DESCRIPTION OF PRESENT LAW AND PROPOSALS

RELATING TO TOBACCO TAX AND TRUST FUND

AND OTHER PROVISIONS

Scheduled for Consideration

by the

SENATE COMMITTEE ON FINANCE

on May 14, 1998

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

May 14, 1998

JCX-35-98

CONTENTS

INTRODUCTION

I. TOBACCO REVENUE AND TRUST FUND PROVISIONS RELATED TO S. 1415, AS

REPORTED BY THE SENATE COMMITTEE ON COMMERCE, SCIENCE, AND

TECHNOLOGY

A. Present-Law Tax and Trust Fund Provisions

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B. Description of the National Tobacco Proposed Resolution

C. Description of S. 1415, as Reported by the Senate Committee on Commerce, Science and

Technology

D. Description of Proposed Finance Committee Amendment Relating to Tobacco Taxes and

Trust Fund

II. OTHER PROVISIONS

A. Deductions for Health Insurance Expenses

B. Trade Provisions

1. Ban on distribution of tobacco products produced by child labor

2. Limits on the authority to promote the exportation of tobacco

3. Report on impact on U.S. international obligations

4. Anti-smuggling Provisions/Prohibition on imports except under a permit

5. Prohibition against sales of tobacco products in duty-free shops or forwarding through or

manufacture in foreign trade zones

C. Medicaid Provision

INTRODUCTION

This document,(1) prepared by the staff of the Joint Committee on Taxation, provides a

description of present law and proposals relating to tobacco tax and trust fund and revenuereduction provisions to be considered by the Senate Committee on Finance ("Finance

Committee") on May 14, 1998. The Finance Committee is considering a committee amendment

to be offered to S. 1415, as reported by the Senate Committee on Commerce, Science and

Technology ("Commerce Committee").(2)

Part I of this document is a description of present-law tobacco revenue and trust fund provisions

and the proposed Finance committee amendment to S. 1415 relating to tobacco taxes and trust

fund provisions. Part II is a description of present law and proposals relating to certain other

provisions.

I. TOBACCO REVENUE AND TRUST FUND PROVISIONS RELATED TO S. 1415, AS

REPORTED BY THE SENATE COMMITTEE ON COMMERCE, SCIENCE, AND

TECHNOLOGY

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A. Present-Law Tax and Trust Fund Provisions

Excise taxes on tobacco products

Excise taxes are imposed on cigarettes, cigars, chewing tobacco and snuff, pipe tobacco, and

cigarette papers and tubes (Code sec. 5701). In addition, tax will be extended to "roll-your-own

tobacco" at the same rates as pipe tobacco, effective on January 1, 2000. These taxes are imposed

upon removal of the taxable tobacco products by the manufacturer, or on importation into the

United States.(3) The current tax rates are shown in the table below.

Tobacco Product Tax Rate

Cigarettes:

Small cigarettes(4) $12.00 per thousand

(24 cents per pack of

20 cigarettes)

Large cigarettes $25.20 per thousand

Cigars:

Small cigars $1.125 per thousand

Large cigars 12.75% of manufacturer's

price, up to $30 per thousand

Chewing tobacco $0.12 per pound

Snuff $0.36 per pound

Pipe tobacco $0.675 per pound

Cigarette papers $0.0075 per 50 papers

Cigarette tubes $0.15 per 50 tubes

Effective on January 1, 2000, the tax rate on small cigarettes is scheduled to increase by $5 per

thousand (to 34 cents per pack of 20 small cigarettes), and the tax rates on other taxable tobacco

products are scheduled to increase by proportionate amounts. Effective on January 1, 2002, a

further increase of $2.50 per thousand (to 39 cents per pack of 20 small cigarettes) is scheduled

to become effective. (Tax rates on other taxable tobacco products will increase proportionately on

that date as well.)

Generally, excise taxes on tobacco products that are removed during any semimonthly period

must be paid by the 14th day after the last day of such semimonthly period. Late payment of

tobacco excise taxes is subject to interest charges and penalties in the same manner as the late

payment of other types of taxes. In addition, a failure to pay penalty equal to 5 percent of the tax

due but unpaid is assessed under section 5761(b).

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Revenues from the current tobacco products excise taxes are deposited in the General Fund of the

Treasury.

Tobacco occupational excise tax

An annual excise tax of $1,000 per premise generally is imposed on manufacturers of tobacco

products, manufacturers of cigarette papers and tubes, and export warehouse proprietors (Code

sec. 5731). The occupational tax is $500 per premise for taxpayers with gross receipts less than

$500,000. Revenues from the occupational tax are deposited in the General Fund of the Treasury.

