Cigarette tax increase cut smoking less payment to states, harm bond repayment..

February 22, 2009 - Ten years later, tobacco deal going up in smoke by Bob Sullivan, Red Tape Chronicles: Consider this the next time you see a teenager take a drag on a cigarette: Your state government likely has a financial stake in that kid continuing to smoke. And quite possibly, so does your retirement portfolio.

That was hardly the intention 10 years ago, when a collection of state attorneys general delivered a crushing blow to Big Tobacco. On Nov. 23, 1998, the nation's four largest cigarette sellers agreed to pay $200 billion over 30 years in what seemed like a victory for David over Goliath. The money was supposed to help the states pay for health care and anti-smoking campaigns. Instead, much of it -- even payments that aren't due for 20 years -- has already been spent on politically popular tax breaks through complicated borrowing schemes initiated by Wall Street investment banks.

Because these states have essentially borrowed against future payments from the tobacco industry, they are now dependent on the continued vitality of cigarette sales. If Big Tobacco stumbles, states will be on the hook for these massive, billion-dollar loans. In other words, David and Goliath are now allies. Higher federal and state taxes on cigarettes this year may bring the biggest drop in smoking ever, reducing the tobacco industry’s annual payments to states by as much as $500 million and threatening the repayment of $37 billion in municipal bonds backed by that money. As a result, many states have a perverse incentive to support the tobacco industry, on whom they are now dependent for future payments against this debt.

Bloomberg article: An expansion of the State Children’s Health Insurance Program this month (February 2009) will raise the federal tax by 62 cents to $1.01 a pack, bringing the average price of a pack of cigarettes nationally to around $5. The tax increase alone will save 900,000 lives, according to the American Cancer Society’s Cancer Action Network.

The higher prices could cut U.S. cigarette consumption by as much as 10 percent, said Richard Larkin, research director at Herbert J. Sims & Co., a municipal-bond firm in Iselin, New Jersey. He noted that most state tobacco bonds were sold based on the assumption that cigarette use would drop by around 2 percent a year. A reduction of 10 percent, which is about 2.5 times the yearly average over the past decade, would decrease payments to states under the 1998 MSAto $6.5 billion in 2010 from an estimated $7 billion this year, Larkin said. Most tobacco bond structures have debt service requirements with built-in increases for future years,” he said. A $500 million decline -- coming amid the industry’s attempts to recoup parts of some previous payments -- could force some issuers to dip into reserves for debt service, said Larkin.

Reference: Cigarette Tax Increases Cut Smoking While Harming Bonds’ Healthby Joe Mysak, Bloomberg.com, 2/19/2009.

Related news brief: Ten Yrs Later the 1998 State Tobacco Master Settlement Agreement (MST)..

Related article: Thomson Financial News Light cigarette ruling to further sideline tobacco bonds by Karen Pierog, Reuters, 12/15/2008.