**DESCRIPTION AND ANALYSIS OFREVENUE-RELATED PROVISIONS OF S. 1415RELATING TO NATIONAL TOBACCO POLICYAS MODIFIED BY THE MANAGER'S AMENDMENT**

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

June 3, 1998

JCX-45-98

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**CONTENTS**

INTRODUCTION		

I.	PRESENT-LAW TAX AND TRUST FUND PROVISIONS		

II.	DESCRIPTION OF REVENUE-RELATED PROVISIONS OF S. 1415 AS MODIFIED BY THE MANAGER'S AMENDMENT		

III. DISCUSSION OF ISSUES RELATED TO ESTIMATES OF THE REVENUE EFFECTS AND DISTRIBUTIONAL ANALYSIS	OF THE "PAYMENTS" REQUIRED UNDER S. 1415 AS MODIFIED BY THE MANAGER'S AMENDMENT		

	A.	Payments Are Taxes		

	B.	Issues Related to the Estimated Revenue Effects of  S. 1415		

		1.	Estimated revenue and price effects of S. 1415		

		2.	Changes in producer and consumer behavior		

		3.	Technical differences between the gross payments prescribed in S. 1415 and net receipts received by the Treasury		

	C.	Analysis of the Distribution of Tobacco Payments		

	D.  Other Economic Considerations		

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**INTRODUCTION**

	This document,(1) prepared by the staff of the Joint Committee on Taxation ("the JointCommittee staff") provides a description and analysis of revenue-related provisions of S. 1415(relating to national tobacco policy) as modified by the manager's amendment to the bill asreported by the Senate Committee on Commerce, Science, and Transportation ("the CommerceCommittee").(2)

	Part I of the document provides a brief description of present-law tobacco excise taxprovisions and general trust fund provisions of the Internal Revenue Code (the "Code").  Part IIis a description of revenue-related provisions of S. 1415.  Part III is a discussion of issues relatedto estimates of the revenue effects and distributional analysis of the "payments" required under S.1415.

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**I.  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.

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| **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(3/4 of one cent per one ounce container) |
| 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                                       |

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	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.  For example, this willincrease the tax on chewing tobacco to 17 cents per pound (1.06 cents per one ounce container). 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 sold or distributed for sale 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).

	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 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.

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**II.  DESCRIPTION OF REVENUE-RELATED PROVISIONS OF S. 1415 AS MODIFIED BY THE MANAGER'S AMENDMENT**

**Payments required of cigarette and smokeless tobacco manufacturers**

In general

	S. 1415 would provide for several types of payments to be made by cigarette andsmokeless tobacco manufacturers.  These include an initial payment of $10 billion, annualgeneral tobacco industry payments estimated to total $161.3 billion through 2007, and "look-back assessments" that could result in an industry-wide surcharge of as much as $4.4 billion peryear (before adjustment for inflation) and manufacturer-specific surcharges of $1,000 perunderage smoker (before adjustment for inflation) to the extent targets in the reduction ofunderage smoking are not achieved.

Initial payment

	S. 1415 would require a lump sum payment in the amount of $10 billion to be made tothe National Tobacco Trust Fund ("Tobacco Trust Fund"), established by the bill, within 30 daysof the date of compliance.(5)  Liability for this amount is allocated between the five major cigaretteand smokeless tobacco manufacturers who participated in the development of the ProposedResolution to the National Tobacco Litigation, dated June 20, 1997.  The allocation generallyfollows the relative capitalization of these manufacturers.(6)  Interest on late payments would beassessed at an annual rate of prime plus 10 percent.(7)

Annual general tobacco industry payments

	S. 1415 would require cigarette and smokeless tobacco manufacturers and importers tomake annual payments to the Tobacco Trust Fund for each calendar year that begins after the due date of the initial payment in the following base amounts:

| *Year*              |  | *Base amount*(billions of dollars) |
|---------------------|--|------------------------------------|
| 1                   |  | 14.4                               |
| 2                   |  | 15.4                               |
| 3                   |  | 17.7                               |
| 4                   |  | 21.4                               |
| 5 and thereafter(8) |  | 23.6                               |

