Would the Proposed National Tobacco Settlement Compensate the Federal Government Adequately for Tobacco-Related Health-Care Costs?
by Andy Schneider and Sara Thom

A companion analysis by the Center on Budget and Policy Priorities, The Proposed National Tobacco Settlement and Recovery of Federal Health Care Costs, examines certain provisions in the settlement proposed by 40 state Attorneys General and five tobacco manufacturers.⁽¹⁾ That analysis explains that the federal government bears very large Medicare, Medicaid, and other costs for treating tobacco-related illnesses and notes that the proposed settlement effectively precludes the federal government from taking legal action to recover such past or future costs. The analysis suggests that if Congress adopts comprehensive tobacco legislation containing such a restriction, the legislation should compensate the federal government for a reasonable share of the future costs it will bear in treating tobacco-related illnesses; the analysis notes the proposed settlement falls short in this area. This paper explores these matters in further detail.

Federal Health Care Costs Attributable to Tobacco

Every year, the federal government pays for a significant portion of health care services. In 1996, some $907.2 billion was spent on health care services for individuals by public programs and private insurers. Federal payments accounted for $322.6 billion of this amount, or about one third of all spending on health care services in the United States. This $322.6 billion in federal health care expenditures compared to $89.4 billion spent by state and local governments combined.⁽²⁾

As shown in Figure 1, the Medicare and Medicaid programs are by far the largest federal health care programs. Other major federal purchasers of health care services include the Department of Veterans Affairs, the Department of Defense, and the Federal Employee Health Benefit Program.⁽³⁾

Two studies have estimated the costs to Medicare and Medicaid of treating smoking-induced illnesses and conditions. The National Center on Addiction and Substance Abuse at Columbia University estimated that in fiscal year 1995, treatment of tobacco-related illnesses and conditions accounted for 14 percent of Medicare spending and 8 percent of Medicaid costs.⁽⁴⁾ A more recent study conducted by Berkeley Economic Research Associates for the Robert Wood Johnson Foundation estimated that an average of 6.6 percent of Medicaid spending in 1993 was attributable to the treatment of smoking-related illnesses.⁽⁵⁾

There appear to be no similar studies estimating the costs attributable to smoking borne by other federal health care programs. It is evident, however, that the federal government spends a significant amount on smoking-related medical care and that the costs it incurs for providing such care substantially outstrip the costs that states and localities bear.⁽⁶⁾

The Proposed National Settlement and Federal Health Care Costs

The 68-page proposed national settlement is a complex document covering a plethora of policy and regulatory issues.⁽⁷⁾ The following provisions apply to the issue of federal health care costs.

Civil Liability

Title VIII of the proposed settlement would terminate all present state (or county or local) lawsuits and all class actions brought against tobacco manufacturers by private citizens. No "third-party payor (and similar)" claims against tobacco manufacturers — e.g., suits by Medicare or the Department of Veterans Affairs or the Federal Employee Health Benefits Program — could be pursued unless the claims were pending as of June 9, 1997 or unless they are "based on subrogation of individual claims." These provisions limiting lawsuits would apply to claims for injury or damage caused as a result of past or future conduct on the part of tobacco manufacturers.

The practical effect of these provisions is to bar federal health care programs from going to court to recover costs that they incur which are attributable to tobacco-related illnesses. Since none of the federal health care programs had claims pending as of June 9, 1997, they would be barred from filing any lawsuits to recover their costs except through "subrogation." Under "subrogation," the federal health care program would have to file a lawsuit on behalf of each individual beneficiary who smoked to recover the costs of treating that individual's smoking-attributable illness or condition. The settlement does not specify that any particular federal health care program would have a right of subrogation, but even if that were established, the practical obstacles to using this route to recover funds would be insurmountable.

Take Medicare for example. If 55 percent of the 33.7 million elderly Medicare beneficiaries have smoked during their lifetimes,⁽⁸⁾ subrogation implies the federal government would have to file as many as 18.5 million lawsuits to recover its costs of treating the smoking-attributable illnesses of these beneficiaries. This volume of litigation represents more than 80 times the average number of civil cases disposed of annually by federal district courts. It would swamp the federal judicial system.⁽⁹⁾

Tobacco Manufacturer Payments

Title VI of the proposed settlement provides for payments from manufacturers that have what the settlement terms a "face value" of $368.5 billion over 25 years. This includes:

• an "up front" lump-sum payment of $10 billion payable on the date of signing the implementing legislation;

• annual payments "in perpetuity" beginning on December 31 of the first full year after enactment of the implementing legislation. The "face amount"of these amounts would total $8.5 billion in the first year and rise to $15 billion by the fifth year and succeeding years. The "face amounts" would be adjusted for inflation (the greater of three percent or the Consumer Price Index), for increases or decreases in domestic tobacco product unit sales, and for increases in industry net operating profits;⁽¹⁰⁾

• treatment of these annual payments for federal corporate tax purposes as "ordinary and necessary" business expenses deductible by the manufacturers.

