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The Proposed Tobacco Settlement: Issues from a Federal Perspective April 1998

The federal government has long considered smoking to be an important public health issue. As early as 1967, the Surgeon General identified smoking as the leading preventable cause of disease and premature death in the United States.⁽¹⁾ According to public health agencies, over 85 percent of lung cancers and 30 percent of deaths from all types of cancer are associated with smoking. Smoking is also responsible for almost 20 percent of deaths resulting from cardiovascular disease.⁽²⁾
 

Trends in Cigarette Consumption by Adults and Teenagers

Because of the adverse health effects of cigarette smoking, public health agencies monitor trends in cigarette consumption closely. Adults (people age 18 and older) constitute over 90 percent of smokers in this country; however, much public concern focuses on underage smokers because most adult smokers begin smoking in their teens.⁽³⁾

Smoking by Adults

Adult cigarette consumption was highest during the 1960s when, averaged over all adults, consumption reached more than 4,200 cigarettes per person annually (see Figure 1). Perhaps in response to reports from the Surgeon General and changing attitudes about smoking more generally, per capita cigarette consumption began to taper off in the 1970s (notwithstanding a sizable reduction in the inflation-adjusted price of cigarettes). Between 1980 and 1993, that downward trend accelerated, with consumption falling by about 3 percent a year. Price increases during that period probably contributed to the decline, as the inflation-adjusted price of cigarettes increased by 80 percent.
 

FIGURE 1. TRENDS IN PER CAPITA ADULT CIGARETTE CONSUMPTION AND CIGARETTE PRICES, 1945-1997

SOURCE:Congressional Budget Office using data from the Bureau of Labor Statistics and the Economic Research Service of the Department of Agriculture.

Between 1994 and 1996, the drop in per capita consumption slowed, with only slight declines from the 1993 level in each of those years. That recent slow-down may have been attributable in part to price cuts in the early 1990s. Heightened competition between name-brand and generic cigarettes contributed to those price reductions.

Between 1996 and 1997, cigarette consumption resumed its earlier downward trend, falling by over 3 percent. The decline coincided with a return to larger price increases, as the inflation-adjusted price of cigarettes rose by 2.3 percent.

Other measures illustrate a similar pattern of long-term decline in the use of tobacco. Between 1965 and 1990, the percentage of adults in the United States who smoke fell from about 42 percent to 25.5 percent (see Table 1). Since then, smoking rates have hovered around 25 percent--representing nearly 50 million smokers.
 

The prevalence of smoking today is quite constant across various age groups of adults, with between 25 percent and 30 percent of people ages 18 to 64 being smokers. Only among those age 65 and older is the prevalence of smoking lower--at about 13 percent.

Smoking by Teenagers

Teenage smokers account for only 2 percent of all cigarettes consumed in the United States. Nonetheless, their smoking generates much concern since many public health officials believe that people who do not start smoking as teens are much less likely to pick up the habit as adults.

After a nearly 20-year decline, it may be that smoking by people under age 18 (termed "teenagers" in this analysis) has, in recent years, begun to rise. Researchers at the University of Michigan have tracked trends in teenage smoking using three different measures: smoking one or more cigarettes in the past month, smoking an average of one or more cigarettes per day in the past month, and smoking an average of 10 or more cigarettes per day in the past month. Using any of those measures, cigarette consumption by high school seniors began rising after 1992, following fairly steady declines between the late 1970s and early 1990s (see Figure 2). For example, the percentage of seniors who smoke an average of one or more cigarettes per day fell from 29 percent in 1976 to about 17 percent in 1992 and then rose to 22 percent in 1996.
 

FIGURE 2. LONG-TERM TRENDS IN SMOKING FOR HIGH SCHOOL SENIORS, 1975-1996

SOURCE: Congressional Budget Office using data from the Monitoring the Future Study (Ann Arbor: University of Michigan, 1996).

