According to articles in the Business Journal (link) and the Wall Street Journal (link), approximately $1.2 billion of payments made to the states under the Master Settlement Agreement (MSA) may be in jeopardy. The participating manufacturers are apparently threatening to make this billion dollar cut to payments to the states - an action that could throw state budgets into turmoil since it was not anticipated or accounted for in state budget preparations.
A little-noticed adjustment provision, hidden in the fine print of the MSA, allows the participating tobacco companies to reduce their payments to the states under the agreement if market shares of their brands (compared to those of non-participating manufactureres) fall below a certain level and an independent economic board finds that these market share declines are attributable to requirements on the participating manufacturers posed by the MSA. The reduction in payments is to be borne by those states which have failed to enact and diligently enforce statutes which require payments from non-participating manufacturers.
According to the formula in the MSA, the amount of the payment reduction for the current year approaches $1.2 billion.
The reason for the timing of the tobacco companies' request for this "rebate" is two-fold. First, there is apparently a two-year waiting period from the time the market shares of the participating manufacturers fall below the threshold, which occurred in 2004. Second, on March 27, the independent economics firm hired under the provisions of the MSA is expected to announce that the loss of market share by the major manufacturers was indeed signficantly attributable to the MSA.
While a tobacco analyst for Citigroup felt it was unclear if the tobacco companies would be successful in arguing for the reduction in payments, she suggested that the dispute might lead to a re-negotiation of the terms of the contract which might "lead to another settlement [and] an ironclad partnership between the states and tobacco manufacturers."
The Rest of the Story
This is a pretty complex issue, so let me do my best to try to explain what I think is going on here and what it all means, to the best of my understanding:
First, we need some background. As I explained in a May 16 post, the MSA contained a clause known as the Non-Participating Manufacturer (NPM) Adjustment, a complex provision described in section IX(d)(1) of the Agreement. Basically, the provision states that if the market share of the participating manufacturers in any given year falls to more than 2 percentage points below the baseline aggregate market share for 1997, then MSA payments for the following year are reduced by a percentage equal to the amount of the market share loss exceeding 2 percentage points (that is, the market share loss minus 2 percentage points) times a factor of 3.
As an example to demonstrate the provision, assume that the market share for participating manufacturers was 99.6% in 1997 and dropped to 91.9% in 2004 (these are the data cited in a recent Business Week article). The market share loss that exceeds 2% is 99.6-91.9-2.0, or 5.7%. The adjustment factor is then 5.7% times 3, or 17.1%. This means that total industry payments to the states would be reduced by 17.1% in 2005. Based on the $6.2 billion paid to the states in 2004, this would represent a loss of about $1.1 billion in state revenue.
Now, the kicker: this loss of $1.1 billion in revenue to the states does not apply to all the MSA states; it only applies to those states which have failed to enact a statute that imposes escrow payments on non-participating manufacturers (companies that are not parties to the agreement).
Here it is - section IX(d)(2)(B): "A Settling State's Allocated Payment shall not be subject to an NPM Adjustment: (i) if such Settling State continuously had a Qualifying Statute (as defined in subsection (2)(E) below) in full force and effect during the entire calendar year immediately preceding the year in which the payment in question is due, and diligently enforced the provisions of such statute during such entire calendar year; or (ii) if such Settling State enacted the Model Statute (as defined in subsection (2)(E) below) for the first time during the calendar year immediately preceding the year in which the payment in question is due, continuously had the Model Statute in full force and effect during the last six months of such calendar year, and diligently enforced the provisions of such statute during the period in which it was in full force and effect."
Well - what is a "Qualifying Statute?"
For that, you have to go to Exhibit T (Model Statute), where, under section (2)(b)(1), you learn that a Qualifying Statute is a state law requiring any non-participating manufacturer (a company that is not a party to the MSA) to "place into a qualified escrow fund by April 15 of the year following the year in question the following amounts (as such amounts are adjusted for inflation) --
1999: $.0094241 per unit sold after the date of enactment of this Act;
2000: $.0104712 per unit sold after the date of enactment of this Act;
for each of 2001 and 2002: $.0136125 per unit sold after the date of enactment of this Act;
for each of 2003 through 2006: $.0167539 per unit sold after the date of enactment of this Act;
for each of 2007 and each year thereafter: $.0188482 per unit sold after the date of enactment of this Act."
In other words, the MSA has pulled a fast one - a trick of a sort. It cannot serve as a vehicle upon which to enact state legislation. Nor can it impose a requirement on non-participating manufacturers to make them pay the states in order that they not have a competitive advantage over the participating manufacturers who are subject to the burdensome MSA payments. After all, the non-participating manufacturers are not party to the agreement. It cannot possibly impose payments on them!
So instead, the MSA goes around it the back way. It first creates an incentive for the states to protect the economic interests (i.e., market share) of the participating manufacturers: that's what the NPM adjustment does.
Then, it imposes a requirement that unless a state enacts the model statute which imposes payments on non-participating manufacturers, they must share the full burden of the reduced payments attributable to the NPM adjustment. This is, of course, a strong incentive for the states to enact such a statute to preserve their MSA payments.
Because the MSA essentially created a compact between the states without the approval of Congress, it is being challenged as being unconstitutional under the Compact Clause of the Constitution. That lawsuit is being brought by none other than an ANR-proclaimed Big Tobacco "front group" - the Competitive Enterprise Institute.
So the defense that the states appear to have under the MSA is to argue that they have indeed enacted and are diligently enforcing such qualifying statutes which are collecting payments from non-participating manufacturers. I have no idea how many states have enacted such statutes and how many are diligently enforcing such laws. But any states which have not seem to be at serious risk of losing huge amounts of revenue.
The revenue loss could become all the more substantial because the $1.2 billion loss is only borne by those states which have failed to enact such laws. This means that the potential economic consequences to the non-exempt states could be devastating.
And it is likely for this reason that the states will seek to modify the agreement in order to bail out the non-exempt states from a tremendous financial jam.
The tobacco companies appear to be in the driver's seat, as they can hold the threat of this economic devastation to some states over all the states in an attempt to extract an even more advantageous contract that more firmly seals the partnership between these companies and the states.
And the irony of this whole thing is that on the same day that this dissastrous result of the MSA was announced, the Attorneys General and the American Legacy Foundation will be holding a press conference to talk about how wonderful the MSA has been and how much it has done to improve the cause of tobacco control in this country.
I'm afraid I might have put myself into contention for the understatement of the year when I called the Master Settlement Agreement the worst public health blunder of my lifetime.
The tobacco company attorneys who negotiated this deal are to be congratulated for their brilliance, and for knowing that putting enough money on the table would entice the Attorneys General to sell out the health of the public for fiscal and political gain.