 gram (less than one ounce) increase in average birth weight.28 On the other hand, there is evidence that higher cigarette prices will not necessarily lead to improvements in health. Smokers can always try to get their fix of nicotine and tar by taking longer drags, reducing the time between puffs or switching to brands with more tar and nicotine. Evans and Farrelly found that smokers in high-tax states buy cigarettes that are longer and higher in tar and nicotine than smokers in low-tax states. This effect is so large that any reduction in smoking is negated and actual daily intake of tar is unaffected. For young adults, tax hikes actually increase average daily tar and nicotine consumption.ss Indeed, a recent study by the Centers for Disease Control found that teenagers are increasingly attracted to non-filtered, high-nicotine cigarettes from India.30 Predatory Public Finance Whatever the settlement s effects on public health, it has set an unhealthy precedent for public finance. Instead of going to taxpayers and asking for money to pay for government programs, politicians now may try to raise funds by preying on businesses in order to recover the costs their products impose on the public. This process of raising funds by persecuting alleged wrongdoers has been called predatory public finance by Benson and Rasmussen, who coined the term ~to refer to the escalation in the war on drugs due to the incentives caused by asset forfeiture laws.31 The states and their lawyer collaborators are already targeting gun manufacturers, HMO s, Microsoft and paint manufacturers. s Fundraising through litigation is dangerous because it usurps legislative powers. The question of how much money government should take from the people should be decided in open debate by the people s elected representatives, not in private strategy sessions and negotiations involving a handful of attorneys whose motivations and interests may or may not coincide with those of the public. The common justification that the tobacco companies are compensating the states for the cost of smoking related illnesses is not supported by the evidence. The net external cost of smoking, that is those not borne by the smokers 28 William N. Evans and Jeanne S. Ringel (1999) C an higher cigarette taxes improve birth outcomes? Journal of Public Economics, 72: *!J William N. Evans and Matthew C. Farrelly (1998) The compensating behavior of smokers: taxes, tar, and nicotine, RAND Journal of Economics, 29(3): Wall Street Journal (1999) Cigarettes From India Said to Be Gaining Favor With Teens, September 17, p. B5. 31 Asset forfeiture laws allow law enforcement agencies to seize property allegedly used in B drug crime and directly acquire the proceeds from its sale. Bruce L. Benson and David W. Rasmussen (1996) Predatory Public Finance and the War on Drugs, The Independent Reuiew, l(2): Judyth Pendell (1999) Trial Lawyers Next Target: The Paint Industry, The Wall Streel Journal. October 18, p. A49; Steven Syre and Charles Stein (1999) Tobacco lawsuit spinoff may cause waves in market, The Arizona Republic. October 24, p. D5.
4 14 Goldwater Institute -.- themselves, is estimated to be 22 to 29 cents per pack in 1997 dollars.33 This represents the maximum amount that government at all levels would have to bear. Yet the state of Arizona alone collects 58 cents per pack in excise taxes. Thus, in Arizona, smokers are net contributors to the state coffers. Preying on the tobacco industry to fund government programs is also questionable on fairness grounds, Smoking is much more prevalent among the poor than the rich. Of those with incomes less than $10,000, 31.6 percent smoke, and the average burden of cigarette taxes is 5.1 percent of income. For those with incomes over $50,000, 19.3 percent smoke, and the average burden of the cigarette tax is 0.4 percent of income.34 To the extent that the settlement is paid for by higher cigarette prices, a relatively large fraction of this money will come from the lower income groups. The Payoff The tobacco settlement has scheduled cigarette manufacturers to disgorge nearly $90 billion to the states over the next ten years. The actual amount paid each year may differ since the payments specified in the settlement are adjusted each year according to the following factors. l Inflation Adjustment. Each year s Annual Payment (but not the Initial Payment) will be adjusted by the higher of either the yearly increase in the Consumer Price Index or 3 percent. The adjustment will be compounded annually so even though the settlement states nominal amounts, the payments are effectively in real, 1999 dollars. l Vohne Adjustment. Each year s Annual and Initial Payments will be adjusted up or down in proportion to how the level of cigarette shipments in the previous year compare to a 1997 baseline. Thus, if shipments in 2003 are 10 percent less than they were in 1997, the 2004 payments will be decreased by roughly 10 percent. l Previously Settled States Reduction. Approximately 12 percent is cut from each year s Annual Payment to account for the four states that had settled with the tobacco companies before the settlement. l Non-Settling States Reduction. If any state is terminated from the settlement, overall payments are reduced by that state s share. This does not affect the amount paid to other states. After these adjustments are made, the resulting aggregate payment is disbursed to the states according to fixed percentages specified in the settlement. 33 Gravelle and Zimmerman supra n. 23, p Cravelle supra n. 26, p. 15.
