98022: The Tobacco Settlement: Issues

C. Stephen Redhead
Science, Technology, and Medicine Division

October 16, 1998

CONTENTS

SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
Introduction
Issues

Promoting Public Health vs. Protecting Personal Freedom
FDA Regulation
Public Health Issues
Economic Issues

Effects on Price, Consumption, and Income
Disposition of Revenues
Tax Deductibility

Immunity and Other Legal Issues

Civil Liability Immunity
Advertising Restrictions
Attorneys' Fees

Tobacco Farmers

LEGISLATION

SUMMARY

Since 1994, 41 states and Puerto Rico have sued the tobacco industry to recover the medical costs of treating smokers. On June 20, 1997, a group of state attorneys general and industry lawyers announced that they had reached a settlement that would protect the tobacco companies from civil liability in return for annual industry payments of $365.5 billion over 25 years to reimburse states for their tobacco-related medical costs, and pay for tobacco control programs to reduce tobacco use among teenagers.

The proposed settlement would require changes in federal law before taking effect. Tobacco companies would also be required to sign contracts with states, waiving their First Amendment rights to advertise their products in exchange for civil litigation protection.

The settlement incorporates the Food and Drug Administration's (FDA) 1996 tobacco regulation and calls for Congress to amend the Federal Food, Drug, and Cosmetic Act (FFDCA) to give FDA specific authority to regulate nicotine-containing tobacco products as restricted devices. Public health officials have criticized the settlement for placing undue restrictions on FDA's ability to regulate nicotine. They are also wary of legislative proposals to establish new legal authority for regulating tobacco under the FFDCA.

The settlement would attempt to reduce underage smoking by raising cigarette prices by at least 62 cents per pack, restricting youth access to tobacco products, and restricting tobacco-product advertising and promotion. Funding would also be provided for adult cessation programs, which can be effective and relatively inexpensive.

If the industry passed the settlement's costs on to the consumers, the distributional effect would be similar to that of a tobacco tax, which is a very regressive tax. Under the settlement, the states would recover the medical costs of treating smoking-related illnesses. However, a more complete accounting of the health costs of smoking suggests that the federal and state governments have benefitted financially from smoking.

The settlement proposed changes to the civil justice system that would provide the tobacco companies with broad protection from future civil litigation. The recent disclosure of industry documents has fueled congressional opposition to granting the industry any such protection. The settlement's advertising restrictions appear likely to be unconstitutional and would therefore require the industry's contractual agreement. Attempts to cap or otherwise restrict the fees of private attorneys retained by states in their lawsuits against the industry may also face a constitutional challenge.

Several comprehensive tobacco bills, broadly based on the settlement, were introduced during the 105^th Congress. Unlike the settlement, these bills all contained financial assistance for tobacco farmers, who fear a drop in demand for domestic tobacco as consumption declines. The Senate killed the McCain bill (S. 1415) after four weeks of floor debate. The House Republican leadership decided against introducing a more narrowly focused tobacco bill that would have also addressed teenage drug abuse. State attorneys general have resumed negotiations with the tobacco companies to try to reach a more limited settlement, one that would not require federal legislation to take effect.

MOST RECENT DEVELOPMENTS

On June 17, 1998, the Senate rejected the McCain tobacco bill (S. 1415) after 4 weeks of floor debate and sent it back to the Commerce Committee. Broadly based on last year's proposed settlement, the McCain bill would have raised cigarette prices by about $1.10 a pack, given FDA new legal authority to regulate tobacco products, and fined manufacturers up to $4 billion a year if youth smoking did not decline by 67% over 10 years. It also would have provided the manufacturers with significant legal protection, and capped the industry's civil liability at $8 billion a year. S. 1415 was amended to use some of the tobacco revenue to offset tax cuts for married couples and to pay for federal anti-drug programs. The House GOP leadership outlined more narrowly focused tobacco legislation, which would also address teenage drug abuse, but decided against introducing a bill.

Following the demise of the McCain bill, the tobacco companies and the state attorneys general resumed talks in an attempt to negotiate a new national settlement, one that would not require federal legislation. In a major development, a federal appeals court this month ruled that the FDA has no authority to regulate tobacco products, reversing last year's lower court ruling confirming the agency's jurisdiction over tobacco. The Administration has appealed the ruling to the full appellate court.

