Tobacco Settlement: States' Allocations of Payments from Tobacco Companies for Fiscal Years 2000 through 2005
Published: 2007-02-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In the 1990s, states sued major tobacco companies to obtain reimbursement for health impairments caused by the public's use of tobacco. In 1998, four of the nation's largest tobacco companies signed a Master Settlement Agreement, agreeing to make annual payments to 46 states in perpetuity as reimbursement for past tobacco-related health care costs. Some states have arranged to receive advance proceeds based on the amounts that tobacco companies owe by issuing bonds backed by future payments. This testimony discusses (1) the amounts of tobacco settlement payments that the states received from fiscal years 2000 through 2005, the most recent year for which GAO has actual data, and (2) the states' allocations of these payments. We also include states' projected fiscal year 2006 allocations. The Farm Security and Rural Investment Act of 2002 required GAO to report annually, through fiscal year 2006, on how states used the payments made by tobacco companies. GAO based this testimony on five annual surveys of these 46 states' Master Settlement Agreement payments and how they allocated these payments.
section_title: What GAO Found
paragraphs: From fiscal year 2000 through 2005, the 46 states party to the Master Settlement Agreement received $52.6 billion in tobacco settlement payments. Of the $52.6 billion total, about $36.5 billion were payments from the tobacco companies and about $16 billion were advance payments which several states had arranged to receive by issuing bonds backed by their future payments from the tobacco companies. The Master Settlement Agreement imposed no restrictions on how states could spend their payments, and as such, the states have chosen to allocate them to a wide variety of activities. Some states told us that they viewed the settlement payments as an opportunity to fund needs that they were not able to fund previously due to the high costs of health care. States allocated the largest portion of their payments to health care--$16.8 billion or 30 percent--which includes Medicaid, health insurance, hospitals, medical technology, and research. States allocated the second largest portion to cover budget shortfalls--about $12.8 billion or about 22.9 percent. This category includes allocations to balance state budgets or reduce deficits that resulted from lower than anticipated revenues, increased mandatory spending, or essential expenditures. Included among the next largest categories are allocations for infrastructure projects, education, debt service on securitized proceeds, and tobacco control.

section_title: Letter
paragraphs: I am pleased to be here today to contribute to your deliberation on the  need for the Food and Drug Administration to regulate tobacco products.  Tobacco use is the leading cause of preventable death in the United States.  Most adults who use tobacco started using it between the ages of 10 and  18. A Surgeon General’s report to the Congress concluded that preventing  youth from starting to use tobacco is key to reducing tobacco-related  deaths and disease. The Centers for Disease Control and Prevention  reported a few years ago that, on average, more than 440,000 deaths and  $76 billion in medical expenditures are attributable to cigarette smoking  annually. Reducing tobacco-related deaths and the incidence of disease,  along with their associated costs, is a significant public health challenge.
Beginning in the mid-1990s, states sued the major tobacco companies for  reimbursement of the cost of health impairments caused by the public’s  use of tobacco. The states alleged that the industry had violated antitrust  and consumer protection laws, withheld information about the adverse  health effects of tobacco, manipulated nicotine levels to keep smokers  addicted, and conspired to keep less risky and less addictive tobacco  products out of the market. Forty six states, along with the District of  Columbia and the five U.S. territories, negotiated and signed a settlement  agreement, called the Master Settlement Agreement, with four of the  largest tobacco companies—Phillip Morris, USA; R.J. Reynolds Tobacco  Company; Brown & Williamson Tobacco Corporation; and Lorillard  Tobacco company. The settlement was the largest civil settlement in U.S.  history. It committed the tobacco companies to pay the 46 states an  estimated $200 billion over the first 25 years of the agreement, with  payments to continue in perpetuity. In addition, it restricted the tobacco  companies’ marketing and advertising practices, among other things.
Today, I will focus on how the 46 states party to the Master Settlement  Agreement have allocated their settlement payments. Specifically, I will  discuss (1) the amounts of Master Settlement Agreement payments that  the states received from fiscal years 2000 through 2005, the most recent  year for which we have actual data, and (2) the states’ allocations of these  payments. The Farm Security and Rural Investment Act of 2002 (the 2002  Farm Bill) required GAO to report annually, from fiscal years 2002 through  2006, on how these 46 states used their Master Settlement Agreement  payments. My testimony is based primarily on these annual reports.
