Beginning in the mid 1990s, more than 40 states and some localities sued tobacco companies, alleging that the industry 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 hold back less risky and less addictive tobacco products from the market. In 1997 and 1998, four states—Florida, Minnesota, Mississippi, and Texas—settled their lawsuits by negotiating independent agreements with the tobacco industry. In November 1998, four of the nation’s largest tobacco companies—Philip Morris Incorporated, R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corporation, and Lorillard Tobacco Company (referred to as the “original participating manufacturers”)— negotiated an agreement with the attorneys general of the remaining 46 states thereby settling a number of lawsuits brought by these states against these tobacco companies. The terms of this agreement, known as the Master Settlement Agreement (MSA), apply only to those tobacco companies and states that are parties to the agreement. Under the MSA, the tobacco companies are required to provide monetary relief to states in the form of annual payments and reimbursement for attorney fees. The MSA also imposes restrictions on the tobacco companies’ marketing and advertising practices. Furthermore, the MSA established a national foundation to support study and programs to (1) reduce youth tobacco use and substance abuse and (2) prevent diseases associated with tobacco use. Tobacco companies are required to provide funding for this foundation, as well as funding for the National Association of Attorneys General (NAAG), which is responsible for assisting states in the implementation and enforcement of the MSA. After the MSA was signed, each state had to take action to receive approval of the agreement from its respective state court in order to make the terms of the agreement legally binding within that state. Under the MSA, once state court approval was final, the state achieved “state-specific finality” status, thereby permitting that state to receive payments under the MSA. No state payments were to be released to any of the states, however, until the agreement reached final approval. This occurred in November 1999 when 80 percent of the states whose shares equaled 80 percent of the total settlement payments had achieved state-specific finality. In addition, to receive its full share of the settlement payments, each state was required by the MSA to enact a statute addressing the potential competitive advantage that tobacco companies not party to the MSA may experience. Under the MSA, if the aggregate market share of the tobacco companies that are party to the agreement (“participating manufacturers”) falls more than two percent below their base level of 1997 and the loss is caused in significant part by provisions of the MSA, the MSA payments may be reduced based on a formula that corrects for this market share loss. The MSA provided that individual states can avoid this downward adjustment—known as the “non-participating manufacturers” (NPM) adjustment—to their payments by enacting and enforcing a statute that is intended to prevent a competitive disadvantage for the participating manufacturers. The MSA provided a model statute that, if enacted and enforced by a state, would protect that state from any adjustment for market share loss, although states are permitted to enact and enforce any statute that achieves the same desired result. The MSA also placed restrictions on the tobacco companies’ business practices, primarily in marketing targeted to youth, advertising, and lobbying. For example, the MSA banned all outdoor advertising by the tobacco companies such as billboards and signs in arenas and stadiums, as well as sponsorship of sporting events with a significant youth audience. Moreover, the tobacco companies are prohibited from lobbying the state or any political subdivision against efforts to enact certain kinds of state laws and regulations intended to reduce underage tobacco access and use. Tobacco companies are not prohibited from lobbying against legislation that would raise excise taxes or restrict smoking in public places. The MSA also required the tobacco companies to pay a total of $50 million for enforcement activities including state enforcement of the terms of the agreement and investigation of suspected violations of antitrust or consumer protection laws related to tobacco products. In addition, the MSA required the tobacco companies to fund a national foundation, the American Legacy Foundation, dedicated to discouraging youth tobacco use and to preventing disease associated with tobacco use through supporting study and education. The participating tobacco companies are required to pay a total of $1.45 billion over 5 years for the advertising and education programs (performed directly or through grant-making) aimed at countering youth tobacco use and informing consumers about prevention of tobacco-related diseases, and an additional $250 million over 10 years for other activities of the foundation. The MSA was preceded by a proposed national settlement between the states and the tobacco industry reached in June 1997. This earlier more far- reaching proposal included payments to states and was a blueprint for a comprehensive national tobacco-control policy, including federal regulation and oversight. The June 1997 proposal could take effect only after federal legislation was enacted. Several comprehensive