BACKGROUND AND ANALYSIS

Introduction

In the past 4 years, 41 states and Puerto Rico have filed lawsuits against the tobacco industry seeking reimbursement for the Medicaid expenses they have paid to treat smoking-related illnesses. On June 20, 1997, a group of state attorneys general, together with private attorneys who have brought class-action lawsuits against tobacco companies, announced that they had reached a national settlement with the industry (see box below). Under that agreement, the industry would pay $368.5 billion over the first 25 years, and $15 billion a year thereafter, to reimburse states for their tobacco-related medical costs, pay for tobacco control programs to reduce tobacco use among teenagers, and extend health insurance to uninsured children. Cigarette prices would increase by at least 62 cents per pack if the industry passed the settlement's costs on to the consumer. The industry would also submit to regulation of its products by the Food and Drug Administration (FDA). In addition to settling the state cases, the proposed settlement would terminate all pending class-action lawsuits and nicotine addiction damage claims, and provide the companies with immunity from such lawsuits in the future. The proposed settlement would require federal legislation before taking effect. Participating companies would also be required to enter into legally binding and enforceable contracts with states, embodying many of the provisions of the settlement and including a waiver of certain constitutional claims by the industry.

After more than 40 years of successfully defending itself in court, the tobacco industry's decision to settle with the states in return for immunity from future civil liability is viewed as an indication of the potentially enormous threat the medical cost reimbursement and class-action lawsuits pose to the industry. Until recently, tobacco litigation consisted entirely of individual plaintiffs seeking compensation for tobacco-related diseases. The industry has always prevailed by arguing that smokers choose to smoke, despite the health warnings, and therefore assume the risks of smoking and negligently contribute to their own harm.

During the past 4 years, however, the disclosure of company documents and testimony of former industry employees has refocused the debate on industry misconduct. A series of revelations about the industry's research on and knowledge of the addictive properties of nicotine, its suppression of health information, and evidence of marketing its products to minors has resulted in a growing number of class-action lawsuits. The prospect of winning huge damages has encouraged plaintiffs' attorneys to pool their resources on behalf of all the class members. Though numerous class actions have been filed across the country, the threat they pose to industry has receded somewhat in recent months as courts in several states have refused to grant class-action status to some lawsuits. Last October, the industry agreed to pay $300 million to settle a class action brought on behalf of 60,000 flight attendants who claimed they were harmed by exposure to environmental tobacco smoke (ETS). The funds will be used to establish a research foundation to study smoking-related illnesses.

An important legal development has been the decision by state attorneys general, working with private attorneys, to sue tobacco companies to recover the Medicaid costs of treating smoking-related illnesses. State lawyers have taken a variety of legal approaches to require the companies to reimburse the states for those expenses. In addition to money, states are also seeking equitable relief (i.e., specific changes in behavior by the industry). For example, the industry would be prohibited from marketing and promoting its products to children and would be required to disclose internal files documenting research and marketing strategies. Labor-management health care funds have also filed lawsuits in more than 30 states seeking reimbursement for the tobacco-related medical costs they are paying for their members.

In March 1996, the Liggett Group, Inc., the smallest of the nation's five major cigarette manufacturers, broke ranks with the other companies and settled with five states. Liggett acknowledged that nicotine is addictive and that marketing has been directed at youths. The company also released confidential industry documents. Liggett, which has since settled with all the remaining states, did not participate in the national settlement negotiations and would not receive immunity from civil liability under the terms of the proposed agreement.

Since the proposed national settlement was announced, the five participating companies (Philip Morris USA, R.J. Reynolds Tobacco Co., Brown & Williamson Tobacco Corp., Lorillard Tobacco Co., and United States Tobacco Inc.) have settled with the first four states to bring their Medicaid reimbursement lawsuits to trial. In July 1997, they agreed to pay Mississippi $3.4 billion over 25 years, based on the state-by-state payment formula in the national settlement. Florida, which had been scheduled to go to trial in September 1997, settled for $11.3 billion in late August. The industry agreed to remove all tobacco billboards, public transit advertising, and vending machines in the state, and release hundreds of internal documents. The $15.3 billion settlement in Texas in January, 1998, included additional tobacco control measures, as well as funding for research and children's health care. Finally, in May, after having gone to trial, and just hours before the case was to go to the jury, the companies settled with Minnesota for $6.6 billion. During the 16-week Minnesota trial, plaintiffs' attorneys presented damaging documentary evidence of the industry's attitudes, knowledge and research about nicotine and marketing strategies. The Minnesota settlement includes the industry's most far-reaching concessions to date. All four state settlements would be superceded by a national settlement if the enabling legislation were enacted.