Penalty excise taxes

In addition to excise taxes imposed primarily to raise revenue, the Internal Revenue Code (the

"Code") includes several excise taxes imposed as penalties for taking (or failing to take) certain

required actions. Examples of these excise taxes include taxes on excess lobbying expenditures

by charitable organizations, certain "self-dealing" activities by officers and others involved with

private foundations, failures by private foundations to distribute required percentages of income,

and numerous regulatory excise taxes imposed with respect to specified activities of qualified

pension plans. Present law does not establish any underage smoking reduction goals or impose

any penalty excise tax with respect to such goals.

Overview of Internal Revenue Code Trust Funds

Most Trust Funds that are financed with dedicated excise tax revenues are established in the

Code (secs. 9501 et. seq.). Examples of these Trust Funds are the Airport and Airway Trust Fund,

the Highway Trust Fund, the Black Lung Trust Fund, the Aquatic Resources Trust Fund, the

Inland Waterways Trust Fund, the Hazardous Substance Superfund, the Leaking Underground

Storage Tank Trust Fund, the Oil Spill Liability Trust Fund, and the Vaccine Injury

Compensation Trust Fund. Each of these Trust Funds includes provisions dedicating specified

revenues to the Trust Fund and provisions approving expenditure purposes of the Trust Fund

(generally as those purposes are in effect on the date of enactment of specific authorizing

legislation). The Code also contains general provisions relating to the management of these Trust

Funds. Under present law, there is no Federal Tobacco Trust Fund.

B. Description of the National Tobacco Proposed Resolution

Payments required of tobacco manufacturers

In general

The National Tobacco Proposed Resolution, dated June 20, 1997, (the "Proposed Resolution") is

a draft document advanced by a number of State Attorneys General, members of the public

health community, and a number of large tobacco manufacturers to resolve litigation between

tobacco manufacturers and the States, to establish a framework for the regulation of tobacco, to

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fund various initiatives related to tobacco cessation and control, and to establish limits on the

civil liabilities of tobacco manufacturers. The Proposed Resolution is intended to be formalized

in a Master Settlement Agreement and implemented through legislation and the execution of a

binding, enforceable Protocol.

The Proposed Resolution provides for a number of payments to be made by tobacco

manufacturers. These include an initial, first-year payment of $10 billion, annual payments

having an aggregate nominal amount of as much as $358.5 billion over 25 years, and a

"look-back surcharge" of as much as $2 billion per year if targets in the reduction of underage

smoking are not achieved.

These payments would be liabilities of those cigarette and smokeless tobacco manufacturers that

join in the resolution. An alternative system of payments is required from manufacturers that do

not join in the resolution. In general, a nonparticipating manufacturer would be required to

escrow an amount equal to 150 percent of what would otherwise be its share of the annual

payment if it were a participating manufacturer. The escrowed funds would be available for

liability claims against such manufacturers.

All payments made under the Proposed Resolution are proposed to be currently deductible in the

year of payment. The Proposed Resolution specifically provides that all payments made pursuant

to its terms will be deemed to be ordinary and necessary business expenses for the year of

payment, and that no portion will be treated as a fine or penalty or the cost of a tangible or

intangible asset.

First-year payments

The Proposed Resolution would require a lump sum cash payment in the amount of $10 billion to

be made on the "Statute Signing Date," the date legislation enacting the National Tobacco

Settlement Agreement is signed into law. Allocation of the $10 billion among the various tobacco

manufacturers is not provided in the Proposed Resolution.

Annual payments

The Proposed Resolution would require participating manufacturers to make annual payments for

each calendar year beginning after the date of enactment in the following nominal amounts:

Year Nominal amount

(billions of dollars)

1 8.5

2 9.5

3 11.5

4 14.5

5 and thereafter 15.0

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Beginning with the first payment, the nominal amount of each annual payment would be

increased annually for inflation at a rate equal to the greater of 3 percent or the increase in the

Consumer Price Index (the "CPI"). The amount of each annual payment further would be

adjusted to reflect changes in sales volume compared to a sales volume in a base year of 1996.

Up to 25 percent of any reduction in an annual payment to reflect reduced sales volume would be

disregarded to the extent of any increase in industry net operating profits for a similar period.

A credit against the annual payment equal to 80 percent of any amounts paid as a result of a

participating tobacco manufacturer's civil liability for past conduct would be provided. As the

annual cap on payment of such civil liability is 33 percent of the annual payment, the maximum

credit available against any annual payment would be 26-2/3 percent.

