CIGARETTE TAXES AND THE MASTER SETTLEMENT AGREEMENT

I. INTRODUCTION In 1998, 46 states and the four major tobacco companies entered into the Master Settlement Agreement (MSA), which settled litigation brought on behalf of the states to recover medical expenses paid by government insurance agencies for illness brought on by consumption of tobacco products (National Association of Attorneys General 2003). The four remaining states (Florida, Minnesota, Mississippi, and Texas) settled separately with the companies. The MSA stipulated that the tobacco companies pay the states an estimated $206 billion over the next several years. The payments are made annually and are adjusted for the number of cigarettes sold in each state in each year. In this sense, the MSA payment structure resembles an excise tax. The strategy of using litigation as an instrument for discouraging consumption of a commodity deemed to be harmful to consumers is becoming more common (Parmet and Daynard 2000). The impact that such litigation has on other tobacco control policies, such as excise taxes, depends on the extent to which litigation and such policies are substitutable. The MSA payments could substitute for excise taxes at the state level. This may be so to the extent that state legislatures have succeeded in levying socially optimal excise tax rates. (1) If so, states would be expected to have reduced excise taxes on cigarettes after the settlements were reached. Similarly, one would expect that various tobacco control policies, such as workplace smoking bans, would be substitutes, albeit imperfect ones, for state cigarette excise taxes and for penalties resulting from litigation that function as excise taxes. Alternatively, litigation and the resulting settlement may have changed the balance of power between tobacco control advocates and the tobacco manufacturers with the consequence that the settlements and state excise taxes are complements. The tobacco industry's influence on federal and state legislatures, historically, has been an impediment to enacting tobacco control legislation at either federal or state levels (Kelder and Daynard 1997; Parmet and Daynard 2000). Rather than crowd out state excise taxes, the MSA could have led to crowding in. A cursory glance at the data supports the view that litigation changes the balance of power. Since the MSA and four individual state settlements were reached, the former in November 1998 and the individual settlements somewhat earlier, state legislatures have increasingly looked to state excise taxes on cigarettes as a source of revenue, relative to both excise taxes imposed on alcohol and state taxes more generally (Figure 1). In particular, the largest jumps in the mean real state excise tax on cigarettes occurred in 1997 and 2002. In fiscal year 2003, for example, state excise tax increases were larger than any other single type of tax including major sources of revenue such as income taxes (National Governors Association and National Association of State Budget Officers 2002). These increases did not coincide with increases in the mean real state excise tax on beer; the only year in which real state excise taxes on beer rose was 1998. [FIGURE 1 OMITTED] Such trends could have been due to factors other than the settlement. The goal of our empirical analysis is to assess whether the changes in cigarette excise taxes can be attributed to the settlement when other factors are held constant. Using pre-post as well as state excise taxes on beer as controls in a panel data difference-in-difference approach, the evidence on balance provides support for the view that litigation and cigarette excise taxes are complements, which is consistent with changes in the political equilibrium. II. DATA AND EMPIRICAL SPECIFICATION Overview We use a panel data difference-in-difference (D-D) regression design to test whether the litigation substituted for (crowd out) or complemented (crowd in) state excise taxes. …