The Cost of Smoking-Related Illnesses

Many studies have examined the medical and other costs associated with smoking, but no firm conclusion has emerged about the net cost of smoking to society or to the federal government. Smoking probably increases the net costs of some federal programs, but it decreases the costs of others.

Smoking-related illnesses lead to increases in spending for federal health care programs, including Medicare, Medicaid, and veterans' health care. To the extent that an illness first occurs during a smoker's working years, smoking-related illnesses also contribute to increased outlays in Social Security's Disability Insurance program. The higher incidence of disability among smokers along with their shorter life spans relative to nonsmokers also reduces smokers' payments of payroll taxes.

Because of shorter life spans, however, the average smoker receives Medicare and Social Security retirement benefits for fewer years than does the average nonsmoker. In addition, smokers pay federal and state excise taxes on cigarettes. In 1997, the federal tax was 24 cents per pack and generated $6 billion in revenue. That same year, state excise taxes averaged 35 cents per pack and brought in about $8 billion in revenue.

Two methods typically used by researchers to estimate the costs of smoking are the prevalence-based method and the life-cycle method. The prevalence-based method estimates the costs of smoking that are incurred over a specific period (usually a year) by calculating the average difference in costs between smokers and nonsmokers in a given population. The life-cycle method makes a similar comparison over the lifetimes of smokers and nonsmokers.

In general, the two methods reach different conclusions about the net costs of smoking because smokers, on average, have shorter life spans than nonsmokers. By comparing the costs of only living smokers and nonsmokers, the prevalence-based method does not include either the avoided costs or lost tax revenue from smokers in years in which they are no longer alive. In contrast, the life-cycle method accounts for the shorter life spans of smokers relative to nonsmokers.

Prevalence-Based Estimates

Plaintiffs in the state suits against tobacco manufacturers used the prevalence-based method to estimate the costs of smoking for Medicaid and other state-funded health care programs. They estimated that the total cost of smoking for Medicaid was about $13 billion in 1993.⁽⁴⁾ The federal share of that cost would be about $7 billion per year.

According to another study, the federal cost of smoking in 1993 also included about $10 billion for Medicare and $5 billion for other federal health care programs such as veterans' health care.⁽⁵⁾ Some prevalence-based studies also estimate the indirect costs, such as lost wages, from smoking-related morbidity and mortality, but those costs do not directly affect the federal budget.

A recent report by the Treasury Department estimates that the net medical costs of smoking total about $45 billion a year.⁽⁶⁾ Those costs include federal, state, and private expenditures.

Life-Cycle Estimates

Studies that use the life-cycle method are more varied than prevalence-based studies in their conclusions. Two major analyses found that the total medical costs of smokers over their lifetimes were from 18 percent to about 28 percent higher than the lifetime medical costs of nonsmokers.⁽⁷⁾ Those estimates suggest that despite their shorter life spans, smokers impose greater costs on federal health care programs than do nonsmokers.

Yet other studies have concluded the opposite---that nonsmokers have higher lifetime medical costs. However, their results may not be reliable, in part because they used data from other countries that may have patterns of smoking or health care systems that are different from those in the United States (see the appendix for further discussion).

A life-cycle study by Manning and others estimated the health care and other costs of smokers. One estimate grouped together private and public pension benefits, Social Security payments, veterans' compensation, and other public payments. The study concluded that over their lifetimes, smokers received about 9 percent less of such income than did nonsmokers. The Manning team's study also looked at how much smokers and nonsmokers paid in earnings-related taxes. It found that smokers paid about 2 percent less in those taxes than did nonsmokers as a result of their shorter life spans and higher incidence of disability.

When the excess medical costs of smokers were taken into account, Manning found that the net costs of smoking that were not paid directly by smokers or their families were equivalent to 33 cents per pack of cigarettes (in 1995 dollars). That cost is well below the combined federal and average state excise taxes of about 56 cents per pack. But those who are paying extra costs because of smoking-related illnesses are not necessarily being fully compensated for the costs. For example, although smoking reduces the costs of some benefits such as pensions, the benefit plans that receive such savings generally do not also pay the additional costs that result from smoking. Similarly, the revenue from excise taxes on cigarettes is not directly distributed to entities, such as private health plans, that incur the greatest additional costs of smoking.
 