Rules allocating liability for the annual payments among the various tobacco manufacturers are

not provided in the Proposed Resolution.

Annual payments under the National Tobacco Proposed Resolution would be required to be made

by February 15 of the year following the year to which the payments relate. If, for example,

legislation implementing the Proposed Resolution were to be enacted in September of 1998, the

first annual payment would be made with respect to 1999, and would be due on February 15,

2000.

Look-back surcharge

The Proposed Resolution provides for a look-back surcharge to be assessed against the

participating manufacturers if certain targets for the reduction of underage smoking are not met.

The targets are as follows:

Year after

enactment

Reduction in underage

use of cigarettes

Reduction in underage

use of smokeless tobacco

5 and 6 30% 25%

7,8 and 9 50% 35%

10 and thereafter 60% 45%

In each case, the underage usage of the tobacco product would be measured by the results of the

University of Michigan's National High School Drug Use Survey "Monitoring the Future." The

rate of reduction is measured compared to the rate of usage in 1996. The surcharge is to be

calculated by the Food and Drug Administration ("FDA").

In the case of underage usage of cigarettes, the surcharge would equal $80 million times the

number of percentage points by which the reduction in teen usage fails to achieve the target. The

surcharge could not exceed $2 billion for any year. The surcharge is reduced to prevent double

counting of persons whose smoking has already resulted in an imposition of the surcharge in

previous years. In the case of smokeless tobacco, the surcharge would be determined through a

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comparable procedure. Abatement of up to 75 percent of the surcharge would be possible if a

manufacturer demonstrates that it acted in good faith, pursued all reasonable available measures

to attain the targeted reductions and there was no evidence of an action taken by the manufacturer

that served to undermine the achievement of the targeted reductions.

Under the Proposed Resolution, the lookback surcharge would be a joint and several liability of

all of the participating manufacturers. Primary liability would be allocated among the various

manufacturers based on their relative sales, as measured by Federal excise tax payments.

Overview of expenditure provisions

The Proposed Resolution includes recommendations regarding the use of a portion of the

payments received from the participating manufacturers. Generally, these recommendations

involve the designation of monies to Trust Funds or specific agencies for purposes related to

smoking cessation and tobacco related research. The bulk of the funds remaining after

satisfaction of the recommendations will be paid over to the States. However, no specific dollar

amount of payments to be made to the States is provided in the Proposed Resolution.

Other provisions of the Proposed Resolution

Regulation of the tobacco industry

The Proposed Resolution would mandate a significant restructuring of how tobacco products are

manufactured, marketed, and distributed in the United States.

Civil liability

The Proposed Resolution would limit any participating manufacturer's exposure to civil liability

arising from the manufacture and sale of tobacco products. All suits brought by the States and all

Castano Civil Actions would be settled legislatively. Other legal actions would be limited to

those brought by individual plaintiffs. No class action suits would be allowed. Punitive damages

would not be allowed in individual tort actions. An annual aggregate cap on the amount that

could be required to be paid by all participating manufacturers in any one year would be

established equal to 33 percent of the annual payment. Judgments in excess of $1 million would

be satisfied only if all other judgments can be accommodated under the annual cap. As noted

above, 80 percent of any payments made to tort claimants could be used as a credit against the

annual payment.

C. Description of S. 1415, as Reported by the Senate Committee

on Commerce, Science and Technology

Payments required of tobacco manufacturers

In general

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S. 1415, as reported by the Senate Commerce Committee, would provide for a number of

payments to be made by tobacco manufacturers. These include an initial, first-year payment of

$10 billion, annual payments having an aggregate nominal amount of as much as $564.1 billion

over 25 years, and a "look-back assessment" of as much as $3.5 billion per year if targets in the

reduction of underage smoking are not achieved. Additional payments would be required to be

made to a Tobacco Community Revitalization Fund and an International Tobacco Control Trust

Fund.

These payments would be liabilities of those cigarette and smokeless tobacco manufacturers that

join in a Master Settlement Agreement with the States implementing the June 20, 1997 Proposed

Resolution. An alternative system of payments would be required from nonparticipating

manufacturers, those that do not join in the Agreement. In general, a nonparticipating

manufacturer would be required to make payments equal to pay an amount equal to 150 percent

of what would otherwise be its share of the annual payment if it were a participating

manufacturer.