The base 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 sixth year afterenactment.  Beginning with calendar year 2002, the amount of each annual payment would befurther adjusted, either up or down, to reflect changes in sales volume compared to 80 percent ofsales volume in 1997.(9)

	Liability for the annual general tobacco industry payment would be allocated among allmanufacturers and importers in proportion to their share of tobacco products sold in the domesticmarket for the calendar year, as determined by the Secretary of the Health and Human Services("HHS").  A manufacturer or importer's share of tobacco products sold in the domestic market isdetermined in terms of  "adjusted units."  In general, one pack of 20 cigarettes equals oneadjusted unit, 1.2 ounces of moist snuff equals 0.75 adjusted units, and 3 ounces of any othersmokeless tobacco product equals 0.35 adjusted units.  In the case of a smokeless tobaccomanufacturer that does not produce more than 200 million units, the first 150 million units wouldbe counted at a 70-percent rate.  No equivalent small cigarette manufacturer allowance isprovided.

	Under S. 1415, deposits toward the estimated amount of the annual general tobaccoindustry payment would be required to be made in three equal installments on March 1, June 1,and August 1 of the year to which the payment relates.  Liability in excess of the amount sodeposited would be due on March 1 of the following calendar year.  Any excess deposits wouldbe applied against deposits required in the following calendar year.(10)  If, for example, S. 1415were to be enacted in September of 1998, the first annual general tobacco industry paymentwould be made with respect to 1999.  Deposits toward the 1999 general tobacco industrypayment would be due on March 1, 1999, June 1, 1999 and August 1, 1999, with reconciliationto take place on March 1, 2000.  The manner in which each deposit would be made is notspecified.

	Deposits of estimated payments made after the due date would accrue interest at anannual rate of prime plus 10 percent.(11)  In addition, a penalty could be assessed under section 406of the bill if the manufacturer or importer failed to make a payment within 60 days of the duedate of the payment.  The penalty would be calculated in the same manner as the interest on latedeposits.  However, no penalty would be due if the failure to make the payment were due toreasonable cause and not to willful neglect and such failure were corrected during the 30-dayperiod beginning on the first day that persons responsible for the payment knew, or should haveknown, that a deficiency existed.(12)

	Any 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 (TheLiggett Group) would be able to meet these standards.

	The annual general industry tobacco payments would be currently deductible as ordinaryand necessary business expenses for Federal income tax purposes.

Look-back assessment

	S. 1415 would provide that a look-back assessment in the form of an industry-widenonattainment surcharge would be imposed on cigarette and smokeless tobacco manufacturersand importers if certain targets for the reduction of underage tobacco use are not met.   Thetargets would be as follows:

| *Year after enactment*Reduction in underageuse of cigarettes*Reduction in underage use of smokeless tobacco3 and 415%12.5%5 and 630%25%7,8 and 950%35%10 and thereafter60%45%
In each case, the underage usage of the tobacco product would be measured by the results of asurvey to be designed and conducted by the Secretary of HHS.  The rate of reduction would bemeasured compared to the rate of usage in 1999.

	The industry-wide nonattainment surcharge would be based on 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 surcharge of $4 billion.   These amounts would be indexed forinflation occurring after 1998, beginning in the fourth year after enactment. The assessmentwould be allocated by  HHS among the manufacturers and importers by market share.  Anymanufacturer or importer 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, with aannual maximum surcharge of $400 million.

	S. 1415 also would establish a manufacturer-specific surcharge on individualmanufacturers and importers whose brands account for more than one percent of the underageuse of cigarettes or smokeless tobacco.  If the reduction in sales of such a manufacturer orimporter's brands did not separately meet the industry-wide underage use reduction targets, amanufacturer-specific surcharge of $1,000 per underage smoker in excess of the target also isassessed.  The $1,000 amount would be adjusted for inflation occurring after 1998, beginning inthe fourth year after enactment.(13)

	The industry-wide nonattainment surcharge and any manufacturer-specific surcharges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 annual interest rateof up to three times the prime rate for late payments.(14)  Additional charges in an amount up tothree times the surcharge could also be assessed for late payment of the surcharge.

	S. 1415 specifically provides that both the industry-wide and manufacturer-specificsurcharges are not deductible, as an ordinary and necessary business expense or otherwise, forFederal income tax purposes.