Our reports were based on our yearly surveys of the 46 states. Each year  we asked the states to report (1) the amount of payments they received for  the current state fiscal year, (2) the amount of payments they expected to  receive for the next state fiscal year, and (3) their allocations of these  payments among 13 spending categories. We independently corroborated  the states’ data to the extent possible by analyzing budget-related and  legislative documents, and interviewing state budget officials, staff from  state attorneys generals’ offices and governors’ offices and others as  needed to clarify information. We performed our work in accordance with  generally accepted government auditing standards.
In summary, from fiscal year 2000 through fiscal year 2005, the states  received $52.6 billion in Master Settlement Agreement payments from the  tobacco companies in amounts that varied from state to state and from  year to year. Of the $52.6 billion, about $36.5 billion were payments from  the tobacco companies and about $16 billion were advance payments  (securitized proceeds) that 15 states arranged to receive by issuing bonds  backed by their future payments from the tobacco companies. The annual  payments from the tobacco companies’ are adjusted based on several  factors that include fluctuations in the volume of cigarettes sales, inflation,  and other variables, such as the participating companies’ shares of the  tobacco market. Also, each state’s share of the tobacco companies’ annual  payments is a fixed percentage based on smoking-related health care  costs, which reflect population and smoking prevalence.
The Master Settlement Agreement imposed no restrictions on how states  could spend these settlement payments and, as such, the states have  allocated their payments to a wide variety of activities. Some states told us  that they viewed the settlement payments as an opportunity to fund needs  that they were not able to fund previously due to the high costs of health  care. States allocated the largest portion of their payments—30 percent or  $16.8 billion—toward health care activities such as Medicaid, health  insurance, hospitals, medical technology, and research. States allocated  the second largest portion of their payments—about 23 percent or $12.8  billion—to help balance state budgets or reduce deficits that resulted from  lower than anticipated revenues, increased mandatory spending, or  essential expenditures.
In descending order, the next largest categories where states used their  tobacco settlement payments were general purposes, infrastructure  projects, education, debt service on securitized funds, and tobacco  control.
subsections: section_title: States’ Annual Tobacco Settlement Payments Have Varied
paragraphs: The 46 states reported receiving a total of nearly $52.6 billion in payments  in varying annual amounts from fiscal year 2000 through fiscal year 2005.  Of the nearly $52.6 billion, about $36.5 billion were payments from the  tobacco companies and about $16 billion were securitized proceeds that  15 states arranged to receive, as shown in table 1.
The tobacco companies’ annual payments are adjusted based on several  factors contained in the Master Settlement Agreement that include  fluctuations in the volume of cigarette sales, inflation, and other variables,  such as the participating companies’ share of the tobacco market.  Declining tobacco consumption alone would result in lower Master  Settlement Agreement payments than originally expected. Tobacco  consumption has declined since the Master Settlement Agreement was  signed in 1998—by about 6.5 percent in 1999 alone—mostly due to one- time increases in cigarette prices by the tobacco companies after the  agreement took effect. Analysts project that, in the future, tobacco  consumption will decline by an average of nearly 2 percent per year. As a  result, tobacco consumption is estimated to decline by 33 percent between  1999 and 2020.
However, the Master Settlement Agreement also includes an inflation  adjustment factor that some analysts have estimated increases payments  more than any decreases caused by reduced consumption. The inflation  adjustment equals the actual percentage increase in the Consumer Price  Index for the preceding year or 3 percent, whichever is greater. The effect  of these compounding increases is potentially significant, especially given  that the payments are made in perpetuity. Assuming a 3-percent inflation  adjustment and no decline in base payments, settlement amounts received  by states would double every 24 years.
Also, several tobacco companies’ interpretation of the provision that  addresses participants’ market share led them to lower their payments in  2006. Under this provision, an independent auditor determined that  participating tobacco companies lost a portion of their market share to  non-participating companies. An economic research firm determined that  the Master Settlement Agreement was a significant factor in these market  share losses. Based on these findings, several participating companies  reduced their fiscal year 2006 payments by about a total of about $800  million. Many states have filed suit to recover these funds.
Each state’s share of the tobacco companies’ total annual payments is a  fixed percentage that was negotiated during the settlement. These  percentages are based on two variables related to each state’s smoking- related health care costs, which reflect each state’s population and  smoking prevalence. In general, the most populous states receive a larger  share of the tobacco companies’ total annual payments than the less  populous states. For example, California and New York each receive about  13 percent, while Alaska and Wyoming each receive less than 1 percent.  However, these percentages are not strictly proportional to population.