All payments made under S. 1415, as reported, are proposed to be currently deductible as

ordinary and necessary business expenses, except for the look-back assessment. The look-back

assessment would be specifically made nondeductible by the bill.

First-year payments

S. 1415, as reported, would require a lump sum cash payment in the amount of $10 billion to be

made to the National Tobacco Settlement Trust Fund within 30 days of the date of enactment.

The allocation of this amount between the participating manufacturers is specified in the bill, and

generally follows the relative capitalization of the participating manufacturers.(5) Interest on late

payments would be assessed at the rate of prime plus 10 percent.

Annual payments

S. 1415, as reported, would require participating manufacturers to make annual payments to the

National Tobacco Settlement Trust Fund for each calendar year beginning after the date of

enactment in the following nominal amounts:

Year Nominal amount

(billions of dollars)

1 14.4

2 15.4

3 17.7

4 21.0

5 and thereafter 23.6

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The nominal amount of each annual payment would be increased annually for inflation at a rate

equal to the greater of 3 percent or the increase in the CPI, beginning with the fourth year after

enactment. Beginning with the seventh year after enactment, the amount of each annual payment

would be further adjusted, either up or down, to reflect changes in sales volume compared to a

sales volume in a base year of 1996.

S. 1415, as reported, would not provide for a credit against the annual payment for amounts paid

as a result of a participating tobacco manufacturer's civil liability.

Annual payments under S. 1415, as reported, would be required to be made in three equal

installments on March 1, June 1, and September 1 of the year to which the payments relate. If, for

example, S. 1415 were to be enacted in September of 1998, the first annual payment would be

made with respect to 1999. One-third of the payment would be due from the industry on March

1, 1999; one-third would be due on June 1, 1999; and one-third would be due on September 1,

1999.

Each payment would be allocated between the participating manufacturers in proportion to their

share of tobacco products sold in the domestic market for the most recent available calendar

quarter, as determined by the Secretary of the Treasury not more than two months, and not less

than one month, before the payment is due. A civil penalty equal to $100,000 for each day any

annual payment is delinquent would be assessed if the payment was not made within 60 days of

the date it was due.

Any participating manufacturer that manufactures and distributes to consumers less than 3

percent of cigarettes in any calendar year, that had resolved tobacco-related civil actions with

more than 25 States before 1998, and that provided to all other States the opportunity to enter

into similar agreements would be exempt from making any annual payment. Only one

manufacturer is able to meet these standards.

Look-back assessment

S. 1415, as reported, provides that a look-back assessment would be imposed on the participating

manufacturers if certain targets for the reduction of underage smoking are not met. The targets

are as follows:

Year after

enactment

Reduction in underage

use of cigarettes

Reduction in underage

use of smokeless tobacco

3 and 4 15% 12.5%

5 and 6 30% 25%

7,8 and 9 50% 35%

10 and thereafter 60% 45%

In each case, the underage usage of the tobacco product would be measured by the results of the

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University of Michigan's National High School Drug Use Survey "Monitoring the Future." The

rate of reduction would be measured compared to the rate of usage in 1996.

The assessment to the industry would be determined by the Secretary of Health and Human

Services ("HHS") and would be based on a sliding scale that depends upon the number of

percentage points by which the targeted reduction in underage use is not achieved. In the case of

cigarettes, the assessment would be $80 million for each of the first 5 percentage points, $160

million for each of the next 5 percentage points, and $240 million for each percentage point in

excess of 10, subject to an annual maximum of $3.5 billion. These amounts would be indexed for

inflation beginning in the fourth year after enactment. The assessment would be allocated by the

Secretary of HHS among the manufacturers by market share. Any manufacturer with less than 1

percent of market share would be exempt from payment unless HHS determined that such

manufacturer's brands were used by underage individuals at a rate equal to or greater than the

manufacturer's total market share. In the case of smokeless tobacco, the surcharge would be

determined through a comparable procedure. Additional penalties, including removal of the

annual aggregation payment limitation, may apply if the District Court for the District of

Columbia determines that a manufacturer has failed to comply substantially with the terms of the

legislation or has taken any material action to undermine achievement of the targets.

The surcharge would be assessed by May 1 of the subsequent calendar year and would have to be

paid by July 1 of the year in which it is assessed. HHS would be authorized to establish an

interest rate of up to three times the prevailing prime rate for late payments. S. 1415, as reported,

does not provide for the abatement of any portion of the surcharge, nor does it provide for

adjustment of the surcharge to prevent double counting persons whose smoking has already

resulted in an imposition of the surcharge in previous years.

