Revised February 10, 1998


The Proposed National Tobacco Settlement and
Recovery of Federal Health Care Costs

by Andy Schneider and Sara Thom


In June 1997, the Attorneys General of 40 states and five tobacco manufacturers entered into a proposed national settlement of lawsuits brought by the states. The proposed settlement calls for, among other things, a limitation on the civil liability of the manufacturers for damages and injuries caused by cigarette smoking, as well as payments by the industry totaling $368.5 billion in "face value" over a 25-year period. The Attorneys General and the manufacturers are seeking federal legislation to implement the proposed settlement.(1)

(President Clinton's budget proposal for fiscal year 1999 assumes enactment of legislation that would raise $65.5 billion from the tobacco industry over five years, to be used for payments to states, health research, smoking prevention and cessation programs, initiatives to improve access to child care and smaller classroom sizes, and other purposes. This paper focuses on the settlement proposed by the Attorneys General and the tobacco industry, rather than the Administration's proposal. The Administration's proposal is briefly examined in the box below.)

The single most important goal of the proposed settlement is to reduce youth smoking. But the settlement also has other elements. In particular, states would receive substantial payments from tobacco manufacturers in return for giving up their "sovereign power" to sue the industry.(2) A significant portion of these payments is intended to compensate for states' tobacco-related Medicaid costs.

The proposed settlement also would bar lawsuits brought by the federal government either on behalf of itself or on behalf of federal program beneficiaries as a class to recover its costs in treating tobacco-related illnesses or conditions under Medicaid, Medicare or any other federal health care programs. In return, however, the settlement would provide for little or no recovery by the federal government of its future costs under Medicare, Medicaid, and other federal health care programs. These federal costs are several times as large as those that will be incurred by the states.

The goal of reducing youth smoking should not be sacrificed to achieve other objectives. But if in the course of developing tobacco-related legislation, Congress gives up the federal government's right to recover its costs from tobacco manufacturers in court, it is essential that the federal government be compensated for the costs it will incur. Federal health care program spending, particularly in Medicare, will drive an increasing share of the federal budget over the next several decades and is the single largest reason the Congressional Budget Office forecasts that budget deficits will return after 2015. The cost of treating tobacco-related illnesses will be a portion of that spending.

Even if national legislation does not preclude the federal government from bringing suit, pursuing litigation that drags on for many years would be an inefficient way of recovering at least partial compensation for the large tobacco-related bills the federal government will have to pay in coming years and decades. Such compensation should include recovery by the federal government of its pro rata share of tobacco industry payments made to cover the tobacco-related costs incurred by the Medicaid program, whether these payments occur through a national settlement or through individual state settlements. States argue these funds belong exclusively to them because they initiated the litigation. As a previous Center paper explains, these claims are dubious for two reasons. First, since 1967, federal Medicaid law has provided that the federal and state governments must share in any amounts recovered by states from liable third parties — such as cigarette manufacturers — for the costs of covering provided services to Medicaid beneficiaries. Second, contrary to popular impression, the federal government did share in the risk that states incurred in bringing these lawsuits; the federal government is obligated to share on a 50-50 basis in all state costs involved in pursuing recovery of Medicaid costs from third parties, including costs of litigation. Had states pursued litigation and lost, the federal government would have been liable for half of the state costs incurred to the extent that states' claims for recovery were based on Medicaid expenditures for treating tobacco-related illnesses.(10)

Tobacco Provisions in the Administration's Budget

The Administration's fiscal year 1999 budget assumes enactment of comprehensive national tobacco legislation to reduce youth smoking. The Administration has not sent a specific proposal to Congress; it assumes that legislation will result from "extensive bipartisan negotiations." The Administration's budget assumes the legislation will yield receipts totaling $65.5 billion over the five-year period from 1999 through 2003, an amount the Administration describes as "consistent" with an increase in the price of a pack of cigarettes of up to $1.50 in constant dollars over the next 10 years. The budget proposes that the receipts take the form of "annual lump sum payments" by tobacco manufacturers.

The Administration proposes to spend these receipts over the next five years for three principal purposes:

  • $27.5 billion for programs operated by the federal government, including National Institutes of Health medical research, Food and Drug Administration enforcement activities, and smoking prevention efforts by the Centers for Disease Control.
  • $15.7 billion for programs operated by states, including a block grant for child care development, a grant to reduce the size of school classes, and matching funds for outreach efforts to enroll uninsured low-income children in Medicaid;
  • $22.3 billion for other uses, probably primarily unrestricted funds for states but also including assistance for tobacco farmers and smoking cessation programs.