It should be noted that the "face value" amount may prove to be substantially smaller than it appears. An analysis by the Federal Trade Commission staff concluded that the "face value" amount of $368.5 billion could translate into actual revenues and settlement payments to the federal government of only $207.3 billion if the volume of cigarettes sold in the United States declines as a result of the likely increase in cigarette prices that would result from the settlement. The FTC staff analysis estimates the present value of this $207.3 billion — that is, what it would be worth if paid out today rather than over 25 years — to be $100.4 billion.⁽¹¹⁾

Distribution of Settlement Funds

Title VII of the proposed settlement sets forth "recommendations by the Attorneys General for consideration by the President and the Congress" with respect to the disposition of public health funds under the proposed settlement. These and other recommendations are summarized in the following table presented by the Attorneys General in recent testimony before Congress.

As shown in Table 1, the $368.5 billion that constitutes the "face amount" the settlement would provide over the next 25 years would be divided into five broad categories.

• Payments to States. The largest share of the settlement — 52 percent of the total — would be reserved for the exclusive use of the states. This $193.5 billion in payments to states includes $7 billion of the $10 billion "up-front" payment the manufacturers would make immediately upon enactment of the national legislation.
  
  The payments to states would be unrestricted. States could use the funds for any purpose, including public health, covering uninsured children, meeting state matching requirements under Medicaid, financing road construction or other public works projects, or reducing taxes.

• Tort Judgment and Settlement Fund. The next largest share of the total settlement — $77 billion over 25 years, or 21 percent of the total — would be allocated to a fund for the payment of awards or settlements in individual lawsuits brought against tobacco manufacturers for compensation for injuries. Under Title VIII of the proposed settlement, individuals would have a right to sue tobacco manufacturers for injuries sustained as a result of smoking, but an annual aggregate cap would be imposed on the amount of payments the tobacco manufacturers would have to make in the event of judgments or settlements in any such lawsuits against them for injury or damages. If damage awards were to exceed the amount in the fund, prevailing plaintiffs would receive their awards over several — perhaps many — years.
  
  The settlement would bar all punitive damages claims in individual tort actions. It would allow some class actions, but any awards or settlements would have to be paid from the fund. The "face" amounts available for such payments total $77 billion over 25 years.

• Tobacco Control and Countermarketing. Ten percent of the total settlement amount — $37 billion over 25 years — would be allocated to programs to reduce the use of cigarettes and other tobacco products, including a multi-media campaign to discourage smoking. The Department of Health and Human Services would administer some of the programs. Other such programs would take the form of grants to state health departments with no state matching requirements.

• Tobacco Cessation. Another 10 percent of the total settlement amount would be placed in a trust fund to provide direct financial assistance to individuals who want to stop smoking or using other tobacco products. The proposed settlement does not explain how such a program of direct payments to individual smokers would be administered or how it would work. A "face amount" of $36 billion over 25 years would be reserved for this purpose.

• Public Health Trust Fund. The smallest share of the settlement — $25 billion over 25 years, or seven percent of the total — would be allocated to a Public Health Trust Fund. All payments would be made into this fund in the first eight years, with no further payments after that. The purpose of the fund would be to finance tobacco-related medical research. The research would be directed not by the National Institutes of Health but by a Presidential Commission composed of representatives of the public health community, state Attorneys General, private attorneys, and others.

Treatment of State Lawsuits

Under Title VIII of the proposed settlement, the 40 lawsuits brought by states would be "legislatively settled," and any additional lawsuits that might be brought in the future by states are barred. In the case of the states that already have settled their lawsuits — Florida, Mississippi, and Texas — the individual settlement agreements in those cases stipulate that the terms of the agreements will be superseded by the terms of any enacted federal legislation that is "substantially equivalent" to the proposed national settlement.⁽¹³⁾

Any National Settlement Should Include the Recovery of Tobacco-Related Federal Health Care Costs

Under the proposed settlement, the federal government would immunize the tobacco industry against civil liability from most class action lawsuits and cap the industry's annual financial exposure for any liability it incurs in individual and allowable class action lawsuits. In addition, the federal government would, as a practical matter, prohibit itself from recovering through the courts any of the tobacco-related health care costs it has incurred in the past or will incur in the future through Medicaid, Medicare and other federal health care programs. In exchange, the federal government would collect payments from the industry and redistribute the lion's share of these funds to the states with no strings attached.

Whether or not Congress decides to limit the civil liability of tobacco manufacturers, Congress should satisfy itself that federal health programs recover at least a fair share of their future tobacco-related costs. Any other result would represent a continuing federal subsidy to the tobacco industry.

In addition, if national legislation calling for payments from the industry is enacted, and if Congress chooses to set aside a significant amount of any such payments for the states, the Congress should satisfy itself that this amount bears some reasonable relationship to the tobacco-related health care costs the states have actually incurred or will incur from their own funds. The federal government spends more than three times what state and local governments spend on health care services. That raises serious questions about the reasonableness of the federal government receiving only slightly more than one quarter of all industry payments, as it would under the proposed settlement.