5 Goldwater Institute 15 (Arizona s is roughly 1.5 percent.) Each individual state may have its allotment adjusted as well for the following reasons. l Non-Participating Manufacturer (NPIM) Adjustment. If the tobacco companies participating in the agreement lose market share because of the settlement then states that have not passed the Model Statute (discussed further below) specified in the settlement will have their payments reduced.. Other Adjustments. If a state or its subdivisions receive money due to further litigation, its payments from the settlement will be reduced by an equal amount. This includes any money states may receive from any federal tobacco tax enacted prior to In order to protect itself from the NPM adjustment a state must enact a model statute exactly as it is drafted in the settlement. By enacting the statute, a state would require tobacco companies that have not signed the Agreement to pay approximately 2 cents per cigarette sold in that state into a reserve fund to pay future claims. Its intent is to protect companies that have signed on to the agreement, and thus are burdened with making annual payments, from having their prices undercut by cigarette makers not participating in the agreement.33 U In the United States, individuals and companies are supposed to pay damages only after receiving due process in a court of law, or before a regulatory body. The fact that legislative action may force cigarette makers choosing not to participate in the agreement to pay damages ex ante into an escrow fund is another disquieting novelty of this agreement. The model statute looks disturbingly like a bill of attainder. The rationale of holding future damages in escrow is especially dubious. First as we have seen above, any financial cost to the state is more than offset by its current tobacco tax. Second, the chief accusations in the State of Arizona s lawsuit were that the tobacco companies conspired to commit fraud by hiding the harmful effects of smoking from the public, What grounds would a state have to withhold future damages from a cigarette company that did not participate in the conspiracy and is utterly frank about the effects of its products? Figure 1 shows an estimate of how much money Arizona can expect to get over the next ten years from the settlement. It assumes a 3 percent annual adjustment for inflation and estimates of the volume adjustments developed by $6 National Conference of State Legislators (1999) Snapshot of Tobacco Settlement Activity,
6 16 Goldmater Institute Standard and Poor sss Arizona can expect approximately $100 million per year-a 1.7 percent goose to annual revenue of the state s General Fund. (The state already has over $35 million waiting for it in an escrow fund.) illionr of Figure 1. Payments to Arizona from the Tobacco Settlement L To start the money flowing, Arizona has to reach finality in its suit against the tobacco companies. Finality is attained when the state and its political subdivisions drop their lawsuits against the tobacco companies. Finality in Arizona is being held up by twelve counties that are seeking to intervene in the state s lawsuit and to alter or amend the judgement. The counties do not want to release their claims against the tobacco companies, as the settlement requires, without the assurance that they will receive a share of the payment. Prior to the creation of AHCCCS in 1981, the counties were primarily responsible for indigent health care, and they still carry 30 percent of the State s share of Medicaid costs. If Arizona does not reach finality by December 31, 2001, it will be terminated from the settlement.37 Finally, there is the question of how long the payments will keep flowing. The settlement stipulates payments in perpetuity, however the market in the 36 A 10 percent decrease in shipment volumes in 1999, a 3 percent decrease in 2000, a 2.5 percent decrease in 2001 and a 2 percent annual decrease thereafter. Federal Funds Information for States (1999) Estimating Tobacco Payments, Issue Brief 99-16, August 20. t Arizona Health Care Cost Containment System. Arizona s version of Medicaid. 37 Arizona Capitol Times (1999) County Group Cdntinuing Suit On Tobacco Funds, November 11, p. 17; Maricopa County et al. Rule 59 Motion to Alter or Amend the Judgement or in the Alternative for New Trial, and Motion to Intervene as Additional Plaintiffs, State o/arizona et al. v. American Tobacco Co. Inc., et al., C.V
7 United States is shrinking, and other parties-health insurers, the Indian nations, private individuals and a handful of foreign countries are also suing the tobacco companies for what,they believe is fair compensation for damages. It is too early to tell what the effect of all the attorneys general and their copycats may be, but it is doubtful that they will drive the tobacco industry into oblivion to join the manufacturers of whalebone corsets, top hats and steam locomotives. There will likely always be a rump of smokers and a market to serve them. It may be that the states settle into a long and cozy symbiotic relationship with a tobacco cartel created and sheltered by the settlement. The settlement has already allowed tobacco companies to coordinate a price increase, and the marketing restrictions will help them to preserve market share. What to Do with the Money The prospect of $100 million a year forever has naturally pricked up the ears of special interests that want to spend public money. In other states there have been calls to spend the money on water projects, jails, roads, schools and tobacco farmers. But most of the proposals have called for spending the money on health, broadly defined to include such programs as family mentoring and parent education. Such plans, in effect, take money from low-income people and give it to social workers, government employees and health care workers-all in the name of helping primarily low-income people. A better way would be to give the money back to the people in the form of tax