State Cigarette Mob Can't Kick the Habit

Under the government-enforced cigarette cartel, every state is a tobacco state

Colorado Treasurer Mark Hillman calls the deal under which the top cigarette manufacturers pay the states billions of dollars a year "a protection racket." In truth, it's worse than that.

The so-called Master Settlement Agreement (MSA), which resolved state lawsuits against the largest tobacco companies, is not a classic extortion scheme in which a business pays to be left alone. Instead Philip Morris et al. are paying for protection against their competitors, and they are passing the cost on to their customers, the very people whose victimization by Big Tobacco supposedly justified the lawsuits in the first place.

A decade ago, states started suing cigarette makers, demanding compensation for the cost of treating smoking-related illnesses under Medicaid. They accused the tobacco companies of tricking people into smoking by denying its health hazards and keeping them hooked with carefully calibrated doses of nicotine.

In 1998, to avoid potentially ruinous liability, the industry's main players agreed to payments totaling more than $200 billion during the first 25 years of the deal. But there was a problem: If the participating companies raised their prices to cover the payments, what would stop existing or new cigarette makers that had not signed the MSA from underselling the big manufacturers and whittling away at their market share?

The answer was a government-sponsored cartel that forces nonparticipating companies to make payments into an escrow account based on their sales, ostensibly to cover their future liability. Under this arrangement (which has been challenged in federal court), cigarette makers that have been nothing but honest with the public pay a penalty so the sleazy, sneaky companies the states sued don't have to.

If that seems unfair, recall that the whole scheme is aimed at forcing those tricked and trapped (and relatively poor) smokers to bear the entire burden of the settlement payments. And then some: Cigarette prices rose by $1.10 a pack during the first two years of the MSA, more than twice the cost of the settlement payments.

Now the states and the big tobacco companies are engaged in an unseemly spat over this unseemly deal. In a bid that gained support this week from an arbitrator, the companies are trying to reduce their annual payments by some $1.2 billion, arguing that the states have not enforced the cartel with sufficient enthusiasm.

The MSA participants' collective market share fell from 99.6 percent in 1997, the year before the deal, to 92 percent in 2003. Even hobbled by the MSA's financial penalties, small manufacturers such as the Virginia-based S&M Brands, maker of Bailey's cigarettes, have managed to lure away smokers with lower prices.

In their defense, the states say they have done their best to destroy competition and hurt consumers. As The Wall Street Journal puts it, "they argue that they have taken the steps required in the settlement to create a level playing field" by passing and enforcing "the necessary laws to deny the upstart tobacco companies unfair advantages."

Unfair advantages? According to the states, the companies that signed the MSA were guilty of a massive fraud that caused millions of premature deaths and racked up billions of dollars in government-covered medical bills. Isn't being unburdened by settlement payments because you didn't participate in such a fraud a fair advantage?

Fairness, of course, has nothing to do with it. This is about money: a windfall that state attorneys general have been happy to take credit for and state legislators have been happy to spend.

Because the settlement payments are tied to cigarette sales, Mark Hillman notes, states are sending "a mixed message to citizens that 'We want you to stop smoking' because it's terrible for your health, but 'We need you to keep smoking' to pay for government programs." Nowadays the states rake in more money from smokers than the cigarette companies do. Big Government and Big Tobacco have not just joined forces; they've become synonymous.