Testimony – Tobacco Settlement

Chairman McCain, Senator Hollings, and members of the committee, my name is Ray Scheppach and I’m the Executive Director of the National Governors Association. Thank you for the opportunity to represent the nation’s Governors before this committee today.

The tobacco Master Settlement Agreement (MSA) was reached on behalf of the Attorneys General of forty-six states, five commonwealths and territories, and the District of Columbia on November 23, 1998. That agreement, worth $206 billion over a 25-year period, is actually worth $246 billion when combined with previous settlements on behalf of Florida, Minnesota, Mississippi, and Texas.

The MSA Contains Many Important Provisions to Discourage Smoking
Two major programs in the settlement are dedicated to reducing teen smoking and educating the public about tobacco-related diseases. A total of $250 million was used to fund the creation of the American Legacy Foundation, a national charitable organization, to support the study of programs to reduce teen smoking and substance abuse as well as prevent diseases associated with tobacco use. An additional $1.45 billion was utilized to create a National Public Education Fund to counter youth tobacco use and educate consumers about tobacco-related diseases.

In addition, the price of tobacco has increased. Immediately after the MSA, the price of tobacco products jumped by 40 to 50 cents per pack. Additional price increases have occurred as companies attempt to maintain profit margins and make settlement payments. These price increases will substantially reduce smoking over time.

The settlement agreement also has a significant number of restrictions on advertising and promotion. The settlement prohibits targeting youth in tobacco advertising, including a ban on the use of cartoon or other advertising images that may appeal to children. The settlement also prohibits all outdoor tobacco advertising, tobacco product placement in entertainment or sporting events, and the distribution and sale of apparel and merchandise with tobacco company logos. Further, the settlement places restrictions on industry lobbying against local, state, and federal laws. These restrictions on tobacco companies’ ability to market their products to children and young adults will eventually have a major impact on smoking.

The MSA Did Not Require Set-Asides
There is a fundamental difference between the settlement we reached and the proposals being promoted in the late 1990s involving federal legislation. For that reason, Congress acted wisely in 1999 in declaring that decisions about the MSA funds should be made at the state and local level.

In the original lawsuits, states filed complaints that included a variety of claims, such as consumer protection, racketeering, antitrust, disgorgement of profits, and civil penalties for violations of state laws. Medicaid was not mentioned at all in a number of cases and was only one of a number of issues in many others. Further, the state-by-state allotments were determined, not based on Medicaid expenditures, but on an overall picture of health care costs in a given state.

It is important to note that, ultimately, the master settlement agreement bore no direct relationship to any particular state lawsuit. The master settlement agreement represents a global settlement approach that encompassed states who sued for Medicaid, states that had Medicaid claims thrown out of court, and other states that simply did not sue at all. The attorneys general were attempting to obtain a fair monetary recovery for all states considering the variety of claims and requests for relief and the common goals of the multistate settlement process.

The federal government was invited to participate in the state lawsuits, but declined. Therefore, states were forced to bear all of the risk initiating the suits and the entire fiscal burden of carrying forth the unprecedented lawsuits against a well-financed industry that had never lost such a case before. It was not until after state victory was ensured that the federal government began to pay renewed attention to state activities.

Simply put, the master settlement agreement negotiated between the Attorneys General and the tobacco companies is separate and distinct from the agreement that was proposed in the 105th Congress. That proposal would have represented almost 50 percent more money, $368 billion compared to the current settlement of $246 billion. That agreement was much more comprehensive, representing both state and federal costs and requiring congressional approval. In the context of the negotiations over the $368 billion amount, the federal government may have had a legitimate claim to a share of the settlement, but the proposal’s inability to garner enough votes for passage in Congress fundamentally changed the debate. Without passage of supporting legislation, states were forced to proceed with their own lawsuits and negotiate settlements based on nonfederal claims.

Congress Acted Definitively to Give States Spending Authority
On May 21, 1999, President Clinton signed into law a measure (P.L. 106-31) recognizing that decisions about how to spend the tobacco settlement dollars were most appropriately made at the state level, where Governors and legislators could be the most responsive to the unique needs and circumstances of their citizens. Championed by a large bipartisan group of Senators led by Sen. Kay Bailey Hutchison (R-Tex.) and Sen. Bob Graham (D-Fla.), the provision was successfully added to the FY 1999 Emergency Supplemental Appropriations bill.

State Spending
Over the 2000 to 2003 period, states have received $37.5 billion from the Master Settlement Agreement. Over this period there has been substantial stability in the allocation of revenues. About 36 percent went to health services and long-term care. About four percent went to tobacco use prevention. Another 12 percent went to research, education, and services for children. Also, states allocated three percent to tobacco farmers for crop diversification efforts to reduce their states’ dependence on tobacco production. The remainder went to endowments, budget reserves, and other programs.

The one area that witnessed a major change over the three year period was the percent allocated to endowments and budget reserves, which went from 29 percent in 2000 to 18 percent in 2003 and then two percent in 2004. This was caused by the worst state fiscal crisis since World War II. Regardless of this crisis, 37 states continued to spend funds on health services and about 33 maintained their commitment to tobacco use prevention.

Throughout the last two years, due partly to the budget crisis as well as concerns regarding the bankruptcy of tobacco firms, 16 states have securitized their tobacco settlement revenues. The proceeds from this securitization were about $13 billion.

Innovative Programs
The tobacco settlement funds allowed states to develop a significant number of innovative programs in biotechnology and economic development, smoking cessation, early childhood, and preventive health care. This period of innovation and experimentation, which helped states develop “best practices”, will pay dividends for a long time. States are proud of the smoking cessation initiatives and other programs they’ve developed with the tobacco settlement funds.

