Once tobacco is regulated, whither the bonds?by Tim Manni
On one hand, the news that tobacco will be regulated like a drug is good news:
WASHINGTON (AP) – The Senate struck a historic blow against smoking in America Thursday, voting overwhelmingly to give regulators new power to limit nicotine in the cigarettes that kill nearly a half-million people a year, to drastically curtail ads that glorify tobacco and to ban flavored products aimed at spreading the habit to young people.
President Barack Obama, who has spoken of his own struggle to quit smoking, said he was eager to sign the legislation, and the House planned a vote for Friday. Cigarette foes said the measure would not only cut deaths but reduce the $100 billion in annual health care costs linked to tobacco.
But this good news has a flip side: it could cost you more money — even if you don’t smoke.
But the industry has also taken hits in recent years as the dangers of smoking became more apparent and states moved to limit smoking in public places. In 1998 the industry agreed to pay the states $206 billion to help cover health care costs, and this year Congress raised the federal cigarette tax by 62 cents, to $1.01 a pack, to fund a health care program for children.
In response to this “windfall,” many states sold bonds — and/or hiked general spending — predicated on the income that cigarettes would supposedly bring. Ever-rising tobacco taxes and other measures have eroded the base that was supposed to generate income for the states.
If FDA regulation has the intended result of reducing the number of Americans who smoke, that revenue also gets cut. Not only will that hit investors who hold those “tobacco bonds,” but it will leave the states with yet another budget shortfall:
Many [states] took the money from the 1998 tobacco settlement and used it for everything but tobacco prevention. But declining tobacco consumption could reduce the industry’s annual payout to the states by up to $500 million, and also poses a threat to the $37 billion in bonds that states issued based on expected future receipts of tobacco money. The bonds were issued so that states could get an upfront, lump-sum payout of the settlement money rather than waiting for each year’s payments, which are based on sales.
“While settlement revenues may be shrinking, most tobacco bond structures have debt service requirements with built-in increases for future years,” said Richard Larkin, an analyst at municipal-bonds firm Herbert J. Sims and Co. Some state bond issues might have to use their reserves to pay the interest on the bonds, he added.
Those states will have to cut spending and/or raise taxes to make up the shortfall. And, by an odd coincidence, the states that relied most heavily on the income are those in financial trouble now:
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. …
The rush to tap the revenue stream began soon after the tobacco settlement was signed 10 years ago. The cigarette companies agreed to make annual payments that would total $200 billion by 2025. The money was to be divided among the 46 participating states, with New York and California each getting about $700 million a year, Ohio about $300 million, Wisconsin just over $100 million and so on.
We could call this the law of unintended consequences, except that this perverse correlation has been known — and predicted — for 10 years.