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######### National Conference of State Legislatures 444 North Capitol Street, N.W., Suite 515 Washington, D.C. 20001

5400. ***202-737-1069 (fax)***

**Testimony of**

**The Honorable Deborah Hudson**

**Chair, Revenue and Finance Committee**

**Delaware House of Representatives**

**On behalf of the**

**NATIONAL CONFERENCE OF STATE LEGISLATURES**

**Regarding**

**Tobacco: States' Use of Settlement Funds**

**Before the**

**COMMITTEE ON COMMERCE, SCIENCE & TRANSPORTATION**

**UNITED STATES SENATE**

**November 12, 2003**

Good morning Chairman McCain, Senator Hollings and Members of the
Committee:

I am Deborah Hudson, a member of the Delaware House of Representatives
where I serve as chair of the Revenue and Finance Committee. I also
serve as a member of the Delaware Health Fund Advisory Committee, which
was established in 1999 to make recommendations to the governor and to
the General Assembly regarding the allocation of Delaware's tobacco
settlement funds.

I am here today on behalf of the National Conference of State
Legislatures (NCSL) to discuss the states' use of tobacco settlement
funds. On November 23, 1998 the Attorneys General and other
representatives of 46 states[^1], Puerto Rico, the U.S. Virgin Islands,
American Samoa, the Northern Mariana Islands, Guam and the District of
Columbia signed an agreement with the five largest tobacco
manufacturers, ending a four-year legal battle between the states and
the industry. A battle that began in 1994, when Mississippi became the
first state to file suit. The settlement funds became available to
states in 2000. I am honored to be a part of such a distinguished panel
on a day so close to the fifth anniversary of the historic tobacco
settlement agreement.

In keeping with the rules of the committee, my oral statement will be
limited to five minutes. I am submitting my written statement to be
included in the hearing record. Today I will focus on the following
observations:

(1) States have dedicated the largest percentage of tobacco funds to
    health care services and programs.

(2) A growing number of states are securitizing their tobacco settlement
    funds and many more are expressing interest in securitization.

(3) The number of non-participating tobacco manufacturers is growing.

(4) Federal legislation is needed to help states in some key areas.

It is difficult to discuss the myriad programs that states currently
support with tobacco settlement funds. It is even more difficult to
contrast and compare among the states. The Master Settlement Agreement
(MSA) provided no direction to states and imposed no restrictions on
states regarding the allocation of their tobacco settlement funds. As
such, these funds are treated as state revenue and are subject to the
regular appropriation process. Most states, like Delaware, receive
continuing feedback from citizens regarding the allocation of tobacco
settlement funds. As a result, state tobacco settlement fund
expenditures by and large reflect the priorities established by the
citizens of each state. Delaware has dedicated the majority of its
tobacco settlement funds to health care. We are comfortable with our
decision, but would not venture to second-guess states that have made
other choices.

### State Tobacco Settlement Expenditures

I have been asked to provide an overview of how states have spent and
are spending their tobacco settlement funds. NCSL has tracked state
tobacco settlement expenditures since FY 2000 and has divided
expenditures into nine categories: health services, long term care,
tobacco use prevention, research, education, children and youth
services, tobacco farmers, endowments and budget, and other. In the
nearly five years since the signing of the historic tobacco settlement
agreement, much has changed.

State fiscal conditions have eroded and tobacco manufacturers are facing
their own financial challenges. How have states spent the funds? What
are the trends? Below is a summary of what we have observed.

######### Table 1

**Allocation of Tobacco Settlement Funds by Category, FY 2000-FY 2004**

**(Dollar figures represent total allocation for the fiscal year)**

+-----------------------+------------+-----------+----------+---------+
|                       | **FY       | **FY      | **FY     | **FY    |
|                       | 2000/FY    | 2002**    | 2003**   | 2004**  |
|                       | 2001**     |           |          |         |
|                       |            | *         | *        | *       |
|                       | **(\$10.97 | *(\$10.97 | *(\$9.83 | *(\$7.9 |
|                       | billion)** | b         | bi       | bil     |
|                       |            | illion)** | llion)** | lion)** |
+-----------------------+------------+-----------+----------+---------+
| **Health Services**   | 33%        | 29%       | 29%      | 28%     |
+-----------------------+------------+-----------+----------+---------+
| **Long Term Care**    | 3%         | 7%        | 8%       | 6%      |
+-----------------------+------------+-----------+----------+---------+
| **Tobacco             | 5%         | 5%        | 5%       | 3%      |
| Prevention**          |            |           |          |         |
+-----------------------+------------+-----------+----------+---------+
| **Education**         | 4%         | 8%        | 3%       | 5%      |
+-----------------------+------------+-----------+----------+---------+
| **Research**          | 3%         | 6%        | 3%       | 3%      |
+-----------------------+------------+-----------+----------+---------+
| **Children & Youth    | 4%         | 2%        | 3%       | 3%      |
| Services**            |            |           |          |         |
+-----------------------+------------+-----------+----------+---------+
| **Tobacco Farmers**   | 3%         | 3%        | 2%       | 4%      |
+-----------------------+------------+-----------+----------+---------+
| **Endowments and      | 29%        | 24%       | 18%      | 2%      |
| Budget Reserves**     |            |           |          |         |
+-----------------------+------------+-----------+----------+---------+
| **Other**             | 16%        | 16.2%     | 29%      | 47%     |
+-----------------------+------------+-----------+----------+---------+