In addition to the annual payments states receive, the Master Settlement  Agreement requires that a Strategic Contribution Fund payment begin in  2008 and continue through 2017. The base amount of each year’s Strategic  Contribution Fund payment is $861 million, which will be adjusted for  volume and inflation and shared among the states. Strategic Contribution  Fund payments are intended to reflect the level of the contribution each  state made toward final resolution of their lawsuit against the tobacco  companies. They will be allocated to the states based on a separate  formula developed by a panel of former state attorneys general.
section_title: States Are Exercising Their Flexibility to Use Tobacco Settlement Payments for a Wide Variety of Activities
paragraphs: The Master Settlement Agreement imposed no restrictions on how states  could spend their settlement payments and, as such, the states have  allocated their payments to a wide variety of activities, with health-related  activities the largest among them. As part of their decision making on how  to spend their payments, some states established planning commissions  and working groups to develop recommendations and strategic plans for  allocating their states’ payments. In six states, voter-approved initiatives  restricted use of the funds and, in 30 states, the legislatures enacted laws  restricting their use.
Overall, we identified 13 general categories to which states have allocated  their Master Settlement Agreement payments, as shown in table 2.  Appendix I provides more details on the categories to which states  allocated their payments.
States allocated the largest portion of their payments—about $16.8 billion,  or 30 percent of the total payments—to health-related activities. To a  closely related category—tobacco control—states allocated $1.9 billion, or  3.5 percent of their total payments. States allocated the second largest  portion of their payments—about $12.8 billion or 22.9 percent—to cover  budget shortfalls. Some states told us that they viewed the settlement  payments as an opportunity to fund needs that they were not able to fund  previously due to the high cost of health care. Figure 1 illustrates the  relative magnitude of the categories receiving allocations.
The seven largest categories of allocations, in descending order, are  health, budget shortfalls, general purposes, infrastructure, education, debt  service on securitized funds, and tobacco control. States’ allocations to  these categories have varied considerably from year to year—with some  categories showing wide fluctuations. For example, for budget shortfalls,  the states allocated from 2 to 44 percent of the total payments. On the  other hand, for health care, the states allocated from 20 to 38 percent of  the total payments. Figure 2 shows these annual changes for these seven  categories.
Information about how states have allocated their Master Settlement  Agreement payments follows.
Health. From fiscal years 2000 through 2005, states allocated about $16.8  billion of their Master Settlement Agreement payments to a variety of  health care programs, including Medicaid; health insurance; cancer  prevention, screening, and treatment; heart and lung disease; and drug  addiction. Over this period, the amounts states allocated to health care  ranged from about $1.9 billion in fiscal year 2005 to nearly $4.8 billion in  fiscal years 2000-2001 combined.
In fiscal year 2005, the most recent year for which we collected actual  data, 36 of the 46 states allocated some of their Master Settlement  Agreement payments to health care. Of the 36 states, 5 states allocated  two-thirds or more of their payments to health care; 19 states allocated  one-third to two-thirds; and 12 states allocated less than one-third. Ten  states did not allocate any of their payments to health care activities. In  fiscal year 2005, Pennsylvania, Illinois, Michigan, and Maryland allocated  larger amounts to health care than the other states. Pennsylvania allocated  over $326 million of its payments to health care programs for adult health  insurance, uncompensated care, medical assistance for workers with  disabilities, and community medical assistance. Illinois allocated nearly  $204 million of its payments to health care, citing Medicaid drugs as a key  program that would receive funds. Michigan allocated over $185 million of  its payments to areas such as elder pharmaceutical assistance and  Medicaid support programs. Maryland allocated nearly $100 million of its  payments to areas such as Medicaid; cancer prevention, screening, and  treatment; heart and lung disease; and drug addiction.
Budget Shortfalls. From fiscal years 2000 through 2005, states allocated  about $12.8 billion of their Master Settlement Agreement payments to  budget shortfalls. Over this period, the amounts the states allocated to  budget shortfalls ranged from a high of about $5.1 billion, or 44 percent of  the total payments in fiscal year 2004, to $261 million, or 4 percent in fiscal  year 2005. In fiscal year 2005, only 4 of the 46 states allocated some of  their Master Settlement Agreement payments to budget shortfalls. Of these  states, only Missouri allocated more than one-third of its total payments–– about $72 million––to budget shortfalls.
General Purposes. From fiscal years 2000 through 2005, states allocated  about $4 billion of their Master Settlement Agreement payments to general  purposes, including law enforcement, community development activities,  technology development, emergency reserve funds, and legal expenses for  enforcement of the Master Settlement Agreement. Over this period, the  amounts states allocated to general purposes ranged from $623 million, or  about 5 percent of the total payments they allocated in fiscal years 2000- 2001 combined, to about $1.1 billion, or 8 percent in fiscal year 2003.
