$240 Billion Tobacco Deal Challenged in Supreme Court in S&M Brands v. Caldwell

Back in 1998, the states settled their lawsuits against the big tobacco companies in a deal called the tobacco Master Settlement Agreement — the biggest legal settlement in history. In exchange for state attorneys general dropping their lawsuits against the four biggest tobacco companies, tobacco companies agreed to pay the states more than $240 billion over the first 30 years of the agreement, and billions more annually in perpetuity. In addition, trial lawyers received over $15 billion (not million, billion).

But there was a catch: to get that money, the states would have to pass laws protecting the big tobacco companies against competition from smaller, newer companies that had never lied about the dangers of smoking, much less been sued for it. That would enable the big tobacco companies to raise prices in unison and pass them on to smokers. Essentially, the states became Big Tobacco’s partner in the cigarette business.

The net result is that each year, a massive transfer of wealth occurs across the country, from smokers to state governments and wealthy trial lawyers. (It also effectively transfers money from growing states to states with stagnant populations, and to a lesser extent, from red states to blue states.)

This settlement is now being challenged in a petition for certiorari that my employer, the Competitive Enterprise Institute, recently filed with the Supreme Court in a case called S&M Brands v. Caldwell. The Court is expected to decide whether or not to hear the case soon, perhaps as early as today.

The deal was falsely sold to the public as a way of making Big Tobacco pay for lying about the dangers of smoking. But the costs of the settlement are paid for not by Big Tobacco, but by smokers — the supposed “victims.” Tobacco companies simply passed along settlement costs by raising cigarette prices. Smokers couldn’t escape those settlement costs even by switching to competing brands, because Big Tobacco’s competitors, who were not part of the backroom deal, were forced to make payments under laws adopted by the states as a condition for receiving their share of the settlement. (Competitors that don’t join the settlement also face “greater administrative burdens,” greater fines for underpayment, marketing disadvantages, and greater liability risks, according to a December 15, 2003, memo from the National Association of Attorneys General, which administers the settlement and defends it in court.)

On its face, the deal would seem to be unconstitutional. It’s an agreement among 46 states — an interstate compact — signed by state attorneys general and the tobacco companies. It regulates an entire national industry, yet it was entered into without the consent of Congress, which had already rejected a similar proposed settlement called The Resolution. The Constitution’s Compact Clause mandates that “No State shall, without the Consent of Congress … enter into any Agreement or Compact with another State.”

While the tobacco deal is clearly unconstitutional under the plain language of the Compact Clause, the legal case is somewhat complicated by a 1978 Supreme Court decision. In that case, the Supreme Court declared — in the teeth of the constitutional language — that the Compact Clause applies only to state compacts that potentially encroach on federal powers or interests.

Still, even that unwritten exception is not broad enough to keep the tobacco deal from being unconstitutional under existing Supreme Court doctrine. As legal scholars such as Michael Greve have noted, the deal encroaches on federal power by regulating interstate commerce beyond the jurisdiction of any individual state

The tobacco deal conflicts with a core purpose of the Compact Clause — to prevent states from exploiting or ganging up on other states. Several states got together and negotiated the agreement with the major tobacco companies, then forced it on other states, which had seven days to decide to join. As former Alabama Attorney General William Pryor pointed out, states had little choice but to join, since smokers in every state would be paying for it, no matter what. By refusing to join, a state would have forfeited all the agreement’s benefits, while still bearing its costs, since the deal is paid for through price increases across the country.

The tobacco deal is also an enormous transfer of wealth from growing states to states with stagnant populations. As Stanford economist Jeremy Bulow once noted, the percentage of revenue that each state receives is fixed forever and does not match either its population or the percentage of cigarettes sold in that state. Arizona and Nevada have 50 percent more people than they did in 1998, while Rhode Island’s population has scarcely changed. But each of those states gets the same share of the tobacco deal now as they did back in 1998. Nevada gets less than Rhode Island, even though it now has two-and-a-half times as many people. In 2005, Colorado state Treasurer Mark Hillman came out in support of the legal challenge to the tobacco settlement. His rapidly growing state is shortchanged more each year by its small, unchanging share of the settlement, as Peter Blake twice noted in the Rocky Mountain News.

The tobacco deal is also an enormous transfer of wealth from Red States (and purple states like Virginia) to Blue States. Conservative states such as Georgia, Kentucky, South Carolina, and Virginia receive only about half as much back in revenue as their citizens pay in to it through higher prices. By contrast, liberal states such as New York and Vermont get back more in revenue than their citizens contribute.

The Compact Clause is not the only legal provision violated by the tobacco deal. Professors of antitrust law say it also violates the antitrust laws, since the unwritten exception in the antitrust laws for state-enforced cartels has never been extended by the Supreme Court to interstate cartels like the tobacco deal. (The Supreme Court has said that the unwritten exception in the antitrust laws for government-backed cartels is narrowly construed to cover only some government-backed cartels, and only covers cartels imposed by a state, not municipalities or other entities that lack Eleventh Amendment immunity.)

Many other legal scholars and commentators have raised questions about the legality of the tobacco deal, such as the following:

Photo credit: dsevilla’s flickr photostream.