credits. That way the people themselves, and not legislators, bureaucrats or lobbyists can decide how to spend the money to maximize their benefit. Action in Other States State and local governments are planning to use their windfall from the settlement to increase spending on a variety of programs ranging from jails to water.projects to education and health care. As of October 1999, 21 states have allocated their share of the money. Of the funds allocated, over 30 percent have gone to health care services including funding for health insurance for children, prescription drugs for seniors and health promotion programs. Twenty-three percent has been given to education-michigan has earmarked 75 percent of its share for college scholarships. Ten percent is spent on non-health related children s services, and 9 percent for programs for the elderly.38 Left behind are smokers, the poor dupes who-according to the attorneys general and others-chose to believe a handful of tobacco company executives about the dangers of smoking instead of their friends, relatives, neighbors, doctors and the government. Now they are irredeemably hooked, so it is believed, yet only 11 L. 38 National Conference of State Legislatures (1999) State Legislatures Prepare to Receive Tobacco Settlement Funds, News Release, November 16, David Gary (1999) Skepticism rises as tobacco settlement payout nears, The Arizona Republic, November 21, p. A25
8 percent of the funds allocated so far are going toward tobacco control and smoking cessationa Of the money allocated so far, 17 percent is assigned for other purposes. North Carolina has given over half of its 2000 payment to a non-profit corporation to aid tobacco farmers, industry workers and others harmed by the settlement. North Dakota plans to use some of its money for water projects, and Orange County, California intends to use the money for jails and debt reduction. 0 In the Name of the Disadvantaged In Arizona, legislative and other proposals have called for spending the state s share of the tobacco settlement on various health care services-mental health, coverage for the uninsured, the state health laboratory, long-term care-and other social services such as family mentoring and preschool. The reason for some of the proposed spending is to meet pressing needs at the state mental hospital and to buy relief from legal obligations to the mentally ill. However, the rationale for most of the spending is the premise that government knows best that what those less fortunate, or disadvantaged, need most is health care. The argument for increased government health insurance for the poor is usually one sentence pointing out the increasing number of people without health insurance. It is generally assumed that lack of health insurance leads t,o a lack of health care, which leads to poor health. Left unexplored are any policies other than expanding government health insurance coverage. The number of uninsured has been growing despite the fact that the fastest growing federal entitlement program over the past decade has been Medicaid, which provides health insurance for the poor. Since 1984, there has been a significant expansion in Medicaid eligibility. States, for example, are required to cover all pregnant women and children under six in households with incomes up to 133 percent of the federal poverty level; and to cover all children born after September 1983 living in households below the poverty line. By 1992, nearly onehalf of all women were eligible to have their pregnancy expenses paid for by Medicaid, and almost one-third of children under 14 were eligible for the program. Two-thirds of those eligible for the expansion already had private insurance; and for every two people who joined the program, one had switched from private insurance. 39 National Council of State Legislators, Crary supra n. 38: Jonathan Gardner (1999) Tobacco Money Trickles-into Healthcare, Modern Healthcare, October Ibid. 41 Jonathan Gruber (1999) Medicaid and Uninsured Women and Children, Journal o/economic Perspectives, ll(4): pp
9 Goldwater Institute 19 Research shows that this expansion has led to better health access and outcomes: a 5.1 percent decrease in child mortality, an 8.5 percent decline in infant mortality and more visits to the doctor for children. Nevertheless, expansion has led t,o decreasing marginal returns. While the increase in eligibility in the early 1980s targeted at those most in need cost less than $1 million per life saved, later, broader expansions cost over $4 million per life saved.42 On the other hand, there is evidence that poverty and lack of insurance have little effect on access to health care. Mayer found that low-income children are more likely to have visited the doctor than high-income children with the same health status. Low income children visit the doctor as often, are only slightly more likely to receive care in an emergency room, and somewhat less likely to see a specialist. Low-income adults visit the doctor more frequently than high-income adults. The likelihood of low-income adults receiving care in an emergency room or visiting a specialist is roughly the same as for high-income adults. Mayer also found that insurance coverage does little to explain differences among children in the number of visits to the doctor and why some go to the emergency room while others do not.43 Furthermore, there is the question of whether more visits to the doctor are the most cost-effective way of improving the health of most people. The RAND. health insurance experiment found that even though increasing out-of-pocket ki.. medical expenses reduced utilization of services, there was no detrimental effect on.health status except for the poorest 6 percent. 44 (Although the implication of this for t.he situation of no health insurance at all is uncertain.) Factors such as education and lifestyle also play an important role in health status.