Source: National Conference of State Legislatures, Health Policy
Tracking Service, 2003

**Trends in State Expenditures**

Health Services represents the largest single category of tobacco
settlement fund expenditures. In FY 2000/FY 2001 a third of the tobacco
settlement funds went toward health care services. Today these
expenditures represent 28 percent of total expenditures. The kinds of
health services vary considerably by state. For instance in Arizona, the
chairman's state, the people in 2000 voted for Proposition 204 which
directed the state to use the tobacco settlement funds to expand
eligibility for the Arizona Health Care Cost Containment System
(AHCCCS), the state's Medicaid program. South Carolina was one of the
first states to securitize its tobacco settlement funds. The state
received \$791 million and distributed the funds as follows: (a) 75
percent of the funds to the Health Care Endowment[^2]; (b) 15 percent to
the Community Trust Fund for farmers affected by the drop in tobacco
demand and prices; (c) 10 percent for economic development grants to the
I-95 corridor of tobacco communities; and (d) 2 percent for water and
sewer projects in rural communities. We established the Delaware Health
Fund and the Delaware Health Fund Advisory Committee to make
recommendations to the Governor and General Assembly regarding the
allocation of Delaware's tobacco settlement funds.

The second largest category of expenditures was, until this year,
endowments and budget reserves. The dramatic shift in funds allocated to
endowments and budget reserves between FY 2003 and FY 2004 to the
"Other" program category is a very clear and dramatic illustration of
the serious fiscal challenges facing the states. While experts may
differ on the adequacy of each state's expenditures for tobacco use
prevention, the level of expenditures for tobacco use prevention in the
aggregate remained constant at about 5 percent until the current fiscal
year. This year states increased the percentage of tobacco settlement
funds that were allocated to education. Tobacco-producing states also
increased the amount of funding allocated to tobacco farmers as part of
their commitment to provide economic and education alternatives to
tobacco farmers and the communities, in which they live and work.

######## Delaware Health Fund

The Delaware Health Fund Advisory Committee, a twelve member board,
chaired by the Secretary of the Delaware Health and Social Services
Department, advises the governor and the legislature on how to allocate
the state's tobacco settlement funds. I am a member of the advisory
committee. The committee has regular, open meetings and maintains a
website where advisory committee meeting minutes and the advisory
committee recommendations can be read and downloaded. All of Delaware's
tobacco settlement funding is dedicated to health care programs and
services and to tobacco prevention and control. Like many other states
we have reduced our reserve fund this fiscal year to provide funding for
state health care priorities. We have slightly increased funding for
tobacco prevention and control and have provided level funding for most
ongoing programs. We are happy that we are able to maintain this
commitment despite the fiscal challenges we face. (See Table 2 for
details).

######## Securitization of State Tobacco Funds

Securitization is the process by which states sell the revenue stream of
its tobacco settlement payments, for a set number of years, in return
for a single, up-front payment. Although the up-front payment is less
than the sum of the annual payments, the state receives a lump sum
payment and the funds are immediately available. It is comparable to
receiving a lump sum payment instead of an annuity. There has always
been a level on uncertainty regarding whether the tobacco funds would in
fact continue into perpetuity. Initial interest in securitization was
among states that feared that the bankruptcy of one or more of the
tobacco manufacturers would undermine the settlement agreement.
Decreasing state revenues, continuing class action litigation against
tobacco manufacturers that may in fact make tobacco manufacturers
vulnerable to bankruptcy, and decreasing tobacco sales, have increased
the interest among states in the securitization of tobacco settlement
funds. To date, 16 states[^3] have securitized all or part of their
tobacco settlement funds. (See Table 3 for details)