In addition to recovering tobacco-related medical costs, the proposed settlement included provisions to reduce teenage smoking. Preventing youth smoking has become the primary focus of the public debate. According to the Centers for Disease Control and Prevention (CDC), most smokers begin smoking during childhood or adolescence, and people who reach age 18 without having smoked are unlikely to take up the habit. Despite growing state and local tobacco control efforts, national surveys show that smoking rates among 10^th- and 12^th-grade students have increased for the last 6 years in a row.

In 1994, the Institute of Medicine and the Surgeon General both released reports that focused on youth tobacco use. That same year, the release of industry documents led to a series of highly publicized congressional hearings on tobacco industry practices and prompted FDA Commissioner David Kessler to investigate the industry's efforts to manipulate nicotine levels to addict smokers. The FDA concluded that cigarettes and smokeless tobacco products are delivery devices for nicotine, an addictive drug. In August 1996, the agency issued final regulations under the Federal Food, Drug, and Cosmetic Act (FFDCA) to limit youth access to tobacco products and reduce the appeal of tobacco advertising to youngsters.

Issues

Promoting Public Health vs. Protecting Personal Freedom

The debate over whether to enact a national tobacco settlement raises a fundamental issue in public policy. What is the appropriate role of the government in promoting desirable personal behavior? Proponents of the settlement point to the public health impact of smoking as a justification for sweeping new tobacco regulation. According to the CDC, smoking is the leading preventable cause of premature death in the United States, accounting for more than 400,000 deaths each year. Concern about the health impact of exposure to ETS (also known as passive, or secondhand smoke) has also fueled the social unacceptability of smoking and resulted in smoking restrictions in many public places. The antismoking movement is also driven by a desire to see the tobacco industry punished for the way it has conducted business in the past, arguing that the tobacco companies have for many years recognized the addictive properties of nicotine and the health risks associated with smoking. The industry has sought to conceal that information and has repeatedly denied it in public. Recently disclosed company documents provide evidence that the industry, contrary to its public statements, has for many years marketed and promoted its products to minors.

The tobacco industry and others have long argued that smoking is a matter of personal choice and that smokers should be free to smoke as long as they do not harm nonsmokers. For years the industry and others have vigorously challenged the evidence linking exposure to ETS (also known as passive, or secondhand smoke) to lung cancer and other illnesses. Some economists and other commentators argue that adult smoking should be treated like other risky behaviors such as overeating or skiing. They contend that the anti-smoking movement seeks to open the door to increasingly intrusive government regulation of personal choice in the name of public health. The government should not interfere in anyone's decision to smoke as long as smokers fully understand the risks, do not harm nonsmokers, and pay for the costs they impose on society. Proponents of that argument point out that surveys clearly show that smokers are generally aware of the health risks of smoking, and that smokers are increasingly prohibited from smoking in public places. As to the question of the external costs of smoking, a 1991 Rand Corporation study concluded that the costs imposed by smokers on nonsmokers are less than the current excise taxes paid by smokers.

Antismoking advocates argue that nicotine consumption, unlike many other risky behaviors, is addictive. Addicted smokers are not in complete control and do not engage in the behavior voluntarily. Therefore, some regulation is justified. Critics of this argument suggest that addiction merely makes it more difficult to quit, but not impossible. Indeed, there are as many former smokers alive today as current smokers. People make risky, hard-to-reverse decisions all the time (e.g., gambling, donating organs, marrying an abusive spouse). The key is whether individuals are fully informed of the risks they take and whether the government should deter or punish such behavior.

Finally, there is the question of underage smoking. It is generally argued that youngsters are not fully able to make rational choices and that society must intervene on their behalf. The fact that an estimated 89% of adult smokers began using cigarettes and 71% began smoking daily by or at age 18, coupled with the development of addiction during the first few years of tobacco use, makes a case for regulating adolescent tobacco use.

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