Politics & Policy

When States Screech, Don’T Listen

Following the tobacco settlement money.

Having barely recovered from the 2001-2002 budget crisis, the poor, pitiful (and binge-spending) states have discovered another revenue “crisis”–reduced payments under their collective1998 agreement with the major tobacco manufacturers. According to an AP story earlier this week, a confidential memorandum by the National Association of Attorneys General has warned states to expect a $2.5 billion decrease in payments due April 15, down from a projected $9.3 billion. Let them wail. The real crisis here is the states’ ability to dip, time and again, into tills that aren’t theirs.

The tobacco settlement sought to guarantee the states a perpetual stream of payments, estimated at some $246 billion over the first 25 years. The big four tobacco companies agree to these payments because the agreement obligated states to protect the companies’ market monopoly (at the time, over 99 percent of the national market), so that the full price would be passed on to consumers. Despite the states’ and the producers’ best efforts to suppress competition, though, small, “renegade” manufacturers–who never signed the tobacco agreement–have captured over ten percent of the market. This entitles the participating manufacturers to reduce their payments to the states.

Those payments supposedly represent the tobacco companies “damages” for inflicting excess smoking-related costs on state budgets. But one problem with this theory surfaced even before the settlement: No such excess costs exist. A second problem appeared after the settlement: well over half of the “damages,” had they existed, should have gone to the federal government rather than the states. A third problem came to light in a thorough study published late last year by the National Conference of State Legislatures (NCSL): The states have found a way to leverage their phantom “damages” into yet another payment stream.

Smoking kills. For precisely that reason, tobacco companies–assuming they are somehow responsible for smokers’ choices–saved money for government-paid health programs, such as Medicaid and Medicare (and for Social Security). By any reasonable accounting, these savings dwarf the states’ costs of treating smoking-related illnesses. In a rational world, the states’ decision to raise the costs-to-the-government argument in the tobacco litigation would backfired, and Mississippi and Florida would have wound up sending money to Philip Morris, not the other way around. When confronted with that powerful argument, however, the states mounted a still more powerful counterattack: while the lawsuits were pending, they passed statutes that wiped out the companies’ ancient common-law defenses, including the incontestable claim that the states were in fact the beneficiaries of the sale of use of tobacco.

Once the ink dried on the 1998 settlement, the Clinton administration laid claim to a large, unspecified portion of the proceeds. The states’ “excess” expenses, the administration argued, were incurred principally under Medicaid. The federal; government pays between half and three-quarters of state Medicaid expenses (depending on the state), and federal law at the time unmistakably provided that state recoveries of excess payments should revert to the federal government to the extent that the feds had incurred the original expense. Confronted with that undeniable claim, the states engineered another legislative fix–this time, a congressional repeal (spearheaded, uncharacteristically, by Republican legislators) of the pertinent statutory provisions. The states got to keep the loot, and the Clinton administration proceeded to bring its own lawsuit against the tobacco firms.

What have the states done with their “damages”? What they have not done is to compensate harmed smokers. (They have resolutely, and successfully, fought smokers’ lawsuits laying claim to the proceeds.) Instead, the states have used the money to pave roads, build sports stadiums, balance their budgets, and pay teachers and their unions. They have even used some 4 or 5 percent of the proceeds for the originally advertised purpose of reducing tobacco consumption.

Well over one-third of the tobacco funds ($14 billion of the $39.4 billion received to date), however, have been devoted to health and long-term care–meaning, principally, Medicaid. The states have devoted another 19 percent to reserves and endowments, most of which are also earmarked for Medicaid and other health expenses. The NCSL explains the reason for this as follows: “The allocation of tobacco settlement revenue to Medicaid has the added benefit of leveraging federal dollars at between a 2:1 and a 3:1 ratio.” In other words, by using the settlement money on Medicaid and other programs that receive federal matching funds, the states have effectively gotten the federal government to match the tobacco settlement.

One might think that the states–having invented phantom expenses, claimed the proceeds as their own, and leveraged them into yet more money–would finally be done. But one would be wrong. This past May, states persuaded Congress to grant them another $20 billion in relief for their various financial crises and, in particular, inexplicably high Medicaid costs.

Having triple- or quadruple-dipped, what more can the states do? Perhaps they could devote a portion of their tobacco proceeds to suing an industry that unnecessarily prolongs lives, such as pharmaceutical drugs. Since the welfare state showers benefits mostly on old folks, products that extend their lives ipso facto create costs that the states would otherwise have “saved.” The states could claim those proceeds as “damages” and leverage them yet again.

Think the states lack the nerve or imagination for a sextuple-dip with a perfect landing? Think again. Several multistate lawsuits against the drug industry–inspired in form and substance by the tobacco litigation–are already pending.

Michael S. Greve is John G. Searle Scholar at the American Enterprise Institute and director of the AEI Federalism Project.


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