S. 1415 specifically provides that the surcharge is not deductible, as an ordinary and necessary

business expense or otherwise, for Federal income tax purposes.

Other payments

S. 1415, as reported, would require additional payments to be made to the Tobacco Community

Revitalization Fund and the International Tobacco Control Trust Fund.

Industry payments to the Tobacco Community Revitalization Fund would equal $2.1 billion for

each of fiscal years 1999 through 2008 and $500 million for each of fiscal years 2009 through

2023. An amount sufficient to offset certain Department of Agriculture costs related to tobacco

would be required to be paid in later years. The industry payment would be allocated among

tobacco product manufacturers and importers according to market share. Participating

manufacturers would be allowed a credit equal to the amount of their annual payment.

A licensing fee equal to $1.00 per thousand cigarettes manufactured or distributed for sale by a

domestic concern either directly or through its foreign affiliates would be assessed to fund the

International Tobacco Control Trust Fund.

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Overview of expenditure provisions

S. 1415, as reported, includes provisions requiring the use of a portion of the payments received

from the participating manufacturers. Generally, these provisions involve the designation of

moneys to trust funds or specific agencies for various purposes. Payments of $196.5 billion

would be required to be made to the States in installments over 25 years. After that time, one-half

of all annual payments would be transferred to the States. Certain additional amounts, including a

portion of all surcharge payments, would also be transferred to the States. States that do not

choose to resolve their civil actions in accordance with the legislation, or to enter into the Master

Settlement Agreement, would not be eligible to receive their share of these payments.

Other provisions of S. 1415, as reported by the Commerce Committee

Regulation of the tobacco industry

S. 1415, as reported, would mandate a significant restructuring of how tobacco products are

manufactured, marketed, and distributed in the United States.

Civil liability

S. 1415, as reported, would limit any participating manufacturer's exposure to civil liability

arising from the manufacture and sale of tobacco products. All suits brought by the States, and all

Castano Civil Actions, would be settled legislatively. An annual aggregate cap of $6.5 billion on

the amount that could be required to be paid by all participating manufacturers would be

established. All settlements, judgements and payments are required to be registered with the

Secretary of the Treasury. A mechanism to allocate payments between claimants in years where

the total payment would otherwise exceed $6.5 billion would be established by regulation.

D. Description of Proposed Finance Committee Amendment

Relating to Tobacco Taxes and Trust Fund

Increase in tobacco products excise tax rates

In lieu of the payments (including the initial $10 billion payment) required of tobacco

manufacturers under S. 1415, as reported by the Commerce Committee, the current Federal

excise tax rate on small cigarettes would be increased by $1.10 effective on January 1, 1999.

The tax rates on all other taxable tobacco products would be increased proportionately to the

increases specified for small cigarettes. In addition, the effective date for imposition of tax on

"roll-your-own" tobacco and of certain compliance provisions regarding exported cigarettes

enacted in 1997 would be accelerated to January 1, 1999, and the compliance provisions would

be modified as necessary to conform to similar anti-smuggling provisions of S. 1415, as reported.

On each January 1 beginning in calendar year 2000, all tobacco excise tax rates would be

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adjusted for inflation, as measured by changes in the CPI occurring during the 12-month period

ending on the preceding August 31.

Floor stocks taxes comparable to those imposed when tobacco excise tax rates previously have

been increased would be imposed on each tax increase date. Floor stocks taxes would be required

to be paid no later than July 1 of the year of tax increase.

As stated above in the description of present law, the current tobacco products excise taxes apply

to tobacco products manufactured in, or imported into, the United States. Solely for purposes of

these increased tax amounts, the term United States would include U.S. possessions as well as the

50 States and the District of Columbia. Accordingly, no amount of the increase would be

covered-over to U.S. possessions under Code section 7652.

Impose penalty excise tax for failure to meet underage smoking reduction goals

Both the Proposed Resolution and S.1415, as reported by the Commerce Committee, would

establish goals for the reduction of underage smoking and would impose lookback "surcharges"

or "assessments" on tobacco manufacturers if these goals are not met. In lieu of the lookback

surcharges or assessments, the Finance Committee amendment would impose a non-deductible

penalty excise tax on all manufacturers and importers of cigarettes and smokeless tobacco.