The Administration's budget documents leave unspecified the method for collecting the annual lump sum payments from the industry, the precise amounts in unrestricted funds for the states, the distribution of those unrestricted funds among the states, and the amount and use of these receipts after the fifth year. There does not appear to be a relationship between the $65.5 billion in receipts assumed by the Administration from the legislation and the amount of costs the federal government will incur for the foreseeable future in paying tobacco-related health care costs under the Medicare, VA, and other federal health care programs.

The lack of detail makes it difficult to compare the Administration's budget proposals with the national settlement proposed by the state Attorneys General and the tobacco manufacturers. It appears, however, that under the Administration's budget, the states would receive somewhat less than $22.3 billion in unrestricted payments over the next five years (since the $22.3 billion would cover assistance to tobacco farmers and possibly smoking cessation programs along with unrestricted payments to states). By comparison, under the proposed settlement, the states would receive a "face amount" of $33.5 billion in unrestricted payments over the same period. On the other hand, the Administration's proposal also would provide states $15.7 billion not specifically envisioned in the proposed settlement, $14.8 billion of which would come in the form of block grants for child care and funds for hiring teachers and reducing class size.

To be sure, the Medicaid statute could be amended to enable the states to keep some or all of the federal share of the Medicaid recoveries. That, however, would produce an anomalous result — the federal government would continue to pay its share of all Medicaid costs of treating tobacco-related illnesses, while the states would keep all of the yearly tobacco company settlement payments intended to offset those costs.

These issues are explored in more detail in another paper, "Would the Proposed National Tobacco Settlement Compensate the Federal Government Adequately for Tobacco-Related Health Care Costs?", available upon request from the Center on Budget and Policy Priorities or on the Center's website at

End Notes

1. Proposed Resolution, June 20,1997,

2. 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.

3. CBO, Economic and Budget Outlook for Fiscal Years 1999-2008: A Preliminary Report, January 7, 1998, Table 2.

4. National Center on Addiction and Substance Abuse, Columbia University, Substance Abuse and Federal Entitlement Programs, February 1995. This study estimates that substance abuse accounts for $31.9 billion of 1995 Medicare expenditures, and that 80 percent of that amount is due to tobacco-related illnesses. On page 7, the study notes that total entitlement spending in 1995 equaled $834.7 billion, and Medicare accounted for 21 percent of that spending. These figures indicate that an estimated 14 percent of Medicare spending in 1995 was attributable to tobacco-related illnesses. Although this particular calculation was not made in the text of the report, this figure, derived directly from the report, will be referred to in this paper as the Columbia University estimate.

5. The $68.5 billion total includes the $10 billion "up front" payment. See Table 1, Proposed National Settlement Distribution, at page 34. The figures in this Table represent the "face amount" of the tobacco industry's annual payments. These "face amounts" are subject to adjustment each year for inflation, for increases or decreases in the volume of domestic tobacco product unit sales volume, and for increases in the net operating profits of manufacturers from domestic sales. Staff of the Federal Trade Commission estimate that these adjustments, along with other factors, will produce actual payments in amounts significantly lower than the "face value" amounts. FTC Staff, Competition and the Financial Impact of the Proposed Tobacco Industry Settlement, September, 1997, pp. 21-33.

6. The $30.5 billion "face amount" figure is not adjusted for inflation, sales, or profits, as required under the settlement. In contrast, the projected Medicare and Medicaid expenditures on which the $233 billion is based are adjusted for inflation. Because the payments actually received by the federal government are likely to be less than the $30.5 billion after adjustments are made, this comparison most likely understates the extent by which federal tobacco-related health care costs under Medicare and Medicaid will exceed federal compensation under the proposed settlement over the next five years.

7. CBO estimates that federal Medicare outlays will total $1,326 billion over the five-year period from fiscal year 1999 through fiscal year 2003. CBO, The Economic and Budget Outlook: Fiscal Years 1999-2008: A Preliminary Report, January 7, 1998, Table 2.

8. Gary Black, a tobacco analyst at Sanford C. Bernstein & Co., quoted in Michael Phillips and Suein Hwang, "Why Tobacco Pact Won't Hurt Industry: Cigarette Makers Can Easily Raise Prices to Cover Payouts," Wall Street Journal, September 12, 1997, p. A2.

9. This amount includes $7 billion of the $10 billion "up front" payment due from the industry upon the signing of national legislation implementing the settlement.

10.  Andy Schneider and Sara Thom, The Tobacco Settlements: Do All of the Medicaid Recoveries Belong to the States?, Center on Budget and Policy Priorities, Revised December 11, 1997.