tobacco policy bills, including legislation to implement the June 1997 proposal, were introduced in the 105th Congress. However, only the National Tobacco Policy and Youth Smoking Reduction Act (S. 1415), introduced by Senator McCain, saw legislative action. The bill debated on the Senate floor provided for new authority for the Food and Drug Administration to regulate tobacco products, measures to restrict tobacco industry marketing and advertising, and measures to reduce underage tobacco use. The bill also required up-front and annual payments by the tobacco companies to provide for settlement of relevant state lawsuits. These and other payments would be deposited into a fund for the benefit of states that settled their lawsuits against the tobacco companies and for the benefit of the federal government. When S. 1415 did not pass in the summer of 1998, states resumed negotiations with the tobacco industry that eventually resulted in the November 1998 Master Settlement Agreement. The MSA was a scaled- down version of the June 1997 proposal and did not require federal action to be implemented. This agreement did not resolve states’ uncertainty over whether the federal government might lay claim to a portion of the payments to the states. In May 1999, Congress moved to resolve that uncertainty by enacting legislation that prohibited treating states’ MSA payments as federal overpayments for purposes of Medicaid. As of April 2001, 45 of the 46 states that signed the Master Settlement Agreement had received nearly $13.5 billion in payments from the tobacco companies. MSA payments to the states, some of which states will receive in perpetuity, were originally estimated to total nearly $205 billion through 2025. There are different types of payments, the largest two of which are “initial” payments— made in five installments through 2003— and “annual” payments which continue in perpetuity. Both of these types of payments are distributed based on “allocation percentages” for each state agreed to by the 46 state attorneys general when they negotiated the MSA. (See appendix IV for the types of MSA payments.) The final agreement resulted from negotiations that began with a formula. However, unlike many other legal settlements with a fixed level of compensation, while the MSA payments are based on set payment amounts, these payments are adjusted for several factors, most notably, the future sales of the tobacco industry. Each state’s payments are adjusted annually based on the participating manufacturers’ cigarette sales and market share, as well as inflation. All adjustments resulted in reductions of about $1.6 billion between 1999 and 2001. The formula that provided the basis for determining the allocation percentages for the MSA payments was composed of two variables each weighted equally: smoking-related Medicaid expenditures and smoking- related non-Medicaid health care costs of each state. The smoking-related health care cost variable included factors for each state’s population and smoking prevalence. After this initial formula was developed, negotiations resulted in some adjustments for state-specific concerns. For example, some smaller states argued that they should receive a larger percentage to enable them to fund smoking cessation programs because they did not have the same economy of scale as larger states. The negotiations resulted in the allocation percentages that are applied to each initial and annual MSA payment. In general, larger states receive a higher percentage of each payment and smaller states receive a lower percentage, however because the allocation percentages were determined by negotiations the payments are not strictly proportional to population. Table 1 shows the final state allocation percentages as explicitly agreed to in the MSA. Prior to the MSA, some counties in California and New York had independently filed lawsuits against the tobacco industry. In these states, the counties bear financial responsibility for a share of Medicaid costs, and the lawsuits sought compensation for the counties’ cost of treating smoking related illnesses. In both these states, under different arrangements, counties receive a share of MSA payments. The state of California had entered into a memorandum of understanding (MOU) with its counties and four major cities in August 1998—prior to the MSA—to coordinate their lawsuits with the state’s suit and provide for the allocation of any settlement. The terms of the MOU included an even 50/50 split of the financial recovery between the state and local governments, with the local share further split between the counties and four major cities. In California’s case, all MSA payments are made to the state and the state distributes payments to the 58 counties and four cities. (See appendix II for the counties’ and cities’ share of payments in California.) In the case of New York, the state’s consent decree provides for allocation of a portion of its MSA payments to the counties and New York City based on the county share of Medicaid costs and population as well as some specific considerations for individual counties. In New York’s case, each of the state’s 57 counties and New York City receive payment directly from the escrow account established by the MSA rather than the state receiving all payments and then distributing them to the localities. (See appendix III for the counties’ and New York City’s share of payments in New York.)