All manufacturers and importers of cigarettes and smokeless tobacco would be subject to the

penalty excise tax. Imposition of this penalty excise tax would be governed by the smoking

reduction goals and imposed at the rates specified in S. 1415, as reported by the Commerce

Committee. In addition, the determination of whether underage smoking goals are met would be

determined under rules prescribed by the Secretary of the Treasury (in consultation with the

Public Health Service).(6) Beginning in that year, the Secretary of the Treasury would be directed

to publish by February 15 of each calendar year the amount of tax allocated to each cigarette and

smokeless tobacco manufacturer and importer based on their prior year's excise tax liability.

The penalty excise tax would be payable in full no later than April 1 of each calendar year.

Cigarette manufacturers and importers would be jointly and severally liable for payment of this

tax imposed with respect to cigarettes, as provided in the Proposed Resolution and S. 1415, as

reported. Smokeless tobacco manufacturers and importers similarly would be jointly and

severally liable for payment of tax attributable to smokeless tobacco. Other Code administrative

and enforcement provisions applicable to excise taxes generally would apply to this tax.

Deletion of Federal requirements relating to "pass through" of payments

Those provisions in S. 1415, as reported by the Commerce Committee, requiring that tobacco

manufacturers use their best efforts to pass through to consumers the amount of any payments on

a per unit basis would be deleted.

Deletion or modification of miscellaneous "fees" contained in S. 1415

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The provisions of S. 1415, as reported by the Commerce Committee, that impose separate "fees"

to support the Tobacco Community Revitalization Trust Fund programs, the "fees" and operative

Trust Fund provisions related to international tobacco control, and the "fees" and "assessments"

on nonparticipating manufacturers would be deleted from the bill.

The Finance Committee amendment would provide that, notwithstanding any other provision of

law, all charges or user fees imposed under the titles of the bill other than the revenue title must

be set in amounts that recover only costs attributable to providing services to the party paying the

fees (i.e., must be true, or cost-based, user fees rather than disguised taxes).

Establishment of National Tobacco Trust Fund

In lieu of the four separate Trust Funds provided for under the Commerce Committee titles of S.

1415, as reported, a National Tobacco Trust Fund (the "Tobacco Trust Fund") would be

established in the Treasury Department pursuant to provisions enacted into the Trust Fund

provisions of the Code. Amounts equal to the net revenues(7) from the changes made by this

amendment would be deposited in the Tobacco Trust Fund.(8) That is, the amounts deposited in

the Tobacco Trust Fund represent monies received by the Treasury after accounting for the

provisions relating to health insurance tax benefits. The balance of the net revenues from the

Finance Committee amendment would remain in the General Fund of the Treasury. The Tobacco

Trust Fund further would receive amounts equal to all penalties imposed under S. 1415. Amounts

in the Tobacco Trust Fund would be available for expenditure as provided in subsequently

enacted appropriations Acts.(9)

Amounts in the Tobacco Trust Fund generally would be available for expenditure for the

programmatic purposes established in S. 1415, as reported by the Commerce Committee. A

separate account, the State Share Account, would be established in the Tobacco Trust Fund to

administer distribution of Trust Fund monies to States. The State Share Account would receive

revenues equal to 40 percent of the total net revenues from the tobacco tax increases. These

revenues would not be available to finance any other Trust Fund expenditure purposes. States

would be eligible for payments from the State Share Account and the Tobacco Trust Fund

generally only if they waived their rights to any State settlements with the tobacco manufacturers

or importers.

Each State would be eligible to receive the portion of the monies appropriated from the State

Share Account shown in the table entitled "Distribution of Funds to States" below. In general,

there would be no requirements or restrictions on the use of funds appropriated to the States from

the Tobacco Trust Fund; however, the Medicaid cost recovery provisions would apply to States

that use Tobacco Trust Fund payments in their Medicaid programs. Cost recovery would be

waived for States that use Tobacco Trust Fund monies for other purposes.

Expenditures for all of the referenced purposes would include those purposes as in effect on the

date of the Finance Committee amendment's enactment. Provisions further would be included

ensuring that no tax revenues are deposited into the Tobacco Trust Fund if any monies are spent

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other than as authorized under these provisions.

General administrative provisions applicable to Code Trust Funds would apply to the Tobacco

Trust Fund, except no interest would accrue on unspent balances in the Tobacco Trust Fund. As

with other Code Trust Funds, the Tobacco Trust Fund would not be permitted to borrow from the

General Fund.