Growing Number of Non-participating Tobacco Manufacturers

The dramatic decline in the volume of cigarettes shipped by
participating manufacturers is due in part lower demand for cigarettes,
but much of the decline can be attributed to the growing number of
non-participating manufacturers who have entered the market and who sell
their products at a deep discount. These deeply discounted products are
more attractive to children and because they are often sold over the
Internet, are more available to children. This represents a serious
problem for states and for people who support reducing youth access to
tobacco. In addition, the reduction in the volume of cigarettes shipped
by

participating manufacturers can result in an overall decrease in state
tobacco settlement fund allocations.[^4]

Five years ago, the most immediate task for state legislatures related
to the Master Settlement Agreement was the consideration and enactment
of the \"Model Statute\" included in the settlement agreement. This
model statute was designed to provide a level playing field between
participating and non-participating tobacco manufacturers by creating a
reserve fund into which non-participating manufacturers are to pay
future claims. Since the signing of the settlement agreement, we have
found that the Model Act needs some fine-tuning to close some loopholes
the non-participating manufacturers have discovered. NCSL is working
with the National Association of Attorneys General (NAAG) to close these
loopholes in the existing state laws.

We are also working with Congress to enact federal legislation that
strengthens the Jenkins Act and provides states with additional tools to
enforce both the Jenkins Act and existing state laws. This legislation
will help states reduce youth access to tobacco products and to collect
state tobacco tax revenue that is not currently being collected. A
recent Government Accounting Office (GAO) report advised that states
would lose approximately \$1.5 billion in tax revenues by the year 2005
if the current state of Internet tobacco sales continues. As you know,
the Senate Judiciary Committee recently reported S. 1177, the Prevent
All Cigarette Trafficking Act (PACT Act), a bill that amends both the
Jenkins Act[^5] and the Contraband Cigarette Trafficking Act.[^6] A
related piece of legislation, H.R. 2824, amends the Jenkins Act and is
pending in the House Judiciary Committee. NCSL looks forward to working
with you to work towards passage of this important legislation.

I thank you for this opportunity to share NCSL's thoughts and
observations with you. I would be happy to answer questions.

.

Table 2

**delaware health fund appropriations state Fy 2002-FY 2004**

**(in thousands)**

  --------------------------- -------------- -------------- --------------
  **Initiative**              **FY 2002**    **FY 2003**    **FY 2004**

  **Continuing Initiatives**                                

  **Strategic Reserve**       6,025          9,843          5,291

  **DE Prescription Drug      5,150          7,213          7,500
  Assistance**                                              

  **Tobacco                   5,005          5,009          5,072
  Prevention/Control**                                      

  **Medical Coverage for SSI  1,485          1,485          4,485
  Transition**                                              

  **DHCC Uninsured Action     1,000          885            500
  Plan**                                                    

  **Chronic Disease Pilot**   500            500            500

  **Medicaid Increase for     409            408            408
  Pregnant Women**                                          

  **Public Access             375            141            134
  Defibrillation**                                          

  **Substance Abuse           200            200            200
  Transitional Housing**                                    

  **Lesser-Known Illnesses**  150            100            100

  **DHCC Staff Assistance**   57             57             57

  **Heroin Residential        500            500            500
  Program**                                                 

  **Attendant Care**          340            430            430

  **Breast & Cervical Cancer  150            150            150
  Treatment**                                               

  **Cancer Care Connection**                 150            150

  **The Wellness Community**                 200            200

  **DE Breast Cancer          40             40             40
  Coalition**                                               

  **Delaware School survey                                  48
  (Statewide)**                                             

  **New Nurse Formation                      750            1,297
  Programs**                                                

  **Disease Cost Containment                 500            500
  Initiatives**                                             

  **Perinatal Association**                  200            200

  **Southbridge Community                    120            
  Health Outreach**                                         

  **University of                            48             
  Delaware/Drug & Alcohol                                   
  Studies**                                                 

  **Instruments for TB &      150            150            
  Metabolic Disorders**                                     

  **Fire Suppression          500            750            
  Program**                                                 

  **Support for People with   200                           
  Cancer**                                                  

  **Gift of Life**            105                           

  **Resource Mothers**        200                           

  **Council on Cancer Inc. &                                4,938
  Mortality**                                               

  **DE Ecumenical Council**                                 100

                                                            

  **Total Initiatives**       **\$20,325**   **\$19,986**   **\$24,509**

  **Total Program and         **\$26,391**   **\$29,829**   **\$29,800**
  Reserves**                                                
  --------------------------- -------------- -------------- --------------

Source: Delaware Health and Social Services Department, Delaware Health
Fund Advisory Committee (<http://www.state.de.us/dhss/healthfund.html>)