There are several innovative programs designed to prevent maternal smoking that are showing great promise. Smoking during pregnancy is currently responsible for 20 percent of all low-birth weight babies, 8 percent of preterm births, and 5 percent of all perinatal deaths. Several states have invested a portion of its tobacco settlement to target smoking cessation among pregnant women. These include both classes and one-on-one counseling on the dangers of smoking; effective protocols for breaking the smoking habit; statewide quit lines, and media campaigns aimed at women of childbearing age. Besides traditional cessation education and counseling, these services address a range of barriers to cessation, including weight gain, by providing support such as free enrollment in sports clubs.

Other states have used portions of the settlement to develop unique approaches to enhance education opportunities for low-income and disadvantaged students; strengthening foster care and child welfare initiatives; and expanding options for early childhood development and Healthy Start programs.

Many states have used tobacco settlement funds to make critical investments in pharmaceutical assistance programs for seniors and home and community-based care programs for people with disabilities. As many as 16 states have invested funds in biomedical research or research on cancer and other tobacco-related illnesses. The dividends that these investments pay will benefit all the other states as well.

Finally, the largest investment has been in traditional health care. States have invested billions in funds for indigent care programs, primary care, increasing insurance coverage for the working poor, for hospital charity care, community health centers as well as Medicaid and the State Children’s Health Insurance Program (S-CHIP).

Fiscal Condition of the States
The most important issue facing the states today is the dismal fiscal situation. States are enduring the worst fiscal stress since World War II, and although the national economy is beginning to recover, state revenue growth has not responded, and historically has lagged federal recoveries by upwards of 18 months. In fact, the current state crises are likely to endure well into fiscal year 2005. These fiscal conditions are driven by two major factors, sagging revenues and exploding Medicaid costs.

States have responded sensibly to these difficult conditions. Although the need for services has increased rapidly, state spending has only increased by 1.6 percent over the last two years, and our estimates for 2004 are that state spending will actually decrease by 2-3 percent. State spending will have been essentially flat for three years.

On the spending side, the program that has been responsible for the deteriorating fiscal condition is Medicaid, the state-federal health care entitlement for the poor, the elderly, and the disabled. Now larger than Medicare in terms of total population, total expenditures, and annual growth rate, Medicaid has become the “Pac-Man” of state budgets, gobbling up every additional dollar of revenue. Medicaid’s growth rate has averaged 10 percent per year during the past two decades and now represents 21 percent of the average state budget, up from 12.5 percent in 1990.

The major reason for Medicaid’s continued growth is that it quietly serves to supplement the Medicare program for the many services Medicare beneficiaries can not obtain anywhere else. Medicaid pays for the prescription drugs and long-term care that Medicare does not cover, and subsidizes the significant cost-sharing burdens that Medicare places on its poorest beneficiaries.

It is shocking to note that of Medicaid’s 50 million beneficiaries, the six million people eligible for both programs (the “dual eligibles”) account for 42 percent of Medicaid’s budget. Therefore, 42 percent of a $280 billion budget is being spent on people who are already receiving the FULL Medicare benefits package. State budgets simply cannot sustain this growing cost shift.

The 2001-2004 state fiscal crisis has had major impacts on:

  • The allocation of funds from the Master Settlement Agreement;
  • The cost of tobacco products in the states; and
  • Total spending on health care.

First, settlement dollars that originally were to be placed in rainy day funds or specific endowment funds were utilized to balance state budgets. Second, a larger number of states were forced to securitize part or all of their funds. Third, funds for tobacco prevention from the MSA were reduced. Fourth, a large number of states enacted significant increases in excise taxes on cigarettes which should have a huge impact on smoking cessation over the next 20 years. The proceeds from some of these taxes went into other endowment funds that are being used for smoking cessation. Finally, with Medicaid spending growing at 10 percent per year all states enacted changes to moderate the growth in Medicaid.

Tobacco Prevention and Control is Important to the States
The federal and state governments have always had the responsibility of ensuring and protecting the public health of its citizens. Smoking, as the leading cause of preventable death and disease, results in $150 billion in direct and indirect medical costs per year.

In 2001, 22.8 percent of the population were reported to be smokers, a reduction from 25 percent reported in 1993. Progress continues to be made in meeting national goals related to reduction in the percentage of the population who smoke. States are leaders in these efforts – through direct program efforts and changes to public policy.

  • Twenty states increased funding in fiscal year 2003 for tobacco prevention.
  • Forty three states have laws restricting smoking in public places, 45 restrict smoking in government buildings, and 25 have laws restricting smoking in private work places.
  • Five states have comprehensive laws with statewide restrictions on indoor smoking in restaurants, bars, and other public places.
  • Between 1990 and 2000, cigarette sales fell 20 percent.

Since January 2002, 28 states and the District of Columbia have implemented or enacted new cigarette tax increases. These increases are as high as $1.01 per pack in Connecticut and are more than 50 cents per pack in a dozen states. This raises the median tax rate to 58 cents per pack, an increase from 28 cents in July 2002.

The nation’s Governors feel strongly that the states are entitled to all of the funds awarded to them in the tobacco settlement agreement without federal restrictions. The master settlement agreement is fundamentally different from the earlier proposals considered by Congress. It is a global settlement of myriad claims.

Given the long history of state expenditures for smoking related illnesses and the fiscal pressures facing states, the financial flexibility provided to states in the MSA is not only appropriate, but vitally necessary. The state fiscal crisis will continue, and without flexible use of MSA funds to target emerging priorities, states will be forced to cut education spending and make painful cuts in Medicaid expenditures for prescription drugs and long-term care as well as other public health and health promotion activities.

I thank you again for the opportunity to appear before the committee, and I would be happy to answer any questions you may have.