Distribution of Funds to States

State Percentage

Alabama 1.237

Alaska 0.400

Arizona 1.709

Arkansas 0.954

California 8.695

Colorado 0.990

Connecticut 1.548

Delaware 0.400

D.C. 0.474

Florida 4.768

Georgia 2.735

Hawaii 0.800

Idaho 0.400

Illinois 3.930

Indiana 1.490

Iowa 0.932

Kansas 0.800

Kentucky 1.664

Louisiana 1.723

Maine 0.800

Maryland 1.425

Massachusetts 3.802

Michigan 3.586

Minnesota 1.246

Mississippi 1.701

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Missouri 1.701

Montana 0.400

Nebraska 0.400

Nevada 0.400

New Hampshire 0.400

New Jersey 3.755

New Mexico 0.800

New York 12.812

North Carolina 1.977

North Dakota 0.400

Ohio 4.205

Oklahoma 0.800

Oregon 1.353

Pennsylvania 4.421

Rhode Island 0.800

South Carolina 1.090

South Dakota 0.400

Tennessee 2.851

Texas 5.930

Utah 0.400

Vermont 0.400

Virginia 1.348

Washington 1.726

West Virginia 0.782

Wisconsin 1.841

Wyoming 0.400

II. OTHER PROVISIONS

A. Deductions for Health Insurance Expenses

Present Law

In general

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Under present law, the tax treatment of medical insurance expenses depends on whether the

individual is self employed, an employee with employer-provided health coverage, or an

employee without employer-provided health coverage. For purposes of the tax provisions relating

to medical insurance expenses, subject to certain dollar limits, premiums for long-term care

insurance generally are treated the same as premiums for health insurance.

Deduction for health insurance expenses of self-employed individuals

Under present law, self-employed individuals (i.e., sole proprietors, partners in a partnership, and

more than 2-percent shareholders of S corporations), are entitled to deduct a portion of the

amount paid for medical insurance for the self-employed individual and the individual's spouse

and dependents. Self-employed individuals may deduct the amount paid for health insurance as

follows: 45 percent in 1998 and 1999, 50 percent in 2000 and 2001, 60 percent in 2002, 80

percent in 2003 through 2005, 90 percent in 2006, and 100 percent in 2007 and all years

thereafter.

The deduction is not available for any month in which the taxpayer is eligible to participate in a

subsidized health plan maintained by the employer of the taxpayer or the taxpayer's spouse. This

rule is applied separately to long-term care insurance and health insurance. In addition, no

deduction is available to the extent that the deduction exceeds the taxpayer's earned income from

the trade or business with respect to which the health insurance is provided. Expenses for health

insurance in excess of the deductible amount may be taken into account in determining whether

the individual is entitled to an itemized deduction for medical expenses. The deduction does not

apply for self-employment tax purposes.

Exclusion from income and wages for employer-provided health care

Under present law, employer contributions to an accident or health plan, including employee

salary reduction contributions under a cafeteria plan, are excludable from an employee's income.

This exclusion for employer-provided health coverage also generally applies to coverage

provided to former employees. In the case of a self-insured medical reimbursement plan, the

exclusion is conditioned on the coverage being provided under a plan meeting certain

nondiscrimination requirements. Insured health plans are generally not subject to

nondiscrimination rules. Employer-provided accident or health coverage is generally excludable

from wages for employment tax purposes without regard to whether the coverage is provided on

a nondiscriminatory basis.

Itemized deduction for medical expenses

Under present law, individuals who itemize deductions may deduct amounts paid during the

taxable year, including expenses for medical insurance (if not reimbursed by insurance or

otherwise) for medical care of the taxpayer, the taxpayer's spouse, and dependents, to the extent

that the total of such expenses exceeds 7.5 percent of the taxpayer's adjusted gross income

("AGI").

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Description of Proposal

The proposal would permit all individuals (including self-employed individuals) who are not

eligible to participate in an employer-subsidized health plan to deduct 100 percent of the amount

paid for insurance which constitutes medical care for the individual, the individual's spouse and

dependents. The deduction would not apply to amounts paid by the individual for Medicare Part

B premiums. The deduction would apply to premiums for long-term care insurance (subject to

the present-law limits).

As under the present-law self-employed health deduction, the deduction would not be available

for any month in which the individual is eligible to participate in an employer-subsidized health

plan maintained by an employer (or former employer) of the individual or the individual's

spouse. This rule would be applied separately to long-term care insurance and health insurance.

An employer subsidy would include pre-tax contributions through salary reduction. An

individual with health care continuation coverage (under sec. 4980B of the Code) would not be

considered to be receiving employer subsidized health care if the employee is charged at least

100% of the applicable premium as defined in section 4980B.

Any amount taken into account for purposes of this deduction could not be taken into account for

purposes of the itemized deduction for medical expenses. The deduction would not apply for

self-employment tax purposes.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1998.

