The landmark 1998 settlement of state cigarette suits for $243 billion broke all records for civil litigation in the United States, yet it set an unfortunate precedent and remains widely misunderstood.
Faced with a series of lawsuits by state attorneys general across the country, the tobacco industry brokered the settlement in two separate deals. First, it settled with four states for $37 billion, then with the remaining 46, including Massachusetts, for $206 billion. Both the litigation and the settlement were novel in many respects.
But smokers, not tobacco companies, on several levels bear the brunt of the deal, which established penalties equivalent to an additional tax on cigarettes. In most years this tax will be about 40 cents. Whether the states get paid off at all hinges on whether people continue to smoke and how much.
With media attention focused on the $243 billion figure, an observer might have expected that this meant the cigarette industry paid off the states with either a single damages payment or a series of payments over time. However, this is not how the settlement works.
Some antismoking advocates wanted the companies' shareholders to suffer, but they also liked the idea of a higher cigarette tax to discourage smoking. They couldn't have it both ways. The tax approach was chosen because it could potentially yield a higher financial return to the states than would a fixed payment up front. Shifting the settlement cost to smokers also presumably appealed to the cigarette industry. The parties who cut the deal benefited. But the smokers, who were unrepresented at the bargaining table, were worse off.
The settlement involved high-stakes political deals among the attorneys general. To determine which states got more than their fair share, I conducted a study calculating each state's share of the country's cigarette-related medical costs and compared that amount to its settlement share. Massachusetts did well. Its share of cigarette-related medical costs was 3.2 percent, and it got 4.1 percent of the settlement. New Hampshire was not as lucky, as its medical cost share was .9 percent, and its share of the settlement was .7 percent.
The three leading tobacco-producing states all were losers. Kentucky accounts for 2.8 percent of the medical costs, but got only 1.8 percent of the settlement. North Carolina accounts for 3.5 percent of cigarette-related medical costs, but received only 2.4 percent. Virginia, which bears 2.8 percent of the medical costs, received only 2.1 percent.
The attorney general most responsible for brokering the deal was Christine Gregoire of Washington state. Her state, which accounts for 1.5 percent of the medical costs, received 2.1 percent of the settlement. In fairness, perhaps the state should have gotten a bonus given Gregoire's central role in brokering the deal. But did the other state attorneys general realize that compensation to Washington for Gregoire's coordination efforts increased the state's piece of the action from $3.1 billion to $4.3 billion?
These enormous payments are even more striking given the speculative nature of the litigation. The lawsuits did not seek to recover for harm to individual smokers. In fact, smokers get nothing from this deal. Nor were the suits about youth smoking. Although many public officials said that the money from the settlement would be used to deter smoking by young people, that has not proven to be the case and was not a concern of the lawsuits. Rather, the suits were largely an accounting exercise in which the states argued that cigarettes increased the medical costs they incurred.
But let's look at the logic. The existence of economic costs is not a sufficient basis for giving the states a valid claim. Cars are also dangerous, but states can't recover for the costs of auto accidents. The states would also have had to show wrongful conduct on the part of the industry. That and other legal concerns combined with the unprecedented nature of the litigation to make the suits seem like longshots when they were launched.
The basic elements of the financial accounting added to the improbable prospects of the litigation. To be sure, smokers do incur higher medical costsabout five cents per pack in Massachusetts in the mid-1990s. Yet, because smokers have a shorter life expectancy than nonsmokers, smokers incur a cost of 11 cents per pack less in nursing home costs and nine cents per pack less in pension costs. On balance, smokers incur about 14 cents less per pack in costs paid by Massachusetts, while contributing an additional 51 cents per pack in excise taxes.
Any cost tally presumably should be comprehensive and recognize all cost effects of cigarettes, both positive and negative. Excise taxes also might get counted. Because the lawsuits were settled, there was never any legal resolution of which cost components get counted and which do not.
Other aspects of the settlement were equally novel and controversial. Lawyers were not paid based on hours worked, but rather were compensated through separate arrangements, most of which have remained secret. Some of the lawyers involved reaped enormous windfalls as a result of the deal, with legal fees in 21 states alone totaling $11 billion. These fees have provoked considerable controversy because many of the arrangements were a result of sweetheart deals with politically connected friends of attorneys general rather than a competitive bidding process that would have ensured that the lawyers would be paid fairly for effort expended.
Widespread concerns over the windfall gains reaped by the attorneys only touched on the most visible symptom of this flawed approach. The settlement established a new tax on cigarettes without going through the usual legislative procedures that enable all segments of society to have political input. And the agreement included numerous regulatory provisions, such as restrictions on cigarette advertising. None of these policies underwent the usual scrutiny accorded governmental regulations.
Rather than settle the litigation, both sides should have pursued the case to its legal resolution. Doing so would have taken tax and regulatory policy out of the legal arena and established guidelines for similar litigation against other controversial products, ranging from guns to lead paint.
While most states remain enthusiastic about the incoming tobacco revenues, higher cigarette taxes, such as those being considered now by legislatures in Massachusetts and elsewhere, could have achieved the same effect without sidestepping conventional political processes.