Tobacco Tax Hike was a Backroom Deal

Every year, a massive transfer of wealth occurs across the country, between states and from smokers to state governments and wealthy trial lawyers, thanks to the largest legal settlement in history: the 1998 tobacco Master Settlement Agreement. That settlement is now being challenged in a petition that the Competitive Enterprise Institute recently filed with the Supreme Court in a case called S&M Brands v. Caldwell. This week, the court is expected to decide whether to hear the case.

This multibillion-dollar deal was drafted behind closed doors by a small group of lawyers representing states and Big Tobacco back in 1998. In exchange for state attorneys general dropping their lawsuits against the four major tobacco companies, tobacco companies agreed to pay the states more than $240 billion. In addition, trial lawyers received over $15 billion.

There was a catch: To get that money, the states would have to pass laws protecting the four biggest tobacco companies against competition from smaller and newer companies that had never been sued and never lied about the dangers of smoking. 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 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 loot.

Not only is the deal unjust, it is also 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. The Compact Clause of the Constitution provides that “No State shall, without the Consent of Congress … enter into any Agreement or Compact with another State.”

The tobacco deal undermines a core purpose of the Compact Clause – preventing states from 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. 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 more than twice as many people. Small wonder, then, that in 2005, Colorado state Treasurer Mark Hillman came out in support of our legal challenge to it. His rapidly growing state is shortchanged more with each passing year by its small, unchanging share of the agreement.

But in a sense, everyone was shortchanged. The tobacco deal created what was, in effect, a national tax increase on cigarettes. Yet not a single elected legislator, at any level of government, ever voted for this tax increase. This lack of accountability is fundamentally contrary to our system of government.

The Supreme Court now has a chance to take a strong stand on behalf of constitutional restraints against runaway government power. Anyone who cares about the rule of law should hope it takes that opportunity.