B. Trade Provisions

1. Ban on distribution of tobacco products produced by child labor.

Present Law: Section 307 of the Tariff Act of 1930 prohibits the import of products produced by

forced or indentured workers.

Settlement: None.

Commerce Committee Bill: Section 1107 would amend Section 307 to prohibit imports of

tobacco products produced in a foreign country by child labor.

Proposed Finance Committee Mark: Modify language in Commerce Committee bill to prohibit

imports of tobacco products produced by forced or indentured child labor.

2. Limits on the authority to promote the exportation of tobacco.

Present Law: FY98 Commerce, State, and Judiciary Appropriations Act include a rider which

prohibits the President from promoting the sale or export of tobacco products and from seeking

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the reduction or removal of trade barriers relating to tobacco exports.

Settlement: None.

Commerce Committee Bill: Section 1133 would prohibit the use of appropriated funds to

promote or encourage the exportation of tobacco. Allows President to seek elimination of barriers

that are applied in an unjustifiable and arbitrary manner and that have been certified by the

Department of Health and Human Service as not being a reasonable means of protecting public

health.

Proposed Finance Committee Mark: Codify the current appropriations rider, clarifying that no

ministerial functions performed by agencies (e.g., processing customs documentation on exports

at a port) are prohibited and that the President may seek the reduction of discriminatory barriers

to U.S. tobacco exports.

3. Report on impact on U.S. international obligations.

Present Law: None.

Settlement: None.

Commerce Committee Bill: Section 1134 would require USTR to report within 90 days of

enactment of the legislation on any provisions that it deems to be inconsistent with our

international obligations, such as the NAFTA and the WTO.

Proposed Finance Committee Mark: Strike.

4. Anti-smuggling Provisions/Prohibition on imports except under a permit.

Present Law: None.

Settlement: None.

Commerce Committee Bill: Section 1141-47 create a broad licensing scheme that would apply to

all sales of tobacco. Section 1145(a) expressly prohibits the importation of tobacco products

except under a permit.

Proposed Finance Committee Mark: Clarify that licensing requirements in the bill apply to all

sales of tobacco products, including imports to avoid allegations that provisions violate WTO

obligations.

5. Prohibition against sales of tobacco products in duty-free shops or forwarding through or

manufacture in foreign trade zones.

Present Law: None.

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Settlement: None.

Commerce Committee Bill: Section 1147 would ban the sale of any tobacco products in duty-free

stores or the use of any foreign trade zone for the distribution or manufacture of tobacco

products.

Proposed Finance Committee Mark: Clarify that the sale of tobacco products in duty free stores

and through FTZs are subject to all applicable U.S. laws, including laws relating to sales of

tobacco products to minors.

C. Medicaid Provision

Present Law

States have the authority to exclude certain drugs or restrict coverage for them. Among these are

agents when used to promote smoking cessation.

S. 1415, as reported, removes "agents when used to promote smoking cessation" from the list of

drugs which may be subject to state restriction. S. 1415 also prohibits states from excluding or

restricting nonprescription drugs when used to promote smoking cessation.

Description of Proposal

The proposal deletes the provision in S. 1415. Federal reimbursement for these agents are

allowed under current law.

1. This document may be cited as follows: Description of Present Law and Proposals Relating to

Tobacco Tax and Trust Fund and Other Provisions (JCX-35-98), May 14, 1998.

2. S. 1415 was reported by the Senate Committee on Commerce, Science, and Technology on

May 1, 1998 (S. Rept. 105-180).

3. The term United States includes the 50 States and the District of Columbia.

4. A significant majority of taxable cigarettes, and of taxable tobacco products, is small

cigarettes.

5. The specified payments are Phillip Morris Incorporated, $6.58 billion; Brown and Williamson

Tobacco Corporation, $1.73 billion; Lorillard Tobacco Company, $710 million; R.J. Reynolds

Tobacco Company, $660 million; and United States Tobacco Company, $320 million.

6. These rules could be, but would not be required to be, based on the University of Michigan's

National High School Drug Use Survey, "Monitoring the Future."

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7. The term "net revenues" means the gross payments received less an income tax offset.

8. These amounts would be reduced by any refunds or tax previously paid that were properly

allocable to revenues deposited into the Tobacco Trust Fund.

9. As reported by the Commerce Committee, S. 1415 provides that spending for certain programs

is to be direct spending. This provision in the Finance Committee amendment supersedes those

direct spending provisions.

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