Master Settlement Agreement Causing Major Budget Woes for States; Further Evidence that MSA Was a Public Health Blunder by the Attorneys General

In 1998, the Attorneys General of 46 states praised themselves for having negotiated a litigation settlement with Big Tobacco that they said had brought to tobacco companies to their knees. At the time of the settlement, Florida's Attorney General - Bob Butterworth - proclaimed that "'The Marlboro Man will be riding into the sunset on Joe Camel."

Even today, the National Association of Attorneys General boasts that: "The MSA is a historic, landmark agreement that affects the lives of all Americans. It generates billions of dollars for Settling States to cover the health care costs generated by smoking and has played a significant role in bringing about a decrease in smoking rates among adults and youth in the United States."

I have long argued that the Master Settlement Agreement was a public health disaster, a huge blunder by the Attorneys General who negotiated and agreed to it. I agree that it is a landmark agreement that affects the lives of all Americans, but not in a good way. It made the states fiscal partners with the tobacco companies, destroying the incentive for states to take any actions that would significantly decrease tobacco sales and revenues. Most of the money that was supposed to be spent on tobacco education, prevention, and treatment has been diverted to all sorts of other uses, mainly to plug holes in state budgets. And in return, what did the tobacco companies get? They were let off the hook in litigation in 46 states, in return for a significant but fiscally stable and predictable payoff. It was a brilliant move by the tobacco companies and a stupid, politically-motivated move by the Attorneys General.

The Rest of the Story

Last week came word that due to the Master Settlement Agreement, California is facing major fiscal problems. You see, it seems that cigarette smoking has been decreasing more rapidly than expected and this decline in cigarette consumption is affecting payments to the state under the MSA. Since the state decided to borrow money against its expected future payments, the declining revenues affect its ability to pay back investors in bonds that were used to securitize the future payments. According to an article in California Watch, there are currently $2.9 billion in outstanding bonds. The need to pay back investors in these bonds could create fiscal havoc, aggravating an already terrible budget situation.

According to the article: "Fewer smokers is bad news for California’s budget. A major bond rating agency sounded an alarm this month, saying the state may have borrowed more than $4 billion against settlement money that might never materialize. A little more than a decade ago, 46 state attorneys general reached a settlement with the four biggest tobacco companies. The companies agreed to pay an estimated $246 billion over a 25-year period to compensate states for tobacco-related health care costs. But there is one quirk: The settlement payments are not fixed, but linked to tobacco sales. Rather than waiting for annual payments, the state and some local governments decided to borrow money against their anticipated future revenue. All told, they’ve issued $16 billion in bonds since 2001. Major bond rating agencies and some municipal finance experts have warned for years that the number of smokers was decreasing more rapidly than expected."

"In December, California had to dip into its reserves to cover bond payments. Dick Larkin, director of credit analysis at Herbert J. Sims & Co., said there were two reasons: fewer smokers and a dispute with the tobacco companies that has resulted in delayed payments.As the state’s finances worsened, officials went back to investors. In 2007, California issued $4.4 billion in tobacco bonds. In order to pay back investors by 2047, it assumes that cigarette consumption will decline by about 1.8 percent per year, according to bond filings. But in the midst of increased taxes and antismoking laws, sales have dropped more quickly than predicted. As a result of the decline and the ongoing dispute with the tobacco companies, annual payments have been less than expected since the settlement was signed in 1998, according to Larkin. If the bonds default, it wouldn’t be bad just for investors. California is one of only a few states that guaranteed a portion of its bonds with general fund revenue. If tobacco settlement money does not cover the debt, the state will have to pick up some of the tab. There are currently $2.9 billion in bonds outstanding that are backed by a state guarantee, according to the state treasurer's office. Although that payment would be subject to legislative approval, it’s unlikely it wouldn’t be approved. “No one would trust California anymore,” Larkin said. “Their name would be mud in the market.”"

This story illustrates the brilliance of the Master Settlement Agreement (from the perspective of the cigarette companies). The states are now fiscally dependent on a steady stream of cigarette revenues. Any substantial drop in cigarette smoking threatens the state's fiscal situation. Thus, there is no incentive to take any action that will substantially reduce cigarette sales. Perhaps this is why we haven't seen many major anti-tobacco initiatives at the state level since the Master Settlement Agreement was signed. We've seen mostly minor initiatives that dilly dally around the margins, but very few which actually aim to put a major dent in cigarette sales.

In direct contrast to what the Attorneys General predicted, the Marlboro Man isn't riding into the sunset on Joe Camel. Instead, they're both having a beer and a good laugh together as they enjoy their trip to the bank.