In fiscal year 2005, 27 of the 46 states allocated some of their Master  Settlement Agreement payments to general purposes. Of these 27 states, 4  states allocated two-thirds or more of their total payments to general  purposes; 2 states allocated one-third to two-thirds; and 21 states allocated  less than one-third. Nineteen states did not allocate any of their payments  to general purposes. Massachusetts, Tennessee, Connecticut, and  Colorado allocated the largest amounts to general purposes in fiscal year  2005. Massachusetts allocated nearly $255 million of its payments to  general purposes for its General Fund, Tennessee allocated nearly $157  million of its payments to its General Fund, and Connecticut allocated  about $113 million of its payments to its General Fund. Colorado allocated  about $64.5 million of its payments to general purposes, but did not  specify which programs would receive funds.
Infrastructure. From fiscal years 2000 through 2005, states allocated  about $3.4 billion of their Master Settlement Agreement payments to  infrastructure-related activities, including capital maintenance on state  owned facilities, regional facility construction, and water projects. Over  this period, the amounts states allocated to infrastructure have ranged  from $31 million, or about 1 percent of the total payments in fiscal year  2005, to about $1.2 billion, or 10 percent in fiscal year 2002.
In fiscal year 2005, 5 of the 46 states allocated some of their Master  Settlement Agreement payments to infrastructure. Of these 5 states, North  Dakota was the only state that allocated more than one-third of its total  payments to infrastructure. North Dakota, Hawaii, and Kentucky allocated  the largest amounts to infrastructure in fiscal year 2005. North Dakota  allocated about $10.5 million of its payments to infrastructure for work on  water projects. Hawaii allocated approximately $10 million of its payments  to infrastructure, citing debt service on University of Hawaii revenue  bonds issued for the new Health and Wellness Center as a primary  program that would receive funds. Kentucky allocated $6.1 million of its  payments to service debt on such things as water resource development  and a Rural Development Bond Fund.
Education. From fiscal years 2000 through 2005, states allocated about $3  billion of their Master Settlement Agreement payments to education  programs, including early childhood development; special education;  scholarships; after-school services; and reading programs. Over this  period, the amounts states allocated to education ranged from between  $280 million or 2 percent of the total payments in fiscal year 2004, to over  $1.1 billion, or 9 percent, in fiscal year 2002.
In fiscal year 2005, 16 of the 46 states allocated some of the Master  Settlement Agreement payments to education. Of the 16 states, only New  Hampshire allocated more than two-thirds of its total payments to  education; 4 states allocated between one-third and two-thirds to  education; and 11 states allocated less than one-third. Thirty states did not  allocate any of their payments to education-related activities. Michigan,  New Hampshire, Nevada, and Colorado allocated the largest amounts to  education in fiscal year 2005. Michigan allocated over $99 million of its  payments to education for Merit Award scholarships and tuition incentive  grants for higher education students; the Michigan Educational  Assessment Program testing for K-12 students, nursing scholarships, the  Michigan Education Savings Plan, and general higher education support.  New Hampshire allocated $40 million of its payments to areas such as an  Education Trust Fund, which distributes grants to school districts in the  state. Nevada allocated about $33 million of its payments to education  programs, citing a scholarship program for Nevada students attending  Nevada’s higher education institutions as a key recipient. Colorado  allocated over $16 million of its payments to education, including its Read  to Achieve program.
Debt Service on Securitized Funds. From fiscal years 2000 through 2005,  states allocated about $3 billion of their Master Settlement Agreement  payments to servicing debt on securitized funds. This category consists of  amounts allocated to servicing the debt issued when a state securitizes all  or a portion of its Master Settlement Agreement payments. Over this  period, the amounts states allocated for this purpose have ranged from  $271 million, or about 2 percent of the total payments in fiscal year 2002,  to about $1.4 billion, or about 24 percent, in fiscal year 2005. In fiscal year  2005, four states—California, Rhode Island, South Carolina, and  Wisconsin—allocated 100 percent of their Master Settlement Agreement  payments to servicing debt on securitized funds, while New Jersey  allocated just under 100 percent. In addition, Alaska, Louisiana, and South  Dakota, allocated more than half of their payments for this purpose. In  fiscal year 2005, California and New York allocated the largest amounts to  servicing debt on securitized funds.