The Regulatory Context of the Settlement

To reduce the impact of smoking in the United States, both the state and federal governments have attempted to regulate the production, sale, and consumption of tobacco products. In many ways, the states have taken the lead in those actions. All states, for instance, have passed laws banning the sale of cigarettes to young people, and many states restrict or prohibit smoking at work sites.

More recently, tobacco products themselves have become the subject of increasing federal regulation. In 1995, the Food and Drug Administration began efforts to regulate nicotine as a drug and tobacco products as drug delivery devices. The agency used evidence of the pharmacological effects of nicotine on the body and manufacturers' control of the level of nicotine in cigarettes as proof that nicotine fit its definition of a drug. According to the FDA, a drug is a substance (other than food) intended to affect the structure or function of the body. The agency claims that manufacturers intend cigarettes to have a calculated physical effect on smokers through the use and control of nicotine levels.

In August 1996, the FDA finalized a series of regulations that would limit promotional activities by the tobacco industry and impose additional labeling requirements and access restrictions on its products. Those regulations were based on the FDA's authority over medical devices. If it had applied its drug authority, manufacturers would have had to remove cigarettes from the market unless they could demonstrate their product's safety and efficacy.

The tobacco industry sued the FDA, but in April 1997, a U.S. District Court ruled that the agency could define nicotine as a drug and tobacco products as drug delivery devices. However, the court further ruled that the FDA could not regulate the advertising and promotion of tobacco products. The FDA's proposed restrictions on the sale and labeling of tobacco products were upheld. Both the FDA and the tobacco industry have appealed the court's decisions.
 

State and Private Lawsuits

Apart from its regulatory battles, the tobacco industry has also had to face increased legal challenges on other fronts. Until recently, tobacco companies had never paid damages to any plaintiff in a lawsuit. Tobacco companies have successfully claimed that the alleged harmful effects and addictive nature of tobacco have never been proven.⁽⁸⁾ Moreover, the 1965 Federal Cigarette Labeling and Advertising Act, which requires warning labels on all cigarette packages, has actually aided the tobacco companies in their defense. Because the federal government required those labels, tobacco companies have invoked an "assumption of risk" defense, arguing that consumers have been adequately warned of any risks that may be associated with smoking. As long as the companies comply with the law, they maintain that no additional information regarding the safety of their products need be supplied. That defense so far has been effective in defeating plaintiffs' claims based on a "failure to warn"--that is, that they were not adequately warned of the dangers of cigarette smoking.

However, the changing nature of the cases brought against the tobacco industry and the uncovering of new evidence suggest that the outcome of future lawsuits may be less certain. Although individual and class action suits against tobacco companies based on a "failure to warn" have been preempted by the law requiring warning labels, the Supreme Court ruled in 1992 that that law would not preempt suits based on a "duty to disclose." Therefore, a plaintiff can bring an action against a tobacco company for failing to test or research its products adequately or for failing to divulge test results.⁽⁹⁾

That ruling helped to create an opening for state governments to sue tobacco companies to recover costs associated with the treatment of tobacco-related illnesses. States have argued that tobacco companies have conspired to suppress research, manipulated nicotine levels in their products, and targeted sales toward minors. Not only are those lawsuits allowable under the Supreme Court's ruling but states have an advantage over individual litigants because they are not hampered by "assumption of risk" defenses. (Because the state governments never chose to consume tobacco products, the companies cannot claim that they, through a deliberate and informed choice, assumed the financial risks involved with using tobacco products.) Although the approaches of the states that have filed lawsuits vary, the legal advantages noted above have allowed them to argue that they should be compensated for Medicaid and other spending on the cigarette-related illnesses of their residents.
 