**Establishment of National Tobacco Trust Fund**

	S. 1415 would establish the National Tobacco Trust Fund (the "Tobacco Trust Fund") inthe Treasury.  Amounts equal to the net revenues(15) from the initial payment, the annual generaltobacco industry payments, and the look-back assessments (including any interest or penalties onsuch payments or assessments) would be deposited in the Tobacco Trust Fund.  Amounts in theTobacco Trust Fund could be spent for the purposes established in S. 1415, pursuant toappropriations Acts and the direct spending provisions of the bill. 

	The Tobacco Trust Fund would not be included in the Code.  However, generaladministrative provisions applicable to Code Trust Funds would apply to the Tobacco TrustFund, except that no interest would accrue on unspent balances in the Tobacco Trust Fund.  Aswith Code Trust Funds, the Tobacco Trust Fund would not be permitted to borrow from theGeneral Fund.

**III.  DISCUSSION OF ISSUES RELATED TO ESTIMATES OF THE REVENUE EFFECTS AND THE DISTRIBUTIONAL ANALYSIS OF THE "PAYMENTS" REQUIRED UNDER S. 1415 AS MODIFIED BY THE MANAGER'S AMENDMENT**

**A.  Payments Are Taxes**

	S. 1415 would require the following payments to be made to the Federal Government:

	(1) 	An initial payment from the five major manufacturers that participated in thedevelopment of the Proposed Resolution as specified in section 402(a) of S. 1415; 

	(2)	Annual general tobacco industry payments assessed on cigarette and smokelesstobacco manufacturers and importers as specified in section 402(b) of S. 1415; and

	(3)	Industry-wide and manufacturer-specific look-back assessments for failure to reduceunderage smoking as specified in section 204 of S. 1415.

	The Joint Committee staff view is that the above tobacco industry payments in S. 1415represent revenues to the Federal Government that are in the nature of taxes.  The JointCommittee staff believes this is the proper classification because the payments are mandated byFederal law, are to be deposited into a new Trust Fund within the Treasury of the United States,and are to be expended for purposes established by Federal law.  These mandatory payments cannot properly be classified as "user fees" because they would not be commensurate with, orintended to compensate for, the cost of providing services to the payors.

	The annual general tobacco industry payments are equivalent to excise taxes on cigarettesand smokeless tobacco products.  The amount of present-law excise taxes that a manufacturer orimporter pays is determined by the volume of cigarettes or smokeless tobacco sold. The proposedpayments likewise are mandatory amounts determined by the volume of cigarettes or smokelesstobacco sold by each manufacturer or importer.

	The look-back assessments are equivalent to a nondeductible penalty excise tax oncigarette and smokeless tobacco manufacturers.  The look-back assessments represent amandatory charge for industry failures to meet prescribed goals.  In addition, as with the present-law tobacco excise taxes, the amount of the look-back assessments are determined by referenceto the sales volume of the tobacco manufacturer.  The look-back assessments closely resemblepenalty and regulatory excise taxes currently in the Code.  Examples of such taxes includepenalty excise taxes on excess lobbying expenditures by charitable organizations and specifiedactivities of qualified pension plans, and regulatory excise taxes on certain wagering transactionsand the manufacture of  "explosive devices."

**B.  Issues Related to the Estimated Revenue Effects of S. 1415**

**1.  Estimated revenue and price effects of S. 1415**

	Table 1 presents the Joint Committee staff revenue estimates of the initial and annualindustry payments and look-back provisions of S. 1415.  Table 1 also presents estimates of theprice of cigarettes under the CBO baseline and under S. 1415.  Table 1 also presents an estimateof the general industry payments on a "payment per pack" basis for the period 1999 through2007.  These payments per pack are the equivalent of an excise tax equal to these amounts.

	The Joint Committee staff estimates embody a number of assumptions regarding changesin producer pricing decisions, consumer behavior, the possibility of a black market in tobaccoproducts, and other changes in the market for tobacco products.  The estimates, made inconsultation with the Congressional Budget Office ("CBO"), also account for restrictions onmarketing and sales of tobacco products that would be imposed by S. 1415.  The subsequent twosections discuss the assumptions and analysis upon which these estimates are based.*** |
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