The States' Tobacco Addiction
Philip Morris USA recently got the Illinois Supreme Court to overturn a gigantic judgment against it in a suit that had originated in a place -- Madison County, Ill. -- that few could locate on a map. The court's ruling resulted in this Wall Street Journal headline: "Tobacco-Revenue Munis Get a Lift." This episode illuminates American governance today.
Philip Morris is America's largest maker of cigarettes, a product legal to use but problematic to merchandise legally. Cigarettes are stigmatized by common sense and all state governments. But because those governments are increasingly addicted to cigarette tax revenue, the governments must be careful not to make cigarettes so expensive they do not sell well.
Madison County, located along a bend in the Mississippi River near St. Louis, elects its judges, some of them very friendly to plaintiffs' lawyers who prosper from class action lawsuits. In 2003 a county court held that Philip Morris deceived 1.14 million current and former Illinois smokers into believing that cigarettes labeled "light" and "low tar" are safer than regular cigarettes. Without blaming Philip Morris for any illnesses, the purchasers of these products accused the company of fraud. A Madison County judge exuberantly awarded them $10.1 billion in compensation. The 0.1 was a nice touch, suggesting -- speaking of fraud -- scientific precision.
But the Federal Trade Commission has ratified the use of the light and low-tar labels, and Illinois law sensibly says that companies cannot be penalized for conduct authorized by a regulatory body. So the Illinois Supreme Court, in a 4 to 2 ruling, vacated the $10.1 billion judgment. Two of the four justices in the majority also argued that the judgment should be overturned because the plaintiffs had not demonstrated that they had been harmed by Philip Morris's actions. That principle could spoil the fun of the asbestos litigation racket, in which some plaintiffs collect even though they have no symptoms of any ailments associated with exposure to asbestos.
The Illinois Supreme Court's ruling stimulated the market for "tobacco-revenue munis." Those are municipal bonds backed by tobacco revenue streams resulting from a real fraud -- the Master Settlement Agreement. In 1998, 46 states conspired to seize $246 billion from companies that sell products made from a commodity -- tobacco -- the cultivation of which was then subsidized by the federal government. Tobacco subsidies totaled $528 million from 2000 through 2004; then the government paid $10.1 billion -- that number again -- to terminate the tobacco quota system.
Under the MSA, the states are scheduled to get their portions of the pot over many years. But deferral of gratification is un-American, so some states, eager to get their loot, have "securitized" their expected portions. Securitization involves selling bonds backed by the anticipated revenue.
The MSA is a deal struck between the state attorneys general and trial lawyers. For the latter, it was a financial windfall, netting about $13 billion in fees that sometimes amounted to tens of thousands of dollars per hour of work. For the former, it was a political windfall, enabling their states to finance this and that with billions paid by smokers, who are disproportionately low-income people.
The MSA rests on the fraudulent claim that smoking costs the states huge sums, principally because of health care costs. Actually, smoking makes money for governments, for two reasons. Cigarettes are the world's most heavily taxed consumer product (state taxes range from 7 cents to $2.46 per pack; the federal tax is 39 cents). And many smokers die prematurely from smoking-related illnesses, curtailing their receipt of entitlements for the elderly.
There is one problem with the states' plans to divvy up the money extorted from the tobacco industry: The MSA may be declared unconstitutional. The U.S. Constitution says (Article I, Section 10): "No state shall, without the consent of Congress, . . . enter into any agreement or compact with another state." A federal district court is being asked to declare that 46 states have done just that.
The states' ability to continue treating the tobacco industry as a "budgetary Alaska" -- the last frontier for exploitation -- depends on brisk sales of cigarettes far into the future. So all 50 states, which in 2004 reaped $12.3 billion in cigarette taxes, have an incentive to carefully calibrate these taxes so as to maximize revenue. They want high taxes, but not high enough to cause large numbers of smokers to quit the habit that is so lucrative to states.
The state governments seem to be calibrating cleverly: The adult smoking rate has not fallen much recently. So we have here a rarity -- a government success story. Of sorts.