*5 The leading killers of children in Arizona between one and fourteen are traffic accidents and drowning; and many of these deaths were considered preventable through individuals taking better care of their children.46 Finally, there are other needs of the poor besides health care. Many consider the lack of affordable housing in Arizona as one of the chief problems faced by poor families, and a recent report raised an alarm about families going hungry in the 2 Ibid. a Susan E. Mayer (1992) Are There Economic Barriers to Visiting the Doctor? Irving B. Harris School, University of Chicago, working paper Joseph P. Newhouse and the Insurance Experiment Group (1993) Free for All? Lessonsfron~ the RAND Health Insurance Experiment, Harvard University Press, Cambridge, MA 15 Folland, Goodman and Stano, supra n. 22, p. 120; James P. Smith (1999) Healthy Bodies and Thick Wallets: The Dual Relation Between Health and Economic Status, Journal of Economic Perspectives, U(2): pp GG. 16 Arizona Department of Health Services (ADHS), Arizona Health Status and Vital Statistics 1997: Age-Specific Mortality, ADHS (1999) 305 Children Died Needlessly, Report Finds, News Release, November 16,
10 20 Goldwater Institute state.47 Although the specter of thousands dying in the streets from starvation is no doubt an alarmist exaggeration, it does emphasize that some families in the state may have more urgent needs than a visit to a doctor-let alone preschool or family mentoring. Families have a broad list of spending needs: health care, education, food, shelter, clothing, energy and transportation. Even if health is deemed a priority, there are myriad possible ways a family can spend money to improve the health of its members: more education, a car seat, health care or membership at the YMCA. It is impossible for the legislature to know the diverse needs of Arizona s families, or allocate money to meet them, Even more impractical is fixing spending priorities into law through an initiative. It is impossible to know what will be the greatest needs for families five or ten years from now. The best solution is to give the money back to the people through a tax credit and let families decide for themselves how to spend the money. Give It Back As the above discussion suggests, most families would be better off receiving cash rather than more government services. The state can expect to receive about $100 million per year from the tobacco settlement. This is enough to give every resident who files an individual income tax return whose federal adjusted gross income is under $20,000 a $120 annual tax credit. Although the amounts are not dramatic, a tax credit would benefit a greater number of people than government programs that benefit only specific groups; an estimated 700,000 persons would benefit from the tax credit in Since many taxpayers in those income brackets will have tax liabilities less than the credit, the credit should be refundable. That is, those with no net liability after deducting the credit would receive a check for the remainder. As Table 1 - shows, the cost of this is estimated to be less than $100 million per year over the next ten years. Thus there will be a small surplus to provide a cushion in the case of unforeseen circumstances. This emergency fund can be kept in a separate trust fund; interest on the fund can be used to expand the credit. However, the fund should not be allowed to grow too large since that will tempt legislators to spend it-at least once, if not twice. The legislation creating the fund would specify that the tax credit may be paid only by money inside the fund. Thus if the payments diminish or disappear, there will be no net drain that would have to be corrected by a tax increase. 47 William Hermann (1999) Working but still poor, The Arizona Republic, November 11, p. Al; Hunger Advisory Council, Arizona Department of Economic Security (1999) Hunger in Arizona Anywhere Is B Threat to Our Well Being Everywhere.
11 GoEclwater Institute 21 Table 1. The Cost of a Refundable Tax Credit Year I C0.d ) Estimated Settlement ($ millions) Payment ($ millions) A refundable tax credit has two advantages over proposed spending plans.. It is reasonably just. Since smoking is more common among those with lower incomes, poor people will be paying most of the settlement through higher cigarette prices. Giving the money back to them rather than to government employees or health care and social workers is more fair.. It is efficient. By efficient I mean providing the greatest benefit for any given expenditure, As belabored upon repeatedly above, poor familiesnot legislators, nor voters, nor government employees, nor community activists, nor special interest lobbyists-are in the best position to know their particular needs. Any one-size-fits-all solution will no doubt not meet the priorities of many families. Cash through a tax credit, despite its modest size, would allow families to decide for themselves how to benefit from the money, as opposed to the employees of some government agency. Other Proposals As mentioned above, most proposals in Arizona call for spending money from the settlement on some form of health care. In some instances, health care does not only mean doctors, nurses and medicine, but a broad array of social services with a tenuous connection to health such as parent education, family mentoring and preschool. If the latter qualify simply because they may result in improved health, other programs are equally if not more deserving. Elementary and secondary education promote health, not just through health classes, but also through physical education and even driver education. Scholarships to the universities would promote better health since researchers have found a link between high status jobs and health.48 Spending on law enforcement can improve health through increased drug interdiction and tougher enforcement of speed limits and child seat and seat belt laws. Highway spending can improve health by reducing the number of traffic accidents. The list is endless. 48 Smith (1999) n. 45