Tobacco Control. From fiscal years 2000 through 2005, states allocated  about $1.9 billion of their Master Settlement Agreement payments to  tobacco control programs, including prevention, cessation, and counter  marketing. Over this period, the amounts states allocated to tobacco  control ranged from $790 million, or about 6 percent of the total payments  in fiscal years 2000-2001 combined, to $223 million, or about 2 percent, in  fiscal year 2004.
In fiscal year 2005, 34 of the 46 states allocated some of their Master  Settlement Agreement payments to tobacco control programs. Of the 34  states, Wyoming allocated more than one-third of its payments to tobacco  control, while 33 states allocated less than one-third. Twelve states did not  allocate any of their payments to tobacco control-related programs.
Pennsylvania and Ohio allocated more than the other states to tobacco  control—about $44 million and $37 million, respectively—in fiscal year  2005.
Mr. Chairman, this concludes my prepared statement. I would be pleased  to respond to any questions that you or other Members of the Committee  may have.
Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this statement. For further  information about this testimony, please contact Lisa Shames, Acting  Director, Natural Resources and Environment at (202) 512-3841 or  ShamesL@gao.gov. Key contributors to this statement were Charles M.  Adams, Bart Fischer, Jennifer Harman, Natalie Herzog, Alison O’Neill, and  Beverly Peterson.
section_title: Appendix I: Categories of States’ Allocations
paragraphs: To standardize the information reported by the 46 states, we developed the  following categories and definitions for the program areas to which states  allocated their payments.
Budget shortfalls: This category is comprised of amounts allocated to  balance state budgets and close gaps or reduce deficits resulting from  lower than anticipated revenues or increased mandatory or essential  expenditures.
Debt service on securitized funds: This category consists of amounts  allocated to service the debt on bonds issued when the state securitized all  or a portion of its Master Settlement Agreement payments.
Economic development for tobacco regions: This category is comprised of  amounts allocated for economic development projects in tobacco states  such as infrastructure projects, education and job training programs, and  research on alternative uses of tobacco and alternative crops. This  category includes projects specifically designed to benefit tobacco  growers as well as economic development that may serve a larger  population within a tobacco state.
Education: This category is comprised of amounts allocated for education  programs such as day care, preschool, Head Start, early childhood  education, elementary and secondary education, after-school programs,  and higher education. This category does not include money for capital  projects such as construction of school buildings.
General purposes: This category is comprised of amounts allocated for  attorneys’ fees and other items, such as law enforcement or community  development, which could not be placed into a more precise category.  This category also includes amounts allocated to a state’s general fund  that were not earmarked for any particular purpose. Amounts used to  balance state budgets and close gaps or reduce deficits should be  categorized as budget shortfalls rather than general purposes.
Health: This category is comprised of amounts allocated for direct health  care services; health insurance, including Medicaid and the State  Children’s Health Insurance Program (SCHIP); hospitals; medical  technology; public health services; and health research. This category does  not include money for capital projects such as construction of health  facilities.
Infrastructure: This category is comprised of amounts allocated for  capital projects such as construction and renovation of health care,  education, and social services facilities; water and transportation projects;  and municipal and state government buildings. This category includes  retirement of debt owed on capital projects.
Payments to tobacco growers: This category is comprised of amounts  allocated for direct payments to tobacco growers, including subsidies and  crop conversion programs.
Reserves/rainy day funds: This category is comprised of amounts  allocated to state budget reserves such as rainy day and budget  stabilization funds not earmarked for specific programs. Amounts  allocated to reserves that are earmarked for specific areas are categorized  under those areas—e.g., reserve amounts earmarked for economic  development purposes should be categorized in the economic  development category.
Social services: This category is comprised of amounts allocated for social  services such as programs for the aging, assisted living, Meals on Wheels,  drug courts, child welfare, and foster care. This category also includes  amounts allocated to special funds established for children’s programs.
Tax reductions: This category is comprised of amounts allocated for tax  reductions such as property tax rebates and earned income tax credits.
Tobacco control: This category is comprised of amounts allocated for  tobacco control programs such as prevention, including youth education,  enforcement, and cessation services.
Unallocated: This category is comprised of amounts not allocated for any  specific purpose, such as amounts allocated to dedicated funds that have  no specified purpose; amounts states chose not to allocate in the year  Master Settlement Agreement payments were received that will be  available for allocation in a subsequent fiscal year; interest earned from  dedicated funds not yet allocated; and amounts that have not been  allocated because the state had not made a decision on the use of the  Master Settlement Agreement payments.
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