Tobacco-tax sponsors say Philip Morris is blowing smoke

Sponsors of an initiative to raise the state’s tobacco tax by $2.60 a pack
say that the effort would not violate the terms of the Master Tobacco
Settlement Agreement (MSA), despite claims to the contrary by Philip Morris.
However, a spokeswoman for Senate President Pro Tem Don Perata, D-Oakland,
said that he still had numerous concerns about the initiative.

The Coalition for a Healthy California, which is sponsoring the Tobacco Tax
Act of 2006, commissioned a report from the San Francisco law firm Renne
Sloan Holtzman Sakai LLP. Delivered last Wednesday, it concluded that,
“Based on the terms of the MSA, the provisions of the Initiative, and
established legal principles governing contracts, we conclude that adoption
of the Initiative would not constitute a breach of the MSA.”

The report was a response to a February 14 letter from the four legislative
leaders to Duane Dauner, president of the California Hospital Association,
which is a co-sponsor of the initiative. The letter expressed concern that
the initiative could violate the terms of the MSA, the 1998 agreement
between tobacco companies and 46 states and several U.S. territories. The
agreement brings California around $800 million a year. In 2002, the state
securitized the revenue stream with a $3 billion bond used in part to make
up a revenue shortfall.

“If the Initiative were ever construed to violate the MSA, the General Fund
implications could be significant if the MSA revenues are unavailable to pay
the debt service that support the tobacco revenue Bonds issued by the
state,” the letter stated.

On Monday, Dauner and members of his group’s board met with the chiefs of
staff of the four leaders and Susan Kennedy, Schwarzenegger’s chief of
staff, and provided copies of the Renne Sloan report.

Perata’s chief of staff, Erin Niemela, said legislative counsel had
expressed concern over the MSA issue. Given the potentially huge budget
implications, she said that Perata wanted to be sure about the implications
of the initiative.

“It is our hope that it doesn’t violate the MSA,” Niemela said.
She added that the letter was not prompted by a January 9 letter from Philip
Morris USA that had been circulated in the Capitol, and that she had not
seen the letter before this week. The four page letter argues that the
initiative would violate the MSA: “In the MSA, the settling states agreed
not to impose additional ‘statutory’ liability for ‘reimbursement of health
care costs’ on MSA participants and their distributors above and beyond the
payments already provided for in the MSA.”

The initiative, the letter states, would impose “additional liability” on
tobacco companies while specifically earmarking money for health care–an
alleged violation of the MSA. The letter concludes: “not only would it fail
to raise the promised guaranteed revenues, it would potentially also have
the harmful effect of creating uncertainty in the state’s budget.”
“Philip Morris’ attacks have nothing to do with the MSA,” said Kris
Deutschman, communications director for the Coalition for Healthy Families.
“It’s just one in an expected series of manipulations and misrepresentations
to stop an initiative that will reduce smoking.”

In addition to the Renne Sloan analysis, she said, the attorney general’s
and legislative analyst’s offices both prepared legal analyses as part of
the standard preparation for putting the initiative on the ballot–and
neither found a conflict with the MSA, Deutschman said.

The Philip Morris letter bases some of it’s analysis on a comparison to it’s
case against the state of Minnesota, which is being heard this week by the
Minnesota Supreme Court. A lower court ruled in Philip Morris’ favor in
December. Minnesota was not part of the MSA, instead signing its own
agreement with tobacco manufacturers.

Furthermore, Deutschman said, the legal issue is different–Minnesota law is
not a tax, but a fee imposed against tobacco manufacturers to offset the
costs of smoking. The initiative, she said, uses a tax to fund health care,
but not to specifically offset the costs of smoking.

“Nowhere in the MSA does it explicitly say you can’t raise tobacco taxes,”
Deutschman said. “It gives tobacco companies the right to oppose new taxes.”
“As an original partner to the settlement agreement with California and the
other states, we feel like we understand the agreement and stand by our
analysis of the impact this potential tax will have,” responded Bill Phelps,
a spokesman for Philip Morris USA.

Niemela said that the initiative does reference the health costs of smoking,
which is an issue in the Minnesota case.

The initiative’s sponsors say it does seek to reduce smoking rates,
partially by pricing younger smokers out of the market. Studies have widely
shown the vast majority of smokers start before the age of 21. If the new
tax passes, it could push the cost of a pack of cigarettes in California
well above $6, with total taxes of $3.47 a pack.

This could backfire, said Norman Sharp, president of the Cigar Association
of America. He said the last time California pushed through a large increase
in the tobacco tax, a 25 cent increase under Proposition 99 in 1988,
hundreds of tobacco retailers went out of business. This time around, the
affect on retailers would be even worse.

“There is no way they can compete with an excise tax of 135 percent,” Sharp
said.

The result, he said, would be to push buyers to stock up in nearby low-tax
states, such as Nevada, or to buy cigarettes at Web sites that don’t charge
taxes at all–something Sen. Deborah Ortiz, D-Sacramento, is seeking to curb
with SB 1208, a bill that targets Internet tobacco sales.

Because the initiative likely would drive down legal in-state tobacco sales,
the initiative would not bring in anything close to the projected $2.27
billion annually that it’s proponents suggest, Sharp said.

The Legislative Analyst’s Office’s (LAO) analysis takes this into account,
noting that rising taxes generally lead to a fall in tobacco sales. The
proposed tax is “substantially greater” than previous taxes, it noted,
likely to lead to a “somewhat greater consumer response.” The LAO’s report
estimates $2.1 billion in revenue from the tax, projected to fall each
successive year.

Niemela said that the coalition’s analysis of the effect of the tax
projected a 26 percent drop in tobacco sales. However, she said, the actual
drop may be larger. This is a problem because two important programs–the
First Families program created by Proposition 10 and the Proposition 99
breast-cancer program–already depend on tobacco taxes and could see their
funding drop with decreased sales. Meanwhile, she said, new programs created
under the program do not expire, potentially creating new unfunded
obligations for the state.

“Everything they start up in this continues when the funding stops,” Niemela
said.

Deutschman said that propositions 10 and 99 guarantees are built into the
initiative. The Tobacco Tax initiative represents the merger of two earlier
tobacco-tax initiatives. The initiative’s supporters have been touting that
it would bring hundreds of millions a year for children’s health care, nurse
training and emergency-room funding. It is currently in the signature phase
for November.

The initiative includes some controversial clauses, such as an antitrust
exemption for private hospitals. While widely supported in the health-care
community, it is opposed by some key groups, including the California Nurses
Association.