The matter of securing adequate federal compensation in return for the federal government forfeiting its ability to go to court to collect payments from the industry for tobacco-related treatment costs that the federal government must bear takes on particular importance given the long-term fiscal challenges that face the federal government in general and the Medicare program in particular. Congressional Budget Office and General Accounting Office long-term budget forecasts indicate that when the baby boomers are retired in large numbers, serious budget deficits will return and that the principal reason for this development is projected increases in the costs of federal health care programs. Furthermore, the Medicare hospital insurance trust fund is estimated to become insolvent in 2010. Federal outlays for treating tobacco-related illnesses contribute to these problems. For the federal government to relinquish its rights to secure recompense from tobacco manufacturers through legal action while receiving payment for only a small fraction of the tobacco-related costs it will incur would not seem to represent prudent fiscal policy.

End Notes

1. Andy Schneider and Sara Thom, The Proposed National Tobacco Settlement and Recovery of Federal Health Care Costs, Center on Budget and Policy Priorities, Revised February 10, 1998.

2. Health Care Financing Administration, Office of the Actuary, National Statistics Health Group. National Health Expenditures, Table 18, "Expenditures for Health Services and Supplies Under Public Programs, by Type of Expenditure and Program: Calendar Year 1996." Http://www.hcfa.gov/stats/nhe-oact/tables/t18.htm. This figure is exclusive of federal expenditures on the Federal Employee Health Benefit Plan (FEHBP).

3. Federal employer contributions to private insurance (e.g., for FEHBP) totaled $11.3 billion in 1996. Health Care Financing Administration, Office of the Actuary, National Health Statistics Group, and Office of Personnel Management. Cited in Levit, et.al, National Health Spending Trends in 1996, Health Affairs, January/February 1998, Vol. 17, No. 1, p.46.

4. National Center on Addiction and Substance Abuse, Substance Abuse and Federal Entitlement Programs, February 1995, p. 18.

5. Vincent P. Miller, Caroline R. James, Carla Ernst, and Francois Collin, Smoking Attributable Medical Care Costs: Models and Results, Berkeley Economic Research Associates, September 3, 1997, Table 5.7 (revised), p. 96. The BERA web site is www.bera.com.

6. None of the studies of smoking-attributable health care costs have contrasted states' medical expenditures due to smoking with those of the federal government. But since states and localities paid for only 10 percent of national personal health expenditures in 1996 while federal expenditures accounted for 36 percent of such costs, it is virtually certain that states bear a much smaller amount of smoking-related health care costs than the federal government does. Given the fact that the federal Medicare program pays for the health care of older, sicker individuals who have smoked for longer periods of time, it is likely that the federal government pays closer to four to five times what states pay for smoking-related medical costs.

Some may argue that tobacco use actually saves governments money, since it results in premature death and thus in lower payments in Social Security, Medicare, Medicaid, and other programs. It is not standard practice in making health economics calculations, however, to estimate benefit from premature death, and for good reason. Taken to its logical conclusion, this line of argument would suggest that to save taxpayer dollars, the government should aggressively promote the use of tobacco products as well as handguns, fatty foods, and dirty needles.

7. Proposed Resolution, June 20, 1997, www.stic.neu.edu/settlement/index.html.

8. National Center on Addiction and Substance Abuse, Columbia University, Substance Abuse and Federal Entitlement Programs, February 1995, p. 18.

9. Over the two-year period 1994-1995, U.S. district courts terminated an average of 229,000 civil cases per year. DOJ, Bureau of Justice Statistics, Federal Tort Trials and Verdicts, 1994-1995, December, 1997, p. 1, at www.ojp.usdoj.gov/bjs.

10. If the volume of tobacco products sold in a given year decreases, as compared to the base year, the amount of industry payments for the given year would be decreased by the same proportion. If, however, profits increase despite reduced sales, the amount of industry payments would be increased by 25 percent of the additional profits. This is explained in further detail in FTC Staff, Competition and the Financial Impact of the Proposed Tobacco Industry Settlement, September 1997, pp. 21-22.

11. FTC Staff, Competition and the Financial Impact of the Proposed Tobacco Industry Settlement, September 1997, Table 10, p. 46.

12. Testimony of Jeffrey A. Modisett, Attorney General of Indiana, before the Subcommittee on Health and the Environment of the House Committee on Commerce, December 8, 1997, p. 4.

13. Settlement Agreement, Florida v. American Tobacco Company, paragraph II.B.5, (www.stic.neu.edu/FL/Flsettle.htm); Memorandum of Understanding, State of Mississippi Tobacco Litigation, p. 3 (www.stic.neu.edu/MS/Mssettle.htm); Comprehensive Settlement Agreement and Release, State of Texas v. American Tobacco Company, page 8 (www.stic.neu.edu/TX/Texas-settlement.htm).