Shady Deals in Smoky Rooms

Can a little lawsuit shut down a big tobacco racket?

Coming soon to a courtroom near you: Bambi meets Godzilla. This week, the Competitive Enterprise Institute, a free-market advocacy group in Washington, filed suit in federal court to challenge the constitutionality of the massive and fantastically lucrative 1998 Master Settlement Agreement—otherwise known as the Tobacco Deal. Arrayed against the suit's five plaintiffs (several small tobacco companies and distributors, plus a discount tobacco store and a smoker) will be Big Tobacco, the state attorneys general, a host of public-health organizations, and probably most of the mainstream media. Other than that, it's a fair fight.

Asked about the lawsuit's prospects, Sam Kazman, the institute's general counsel, says, "It's a long shot to ever get something declared unconstitutional." After a beat, he adds: "A meritorious long shot." After another beat: "I don't think it's even right to call it a long shot. I think we've got a significant chance of success."

Sorry, Sam—it's a long shot. Still, miracles do happen, and this lawsuit deserves a prayer. Not without reason has the Tobacco Deal been called the constitutional crime of the (last) century.

For years, tobacco companies faced and won lawsuits in which smokers claimed damages for ailments caused or aggravated by smoking. In 1994, however, the state of Mississippi filed a different kind of suit, demanding that the companies repay the state for health-program costs allegedly attributable to smoking. Dozens of other states soon filed copycat suits, many of them financed by law firms that acted as subcontractors and stood to earn contingency fees of unprecedented size.

The four tobacco giants that together controlled about 99 percent of the market were smart enough not to bet on prevailing against dozens of state governments. They and nine attorneys general retreated behind closed doors and emerged in 1998 with a 245-page settlement. "The nonparticipating attorneys general," notes the CEI complaint, "were given seven days to review its terms and decide whether to join it." Thus hustled, they signed on. The AGs would drop the state lawsuits. In exchange, the companies would pay the states (including four that had already made separate deals) a total of almost $250 billion over 25 years—as in, a quarter of a trillion dollars.

Who would foot this enormous bill? Ordinarily, shareholders. But the majors didn't like that idea. They preferred to pass the cost to smokers. So they colluded with the AGs to create a national tobacco cartel. The deal guaranteed the majors their overwhelming market share and effectively barred new competitors from all but a tiny sliver of the U.S. tobacco business.

Any company that wanted to sell cigarettes—even a start-up that had never fouled a single pair of lungs, much less committed any tort—would be forced either to join the MSA and pay "damages" for wrongs never committed or to place an even larger amount into "escrow" against wrongs that might be committed someday. Not surprisingly, the majors' small competitors—about four dozen of them so far—have reluctantly agreed to pay the same new national tax as the majors pay.

And a national tax, not damages, is plainly what these payments are. Under the settlement's terms, all tobacco companies, large and small, are assessed at nationally standardized rates based on their national (not state) sales. The states give Big Tobacco permanent protection from competition, Big Tobacco showers the states with money, and smokers pay. Not at all coincidentally, billions of dollars also found their way to lawyers who cut themselves in for mind-boggling fees.

What was wrong with this deal? A better question would be, What was not wrong with it? For a start:

• The states' claim was bogus to begin with. Economists have found that smoking, if anything, reduces the cost of government programs, because smokers die younger and have fewer years to collect health and pension benefits. Smoking is bad for smokers, but it has done state coffers no harm at all.
• The transaction was, literally, mercenary. In effect, the attorneys general rented out the states' sovereign authority to private lawyers who were cut in on the take. Moreover, some of the lucrative subcontracting deals smacked of cronyism, or worse. (Former Texas AG Dan Morales got a four-year prison sentence in a case stemming from his role in the deal.)
• The deal was Robin Hood in reverse. It provided an immense windfall to the powerful (state governments) and the rich (giant tobacco companies, now favored with a state-enforced cartel), at the expense of the small (would-be competitors to the tobacco giants) and not-rich (smokers).
• The deal was falsely advertised. Most of the settlement revenues did not go for public-health programs, as promised, but for whatever a state's politicians chose to spend the money on. Public-health advocates were played for patsies.

Still, the tobacco deal is not the first public policy arrangement to break a promise, or to favor the rich, or to be tainted with cronyism, or to be built on bogus premises. What sets it apart is that it bypasses and neuters the system of checks and balances we call constitutional government.

Congress never approved the deal. Nor did any court order it. The deal was done by private parties acting on their own account. Those who were present in the room benefited spectacularly, at the expense of the smokers and small businesses that were shut out.

To enforce the restrictions on new entrants, however, the deal had to be written into law. So the deal-makers gave every state a choice: It could pass an implementing statute precisely as dictated—"without any modification or addition"—or it would lose all of its billions in settlement money. Faced with those terms, the states did as they were told. Once the cartel was in place, it could be changed only by the unanimous consent of the states. If Iowans, say, hate this deal, they'll get nowhere by voting out their own AG and legislators. They would also have to vote out the AGs and legislators of the other 49 states. Which, of course, they can't do.

In short, a cartel of states has colluded with a cartel of tobacco companies to create a public-private supercartel: a market-fixing scheme that is locked in by law, yet is accountable to no particular government authority; that is immensely profitable to the parties at the expense of millions of hapless consumers; and that is enforced with penalties that clobber any would-be defectors. The deal also creates what amounts to a new national taxing authority that arises from state collusion and that bypasses Congress. The companies provided the deep pockets, the states provided the muscle, private law firms provided the legal talent, and public-interest groups provided legitimacy.

The deal got through in the first instance because few but the beneficiaries clearly understood it. It has survived because the states soon became addicted to tobacco money. Congress could shut down the racket, but it won't, because the states would howl. For objectors, that leaves only the courts—and the Constitution.

With uncanny foresight, as if with the tobacco deal in mind, the Founders stipulated in Article I, Section 10—the Compacts Clause—that "No state shall, without the consent of Congress…, enter into any agreement or compact with another state." The clause is intended to prevent states from colluding to supplant or circumvent Congress's unique national authority. Pursuant to this clause, Congress has been asked to approve all sorts of state compacts over the years.

If the tobacco deal is not an interstate compact designed to circumvent and supplant Congress's authority, it is hard to imagine what would be. In fact, an earlier version was rejected on Capitol Hill. The Master Settlement Agreement was Plan B, specifically designed to cut Congress out of the picture.

Earlier court challenges have raised the Compacts Clause and failed; but none, Kazman says, has raised it as frontally as this new one. "The Compacts Clause claim is the heart of the case," he says. Even so, the odds are long. "Courts are very reluctant to unravel such a complicated and delicately balanced agreement as the MSA," says Kenneth Bass, who until June was a lawyer with Kirkland & Ellis, where he represented the Brown & Williamson tobacco company.

Meanwhile, state attorneys general are shopping for new opportunities to supplant Congress. Last year, eight AGs sued five big utilities for—this is not a joke—contributing to global warming. News reports quoted Connecticut Attorney General Richard Blumenthal as saying, "Some may say that the states have no role in this kind of fight or that there's no chance of success. To them I would say, 'Think tobacco.' "

Watch the new tobacco lawsuit. If it fails, watch your wallet.

© Copyright 2006 National Journal

Jonathan Rauch is a senior writer and columnist for National Journal and a frequent contributor to Reason. The article was originally published by National Journal.