Testimony – Tobacco Settlement Funds

Mr. Chairman, thank you for the opportunity to appear before this subcommittee today to testify on the Governors’ number one legislative priority.

Tobacco Settlement Funds Belong to the States

The nation’s governors agree that the funds obtained in the historic tobacco settlement agreement rightfully belong to the states. The retention of all funds received as a result of the settlement reached with the major tobacco companies of the nation. The governors’ position is clear it was re-articulated in a policy resolution adopted at the 1999 winter meeting here in Washington on February 23rd. This meeting was attended by all but two of the governors and I know of no governor who does not agree with the resolution. This is truly a bipartisan position. Simply stated, our position is that the tobacco settlement funds belong to the states.

Without the states’ leadership and years of commitment to initiating and undertaking state lawsuits, we would not have achieved this major goal – a comprehensive settlement of myriad claims against the tobacco industry. After bearing all the risks and expenses in the arduous negotiations and litigation in which the states have been engaged we are now fully entitled to all the funds awarded to us.

The nation’s Governors strongly endorse S. 346, the Hutchison/Graham tobacco recoupment protection bill, and applaud the support of the many bipartisan cosponsors. It is crucial that the passage of this legislation, without federal restrictions, take place this year.

There is a fundamental difference between the settlement we reached and the proposals being promoted a year or so ago involving federal legislation to enact a tax on tobacco and appropriate the proceeds for several purposes. For the federal government to take the position that the entire $246 billion settlement amount represents the recovery of Medicaid-related expenditures and that therefore HCFA is entitled to recoupment of 57 percent of the entire settlement is clearly untenable for a number of reasons.

  1. In the original state suits, 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.Speaking for Kentucky, I can assure you that I agreed to the settlement on behalf of all Kentuckians as an attempt to recover at least a small portion of the money they have spent or will spend on tobacco-related illnesses, personally or through the federal government. As a consequence, I view the money that the Kentucky state government will receive as belonging to the people of Kentucky and therefore the decision about how it should be spent should be made by their representatives in the Kentucky General Assembly. Our legislature does not meet this year, however they have already expressed, in a joint resolution passed in our 1998 regular session, their intention to make that decision on behalf of our people. The fact is that I believe that we will devote these funds to the same kinds of activities as are generally being discussed around the country and here in Washington. But even if we do intend to spend the funds on programs that are similar to the ones Washington would place in legislation, as a matter of principle, the people of Kentucky, the legislature, and I would be opposed to it. For the federal government to use its power to cause us to have to involuntarily remit these funds to the federal treasury is offensive and totally unacceptable.
  2. It is important to note that, ultimately, the master settlement agreement bears no direct relationship to any particular state lawsuit. The master settlement agreement represents a global settlement approach that represents states who sued for Medicaid, states who had Medicaid claims thrown out of court, and other states that simply didn’t 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 aims of the multistate settlement process.
  3. The federal government was invited to participate in the lawsuits, but declined. 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 wasn’t until after state victory was ensured that the federal government began to pay renewed attention to state activities.
  4. The Medicaid third-party recovery provisions of the Social Security Act do not encompass, nor did Congress intend them to apply to, situations in which states initiate lawsuits on behalf of all of their residents against manufacturers of products, asserting a variety of consumer protection and other causes of action. These Medicaid provisions were adopted to facilitate reimbursements from insurance companies for small claims and to provide a tool to fight provider fraud. No one envisioned the use of the provisions to take from the states payments received as the result of massive, state-originated negotiations with the tobacco industry.
  5. As I have already stated, the master settlement agreement negotiated between the attorneys general and the tobacco companies is separate and distinct from the agreement that failed to pass in the 105th Congress. That failed proposal would have represented almost twice as much money, $368 billion compared to the current settlement of $246 billion. The failed 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 failure 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.

Governors Oppose Federal Restrictions

The nation’s Governors also are strongly opposed to any federal restrictions on how states spend their tobacco funds. Each state must be given the flexibility to tailor its spending to the unique needs of its citizens. For example, some states need to be able to assist farm communities while others may want to expand health coverage to the uninsured. For example, to force Kentucky or Virginia to spend all their funds on health insurance for children would represent flawed federal policy when they need to assist farm communities. Similarly, to force Vermont to spend all its funds on health insurance for children would be unwise, given the low percentage of uninsured children in that state.

Many Governors, through state-of-the-state speeches or through proposed or finalized state legislation, have already publicly committed to spending these funds for the health and welfare needs of their citizens. The majority of Governors have already made commitments to create trust funds and escrow accounts that will ensure that tobacco settlement funds are spent on health care, services for children, assistance for growers, education, and smoking cessation.

The nation’s Governors and state legislators are committed to spending the settlement funds on a wide variety of state programs that will reduce teen smoking and improve the health, education and public welfare of each state’s citizens. Ensuring this requires the flexibility for states to spend the settlement funds on programs targeted to the specific needs of each state. States do not need the federal government to tell them when and how to spend the money.

Examples of spending commitments include the following.