The Proposed Settlement

With those events as backdrop, representatives of the tobacco industry and a number of state attorneys general reached an agreement in June 1997 that could dramatically change the landscape of tobacco production, marketing, sales, and consumption in the United States. Provisions of the settlement would affect tobacco manufacturers, sellers of tobacco products, consumers, states, federal agencies, and other entities.

Under the settlement, tobacco manufacturers would face restrictions on advertising and promotion of tobacco products and would be subject to FDA regulation of their products. Cigarette retailers would have to be licensed, would be allowed to sell only to adults, and would be subject to rules about where they placed tobacco products in their outlets. Employers, fast-food restaurants, and some other establishments would have to create smoke-free environments. The right of consumers to sue tobacco companies for past damages would be substantially limited.

Tobacco manufacturers would be assessed annual payments based on total domestic sales for as long as they sold tobacco products in the United States. If sales remained at current levels, those fees would total $368.5 billion (in 1998 dollars) over the next 25 years; annual payments would rise during the first few years until they reached $15 billion per year, where they would remain (see Table 2). If total consumption fell in future years, the payment due in each year would be reduced proportionately. The manufacturers would be at risk for additional payments--up to $2 billion per year--if the prevalence of daily smoking among teenagers did not decline by the amounts specified in the settlement.
 

The payments obtained from the manufacturers would be distributed for a variety of purposes. Of the reported $368.5 billion in payments scheduled over 25 years:

• About $193 billion would be distributed among all 50 states as compensation for past and future tobacco-related costs;
  
  
• About $77 billion would be used by the tobacco industry to pay for judgments and settlements it would make related to private suits that would continue under the settlement;
  
  
• $73 billion would pay for smoking cessation programs, state and local enforcement of laws restricting access to tobacco, antitobacco media campaigns, and other smoking prevention programs; and
  
  
• $25 billion would finance a trust fund to carry out tobacco-related medical research.

The federal government would receive the $25 billion in research funds. It would also control the use of the $73 billion in public health-related funding, presumably passing most of the money along to the states for enforcement, prevention, and cessation programs.

1. Office of the Surgeon General, The Health Consequences of Smoking (1967). The first Surgeon General's report linking smoking with lung cancer and other diseases appeared in 1964.

2. See Office of Technology Assessment, Smoking-Related Deaths and Financial Costs: Estimates for 1990 (1993); Office of the Surgeon General, Reducing the Health Consequences of Smoking: 25 Years of Progress (1989), and The Health Consequences of Smoking: Cancer (1982); American Cancer Society, Cancer Facts and Figures, 1993 (New York: ACS, 1993); and Carl E. Bartecchi and others, "The Human Costs of Tobacco Use (First of two parts)," New England Journal of Medicine, vol. 330, no. 13 (1994), p. 910.

3. Office of the Surgeon General, Preventing Tobacco Use Among Young People (1994).

4. Leonard S. Miller and others, "State Estimates of Medicaid Expenditures Attributable to Cigarettes Smoking, Fiscal Year 1993," Public Health Reports, vol. 113 (March/April 1998).

5. Centers for Disease Control and Prevention, "Medical-Care Expenditures Attributable to Cigarette Smoking--United States, 1993," Morbidity and Mortality Weekly Report, vol. 43, no. 26 (1994).

6. Department of the Treasury The Economic Costs of Smoking in the United States and the Benefits of Comprehensive Tobacco Legislation (March 1998).

7. Willard G. Manning and others, The Costs of Poor Health Habits (Cambridge, Mass.: Harvard University Press, 1991); and Thomas A. Hodgson, "Cigarette Smoking and Lifetime Medical Expenditures," Milbank Quarterly, vol. 70, no. 1 (1992).

8. Mark Hansen, "Capitol Offensives," American Bar Association Journal (January 1997).

9. K. E. Meade, "Breaking Through the Tobacco Industry's Smokescreen: State Lawsuits for Reimbursement of Medical Expenses," Journal of Legal Medicine, vol. 17 (1996).

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