Table 3

**securitized state tobacco settlement funds**

+-----------+-----------+-----------+--------------------------------+
| ######    | **Year**  | *         | **Purpose**                    |
| ## State  |           | *Amount** |                                |
+===========+===========+===========+================================+
| **        | 2000      | \$50      | Industrial bonds to attract    |
| Alabama** |           | million   | new jobs                       |
+-----------+-----------+-----------+--------------------------------+
| *         | 2000,     | \$242     | Remodel and build new schools, |
| *Alaska** | 2001      | million   | rehabilitate buildings at the  |
|           |           |           | University of Alaska and       |
|           |           |           | update several port facilities |
+-----------+-----------+-----------+--------------------------------+
| **A       | 2001      | \$60      | Biomedical research facilities |
| rkansas** |           | million   |                                |
+-----------+-----------+-----------+--------------------------------+
| **Cal     | 2002,     | \$4.2     | Deficit                        |
| ifornia** | 2003      | billion   |                                |
+-----------+-----------+-----------+--------------------------------+
| **Conn    | 2003      | \$300     | General revenue                |
| ecticut** |           | million   |                                |
+-----------+-----------+-----------+--------------------------------+
| **Iowa**  | 2001      | \$644     | Retire capital debt to free up |
|           |           | million   | general fund revenue for       |
|           |           |           | health care services           |
+-----------+-----------+-----------+--------------------------------+
| **Lo      | 2001      | \$1.2     | Millennium Fund (endowment) to |
| uisiana** |           | billion   | be used for health care,       |
|           |           |           | education and scholarships     |
+-----------+-----------+-----------+--------------------------------+
| **New     | 2002      | \$1.8     | Deficit                        |
| Jersey**  |           | billion   |                                |
+-----------+-----------+-----------+--------------------------------+
| **New     | 2003      | \$4.2     | Deficit                        |
| York**    |           | billion   |                                |
+-----------+-----------+-----------+--------------------------------+
| **North   | 2000      | \$32      | Debt service on water resource |
| Dakota**  |           | million   | and flood control projects     |
+-----------+-----------+-----------+--------------------------------+
| *         | 2002      | \$200     | Deficit                        |
| *Oregon** |           | million   |                                |
+-----------+-----------+-----------+--------------------------------+
| **Rhode   | 2002      | \$685     | Retire capital debt, deficit   |
| Island**  |           | million   |                                |
+-----------+-----------+-----------+--------------------------------+
| **South   | 2000      | \$934     | 73% to the Health Care         |
| C         |           | million   | Endowment[^7], balance for     |
| arolina** |           |           | rural infrastructure and       |
|           |           |           | tobacco farmers                |
+-----------+-----------+-----------+--------------------------------+
| **South   | 2002      | \$278     | Education endowment            |
| Dakota**  |           | million   |                                |
+-----------+-----------+-----------+--------------------------------+
| **Was     | 2002      | \$518     | Deficit                        |
| hington** |           | million   |                                |
+-----------+-----------+-----------+--------------------------------+
| **Wi      | 2001      | \$1.6     | Deficit                        |
| sconsin** |           | billion   |                                |
+-----------+-----------+-----------+--------------------------------+

[^1]: Florida, Minnesota, Mississippi and Texas had previously settled
    with tobacco manufacturers for \$40 billion.

[^2]: The initial awards from the endowment supported the state's
    pharmaceutical assistance program.

[^3]: Alabama, Alaska, Arkansas, California, Connecticut, Iowa,
    Louisiana, New Jersey, New York, North Dakota, Oregon, Rhode Island,
    South Carolina, South Dakota, Washington, Wisconsin

[^4]: Under the provisions of the MSA, if the total aggregate market
    share of the participating manufacturers decreases more than 2
    percent and an economic consulting firm determines that the
    provisions of the MSA were a significant factor contributing to the
    market share loss, the payments to states may be reduced based on
    that loss. This reduction in state payments is called the
    non-participating manufacturers (NPM) adjustment. This analysis is
    done annually. A state's enactment of the model statute is
    significant because if there is an NPM adjustment in any year, a
    specific state's share of the funds from the payment in question
    will not be reduced at all if that state has passed and has in force
    the model statute

[^5]: The Jenkins Act (18 U.S.C. 375) requires any person who sells and
    ships cigarettes across state lines to anyone other than a licensed
    distributor, to report the sale to the buyer's state tobacco tax
    administrator, allowing state and local governments to collect the
    taxes due. The current penalty for violating the Act is a
    misdemeanor.

[^6]: The Contraband Cigarette Trafficking Act (CCTA) (18 U.S.C. 2342)
    makes it unlawful for any person to ship, transport, receive,
    possess, sell, distribute, or purchase contraband cigarettes.

[^7]: The initial awards from the fund supported the state's
    pharmaceutical assistance program.