  • Governor Jane Dee Hull of Arizona has proposed: building medical facilities and permanently funding a variety of health care programs; forming a trust fund for research and education on smoking cessation; establishing an up-front payment for a new state mental hospital, new state health laboratory, and rural health clinics; and funding a county health care block grant.
  • Governor Gary Locke of Washington has proposed: increasing funding for Washington’s Basic Health Plan for working families; expanding Medicaid health coverage for children in low-income families; and establishing an endowment fund to help smokers quit and convince young people not to use tobacco.
  • Governor Frank O’Bannon of Indiana has proposed: increasing funding for children’s health, antismoking programs, other public health programs, and support of local health departments; expanding health insurance to low-income working families; and providing support to tobacco farmers to ease their transition to other crops.
  • Governor James S. Gilmore III of Virginia has proposed: establishing a fund for economic and agricultural development targeted at assistance for farm communities hurt by the settlement; establishing a health fund for children, community-based treatment for mental illness, long-term care, and youth antismoking programs; and establishing a fund that addresses other critical needs such as education infrastructure.

Set-asides for Smoking Cessation Programs Are Bad Public Policy

One of the restrictions under consideration in the Senate is a proposal to require states to spend 25 percent of the funds on smoking cessation programs. Although the nation’s Governors agree with the goal of substantially reducing smoking, we are adamantly opposed to this restriction. It would represent very poor public policy. There are already four major initiatives that are going into effect to reduce smoking.

  1. The price of tobacco has increased. The price of tobacco products has already increased between 40 cents and 50 cents per pack. Additional price increases may come over time as companies attempt to hold profit margins and make settlement payments. These price increases will substantially reduce smoking over time.
  2. Two major programs in the settlement are dedicated to reducing teen smoking and educating the public about tobacco-related diseases. $250 million will create a national charitable foundation to support the study of programs to reduce teen smoking and substance abuse and prevent diseases associated with tobacco use. An additional $1.45 billion will create a National Public Education Fund to counter youth tobacco use and educate consumers about tobacco-related diseases.
  3. The settlement agreement 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. Over time, these restrictions on tobacco companies’ ability to market their products to children and young adults will have a major impact on smoking.
  4. States are already spending state funds on smoking cessation and will substantially increase funding as the effectiveness of programs becomes established. Many states have already invested years in program design, modification, and evaluation to determine the best ways to prevent youth from taking up cigarette smoking and helping youth and adults quit smoking. Governors and states are highly motivated to implement effective programs. We see the human and economic burdens of tobacco use every day in lost lives, lost wages and worker productivity, and medical expenditures for tobacco-related illnesses. Thirteen states have already committed to creating a dedicated trust fund or devoting considerable settlement revenues to smoking cessation programs – Alabama, Alaska, Arizona, Delaware, Hawaii, Indiana, Maryland, Massachusetts, Missouri, New Jersey, North Dakota, Vermont, and Washington.

Given the fact that these four major initiatives to reduce smoking are now being implemented, it is critical that additional spending be well coordinated with these and other initiatives. Governors will commit additional funds as the effectiveness of new programs is proven. However, the funds must be well coordinated with these four new initiatives. States must have the flexibility to spend funds in a cost-effective way. They should not have to meet an artificial restriction that has no basis in sound public policy.

State Revenue Impacts of the Tobacco Agreement

Although the tobacco agreement will create payments of $246 billion to states over the next twenty-five years, the net revenue gain to states may be substantially below that total as state tobacco tax-revenues are substantially reduced. In 1996 state tobacco tax collections were about $7.1 billion per year. Over the next twenty-five years, these revenues will fall substantially below what they would have been without a tobacco agreement.

There are three major reasons for this reduction in revenue. First, the tobacco agreement has already increased the price of tobacco products by from 40 cents to 50 cents per pack. This could reduce state tobacco tax collections by around $700 million per year. However, over time there is the possibility that tobacco companies will be forced to increase prices more in order to maintain profit margins. If this were to lead to another increase of 50 cents per pack, the combination of the two price increases could lead to a reduction in state revenues of $1.4 billion per year.

Second, in addition to the price effects, the tobacco agreement puts a number of restrictions on advertising that will further reduce smoking and thus state tax revenues.

Third, the foundation created in the agreement to fund national smoking cessation programs coupled with state programs for smoking cessation will further substantially reduce smoking and therefore state tobacco tax revenues. Although it is difficult to provide an accurate estimate of the reduction in tobacco revenues, the combination of significant price increases coupled with major new smoking cessation programs would likely reduce state tobacco tax revenues by tens of millions of dollars over the twenty-five year period. This would substantially reduce the net revenues from the tobacco agreement.

Further, there is another major potential offset to the settlement funds if the volume of cigarette sales is reduced. Specifically, there is a net revenue reduction for every percentage reduction more than 2 percent. For example, if the volume of cigarettes sold is reduced by 12 percent, state revenues from the agreement would be reduced by $14 billion over twenty-five years. Similarly, if the volume went down by 22 percent, then revenues would be $32 billion lower.

This reduction in overall tobacco use is one of the primary purposes of the tobacco settlement, and the Governors will applaud such reductions. Although a worthy goal, such reductions will reduce net funds available to states, and thus must be taken into consideration.


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 seizure. The master settlement agreement is fundamentally different from the proposals recently considered by the Congress. It is a global settlement of myriad claims. Medicaid was not the major focus or force in the settlement, and there is therefore no legitimate federal claim to the funds. Reduced tobacco consumption will significantly reduce state revenue and a part of these funds must be utilized to replace them. By their words and actions, Governors and states are allocating these funds, for the most part, to the same areas that are being discussed in Washington. But the Governors, working closely with state legislators and concerned parties must have the flexibility to tailor the spending of these funds to meet the needs of individuals in their states. There is no reason to believe that the federal government’s wisdom on this issue is superior to the wisdom of the individual states and territories. Although states will spend significant amounts of money on programs that improve the health, education, and welfare of their citizens, states do not need to be told how to spend any portion of their money.

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