A long-simmering dispute over whether state officials have done enough to regulate off-brand cigarette companies is threatening to pull tens of millions of dollars from the state’s programs for children and at-risk families.
“The potential is there, certainly, for this to decimate children’s programs all across Kansas,” said Shannon Cotsoradis, chief executive of the advocacy group Kansas Action for Children.
The dispute stems from the 1998 master settlement agreement in which tobacco companies agreed to make billions of dollars in compensatory payments to states for as long as they remain in business.
In Kansas, most of the tobacco companies’ payments — $761 million in total since 1999 — are used to finance early childhood development services and programs that assist at-risk families, such as those with disabled children.
‘Clawing back’ payments
The settlement agreement includes a section that requires states to be “diligent” in making sure that cigarette companies that weren’t part of the settlement pay a $6-per-carton fee to an escrow fund.
“That was part of the deal,” said Bryan Haynes, tobacco team leader with Troutman Sanders, a Richmond, Va., law firm that represents several tobacco companies.
“In exchange for the participating manufacturers making settlement payments on a going-forward basis, the states were to force the non-participating manufacturers to pay a comparable amount — about $6 a carton — into an escrow fund,” Haynes said. “It’s meant to keep non-participating companies from coming in and undercutting the companies that were making settlement payments.”
<a name="continued"></a>The agreement allows the participating tobacco companies to retrieve or ‘claw back’ a sizable portion of their payments if they can prove three things:
• That they lost market share;
• That the lost market share was a result of conditions in the settlement agreement;
• That a state had been lax in its enforcement of the non-participating companies' escrow obligation.
Since 2006, the participating companies — R. J. Reynolds, Philip Morris Inc., Brown & Williamson, Lorillard and 16 smaller companies — have accused the states of being less than diligent in enforcing the non-participating companies’ payments.
When the companies joined the agreement in 1998 and 1999, they controlled 99.6 percent of the nation’s cigarette market. By 2003, their share had fallen to 91.6 percent, and the non-participating companies’ share had increased from less than half a percent to almost 8.4 percent.
The non-participating companies manufacture cut-rate cigarettes that tend to be sold in smoke shops, on Indian reservations and online. Their brand names include Tracker, Cheyenne, Carnival, Mohawk, Heron, American Harvest and Smokin Joes.
A question of enforcement
In July, a three-judge arbitration panel began a year-long process for hearing the tobacco companies’ complaints and each state’s defense.
“There are state-specific arbitrations going on right now,” Haynes said, noting that the initial scope of the hearings is limited to what happened in 2003.
Many states, he said, have argued that they did as much as their then-current laws allowed them to do.
“One of the most interesting questions for the arbitrators is: What does diligent enforcement mean?” Haynes said. “Because for better or worse, the MSA does not have any definition or specifics as to what it means.”
Kansas’ arbitration hearing was held Aug. 1 in Chicago.
Jeff Wagaman, a spokesman for Kansas Attorney General Derek Schmidt, declined comment about the issues raised during the hearing.
“As this matter is in arbitration we decline comment,” he wrote in an email to KHI News Service.
The state-by-state arbitration hearings are due to continue into June 2013. The panel is expected to issue its ruling later in the year.
Late last year, the tobacco companies dropped their complaints against 13 states: Alaska, Delaware, Hawaii, Idaho, Massachusetts, Montana, New Jersey, Rhode Island, South Dakota, Utah, Vermont, Wisconsin, and Wyoming.
“There’s a formula that the participating companies use to figure out which states were dropped,” said Clyde Hutchins, a senior Wyoming Assistant Attorney General. “A lot of factors were involved and ‘diligent enforcement’ was one of them. It wasn’t the only one, but it was one of the bigger ones, certainly.”
Kansas may owe refund to big tobacco
The decision is significant because the 12 states’ share of whatever refund may be owed to the participating tobacco companies will fall on the remaining states that didn’t do enough to enforce the escrow payments.
