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Tobacco payment in danger

Possible $15M shortfall could hurt state budget

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Major U.S. tobacco companies are seeking to withhold nearly $1.2 billion in payments to states this year, threatening to leave South Carolina with about $15 million less than expected.

The state expected to receive a total of about $82.3 million this year in payments stemming from the multibillion-dollar 1998 Master Settlement Agreement between 46 states and the big tobacco companies.

The problem is that the state is counting on the $82.3 million to pay off bonds and could be faced with juggling its budget to make up for the shortfall.

As part of the agreement, big tobacco companies agreed to make annual payments to the states largely tied to the prior year's cigarette sales.

With states and municipalities across the country passing laws to ban and discourage smoking, cigarette sales dipped to the lowest level since 1951 and the nation's per-capita consumption of tobacco fell to levels not seen since the early 1930s, the association of state attorneys general said last week.

As the use of tobacco and the number of smokers in the United States continues to tumble, so do profits for tobacco companies and their ability to meet the expected payments that states are counting on.

"It's another lunacy of this program," said Trey Walker, spokesman for South Carolina Attorney General Henry McMaster. "(Attorney General McMaster) finds himself the tobacco regulator in South Carolina, and put in a position where he has to prop up big tobacco to make sure they sell enough cigarettes to make payments to the states.

"That shouldn't be the role of government. (McMaster) has said this is one of the most disgraceful abuses of the legal system that he's ever seen."

As part of the 1998 Master Settlement Agreement, big tobacco companies agreed to give money back to states to help pay for medical expenses associated with smoking and to go toward initiatives for smoking cessation and prevention programs. So far, tobacco companies have doled out more than $41 billion to states, with each year's payments based largely on cigarette sales volume from the previous year.

The 46 states that were part of the agreement are expecting to receive a total of $6.5 billion in settlement money this spring.

Each state could decide how it allocates the money, and many states -- including South Carolina -- have spent large portions of the money or earmarked it for various programs in state budgets.

South Carolina has used the bond proceeds to pay down previous debt, subsidize tobacco farmers, pay for various water and sewer projects and fund Medicaid programs.

"Now states are addicted to this money," Walker said. "The state, for better or for worse -- we are wedded now to those payments."

In 2001, through a decision by the General Assembly, the state issued about $921 million in bonds -- about half of its total expected future flow of settlement money -- to make more money available to fund programs up front, according to the state Budget and Control Board.

Between 2000 and 2025, South Carolina expects to receive about $2.3 billion in tobacco settlement payments. All payments through 2018 will go toward paying debt service on bonds.

The state set up a reserve fund and planned for fluctuations in annual settlement payments, according to the Budget and Control Board.

"Still, it would be a negative impact," said Trav Robertson, spokesman for the state's Treasurer's Office. "But at this juncture, I think it's somewhat premature to panic about this yet. The impact, while initially startling, might not be as great if you look at the big picture."

Robertson said the Treasurer's Office will withhold further comment until the issue is resolved.

FIGHT FOR MONEY

The major tobacco companies that signed the Master Settlement Agreement -- including Philip Morris USA, R.J. Reynolds Tobacco, and Lorillard Tobacco -- say they're entitled to cut payments by as much as $1.2 billion this year because they're losing market share to smaller companies that didn't sign the agreement.

Michael Neese, spokesman for Philip Morris USA, said the company has "not threatened to withhold a portion of (its) payment," but said the provision "clearly allows" for lower payments to states based on lost market share.

The provision was included in the settlement out of concern that smaller tobacco companies not included in the agreement would be able sell cigarettes at lower prices. It states that if participating manufacturers, in aggregate, lose more than 2 percentage points in market share, they can cut annual payments to states.

In 2003, Neese said, the companies reached that threshold. Their collective market share dropped from 99.6 percent in 1997, a year before the settlement was reached, to 91.9 percent in 2003, an 8 percent decline.

However, the tobacco companies would have to prove that the market-share loss was due to burdens of the agreement.

In a blow to the states, an independent arbiter ruled on March 1 that the burdens of the settlement agreement on big tobacco companies -- including marketing restrictions and the payments to states -- were a contributing factor in the market-share loss.

But Walker, of the Attorney General's Office, said, "Any reduction in market share is happening because the public is stopping smoking. It's not because the states haven't done enough to enforce provisions in the MSA."

The association of state attorneys general has said they plan to fight for full payments. Walker said the South Carolina Attorney General's Office has been working with the other states to dispute the cuts in payments.

States had until Monday to submit comments and arguments to the arbiter, which is due to submit a final decision March 27.

"It's a very serious issue -- serious enough for Attorney General McMaster to gather support from the governor, the state's tobacco authority, the budget control board and the chairmen of the House budget committees to prepare for any contingency necessary to protect the state and protect the securitization of the bonds the state issued in 2001," Walker said.

Despite rallying opposition from the states, the tobacco companies remain confident that the arbiter's preliminary ruling will stand, said Maura Payne, spokeswoman for R.J. Reynolds.

"When you have an increase in cost on any consumer product, consumption declines, and it's fairly intuitive that at any time a consumer product ratchets up considerably, you'll see some shifts in buying patterns -- in this case away from our products," she said. "And that's what provisions in the MSA are there to protect."

Contact Peter Frost at 706-8169 or . To comment on this story, please go to islandpacket.com.

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