Tobacco Deal-Breaker?

 “No State shall, without the Consent of Congress, . . . enter into any Agreement or Compact with another State.”

—- U.S. Constitution, Article I, Section 10

November will mark seven years since 46 state attorneys general ignored the above clause of the Constitution and struck a historic deal with tobacco companies, which agreed to pay the states $246 billion over 25 years for health-care costs related to smoking. We're glad to say someone is finally asking a court if this wasn't illegal.

More recently, attention has focused on federal attempts to get a piece of the tobacco booty. This week the Justice Department moved to wrap up a pending lawsuit against the industry that seeks $14 billion in damages from Philip Morris and others for supposedly misleading people about the dangers of smoking — notwithstanding that warning labels have been required on cigarettes for 40 years.

But from a public policy standpoint, the 1998 tobacco settlement with the states is far more troubling because it provides a template for activist state attorneys general and trial lawyers to target other lawful enterprises. In recent years, AGs have begun a wave of lawsuits aimed at the pricing of pharmaceuticals, another deep-pocketed industry currently out of fashion. And a report in Wednesday's Journal about selling soda in elementary schools noted that “plaintiffs' lawyers are circling, raising the specter of litigation reminiscent of the courtroom battles that cost cigarette makers billions of dollars.”

In going after Big Tobacco, state officials took a major industry, wrung previously unimaginable sums out of it and thus turned the attorney general's office into a profit center for state government. Thanks to the settlement, states are receiving huge new amounts of revenue each year without legislatures having to raise taxes.

Challenges to the so-called Master Settlement Agreement (MSA) on antitrust grounds have been unsuccessful; courts have held that state officials can't be sued under federal antitrust laws. Unbowed, the folks at the Competitive Enterprise Institute, a free-market think tank in Washington, are trying a different tack. Earlier this month in a U.S. District Court in Louisiana, they filed a challenge to the MSA that focuses on the Constitution's compact clause, which says agreements between states require Congressional consent.

As the CEI complaint notes, a handful of state AGs originally cut a back-room deal with tobacco companies and then gave other states “seven days to review its terms and decide whether to join it.” Eventually, every state joined, which is no surprise given that a cut of a quarter-trillion dollar carrot was dangling in front of them. In return for the money and an ongoing stake in tobacco industry profits, the AGs agreed to drop individual state lawsuits against the companies.

States also agreed to give their new tobacco business partners a nifty competitive advantage that allows them to make the payments without losing market share. By passing identical laws that enforce a cartel among the major tobacco companies, the states effectively give smaller cigarette competitors no choice but to join the settlement and pay up. The alternative is to make even larger payments into an escrow account, ostensibly for possible future violations. And the ultimate effect has been no price competition for the larger companies and higher prices for consumers.

So an attempt by the states to recoup Medicaid costs related to smoking has resulted in states becoming the biggest stakeholder in the tobacco industry's success. According to a 2004 Government Accounting Office report, 54% of the MSA money is being used by states to fill budget gaps; only 17% is being used to treat smoking-related illnesses.

Constitutional challenges are always tough. And given that tobacco companies, states and public-health advocates — who were also bought off in the MSA — will align to protect their lucrative arrangement, success is a long shot. But there are good reasons — not least the doctrine of constitutional federalism that has served our system of government well — to hope it succeeds.