The settlement allows the tobacco companies to recoup more than $1.2 billion — 20 percent of the total payments made in 2003 — if they can prove the states fell short of meeting their obligations.
In 2003, the participating tobacco companies paid Kansas $48.3 million. So if the panel finds that Kansas was less than diligent in its enforcement efforts, the state likely will have to refund at least $9.6 million (20 percent) or, in a worst-case scenario, all of what it received, according to the original settlement terms as analyzed by attorneys familiar with the proceedings.
The refund — whatever it may be — will be deducted from the tobacco companies’ 2014 or 2015 payment, depending on when the panel issues its decision. The companies pay the states on April 15 each year.
A state will not have to give back more than it received in 2003.
Similar refunds are possible in subsequent years as well.
In Kansas, most of the tobacco companies’ payments are deposited in a Children’s Initiative Fund, which is used to underwrite early childhood development programs throughout the state.
The underwriting is administered by the 15-member Children’s Cabinet. Its president is appointed by the governor.
In an email to KHI News Service, Children’s Cabinet President Amanda Adkins said she expected the prospects for reduced funding to be discussed during the group’s Sept. 26 meeting. She declined further comment.
In addition to her Children’s Cabinet duties, Adkins is chair of the Kansas Republican Party.
Cotsoradis of Kansas Action for Children also serves on the Children’s Cabinet. She said she and other child advocates are exploring alternate sources of revenues for offseting whatever monies may be lost in the diligent enforcement arbitration.
“It’s obvious, I think, that there’s going to be some kind of cut because other states have been dropped from the arbitration and Kansas wasn’t,” Cotsoradis said. “But little kids shouldn’t be left holding the bag for whatever the state failed to do. Alternative funding solutions have to be on the table.”
Low state cigarette taxes
Nationally, the Campaign for Tobacco-free Kids is encouraging states to consider offsetting the losses — as well as losses tied to declines in cigarette sales — with increases in their cigarette taxes.
"To protect against any serious future budget disruptions relating to the cigarette companies’ MSA payments...states could respond to the ongoing MSA payment reductions by increasing their tobacco tax rates, or could pass legislation directing the state revenue department to increase all state tobacco tax rates whenever the state’s total tobacco settlement and tobacco tax revenues fall below certain stated amounts or significantly below the prior year’s level," the advocacy group wrote in a recent position paper.
"Our position is that raising the tax on cigarettes reduces smoking. That's why we're for it," said Danny McGoldrick, vice president for reserach with Campaign fo Tobacco-free Kids. "But, yes, it it could be used to offset lost revenues as well."
Kansas last raised its tax on cigarettes — from 24 cents per pack to 79 cents per pack — in 2002.
In the fiscal year that ended June 30, 2011, the tax generated almost $96 million, all of which went into the state’s general fund.
Cigarette taxes by state
Among states — which average $1.46 per pack — Kansas’ cigarette tax is the 15th lowest. The tax rate is even lower for other tobacco products.
Earlier this year, Gov. Sam Brownback proposed cutting the Children’s Initiative Fund expenditures by $16 million, arguing that tobacco payments had fallen short of projections in 2010 and 2011. Both times, the shortfalls — $1.2 million in 2010, $6.7 million in 2011 — were offset by transfers from the State General Fund.
Legislators restored most of the funding after the tobacco money came in as expected.
Brownback spokeswoman Sherriene Jones-Sontag declined to say whether the governor would support increasing the state tax on cigarettes.
The Attorney General’s Office isn’t expected to submit its tobacco-revenue projection for the coming fiscal year until early November. The governor’s proposed budget will be unveiled in early January.
That doesn’t leave much time for figuring out how to replace whatever revenues may be lost.
“I understand that if we’re in the midst of arbitration there’s some information that ought not to be shared,” Cotsoradis said. “But at the same time, given the gravity of what’s transpiring, there ought to be enough transparency to let us begin having a conversation about a solution. Right now, we don’t have that. Very few people know this is going on.”
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