Jacob Sullum

Colorado Treasurer Mark Hillman calls the deal under which the top cigarette manufacturers pay the states billions of dollars a year "a protection racket." In truth, it's worse than that.

The so-called Master Settlement Agreement (MSA), which resolved state lawsuits against the largest tobacco companies, is not a classic extortion scheme in which a business pays to be left alone. Instead Philip Morris et al. are paying for protection against their competitors, and they are passing the cost on to their customers, the very people whose victimization by Big Tobacco supposedly justified the lawsuits in the first place.

A decade ago, states started suing cigarette makers, demanding compensation for the cost of treating smoking-related illnesses under Medicaid. They accused the tobacco companies of tricking people into smoking by denying its health hazards and keeping them hooked with carefully calibrated doses of nicotine.

In 1998, to avoid potentially ruinous liability, the industry's main players agreed to payments totaling more than $200 billion during the first 25 years of the deal. But there was a problem: If the participating companies raised their prices to cover the payments, what would stop existing or new cigarette makers that had not signed the MSA from underselling the big manufacturers and whittling away at their market share?

The answer was a government-sponsored cartel that forces nonparticipating companies to make payments into an escrow account based on their sales, ostensibly to cover their future liability. Under this arrangement (which has been challenged in federal court), cigarette makers that have been nothing but honest with the public pay a penalty so the sleazy, sneaky companies the states sued don't have to.

If that seems unfair, recall that the whole scheme is aimed at forcing those tricked and trapped (and relatively poor) smokers to bear the entire burden of the settlement payments. And then some: Cigarette prices rose by $1.10 a pack during the first two years of the MSA, more than twice the cost of the settlement payments.

Now the states and the big tobacco companies are engaged in an unseemly spat over this unseemly deal. In a bid that recently gained support from an arbitrator, the companies are trying to reduce their annual payments by some $1.2 billion, arguing that the states have not enforced the cartel with sufficient enthusiasm.

The MSA participants' collective market share fell from 99.6 percent in 1997, the year before the deal, to 92 percent in 2003. Even hobbled by the MSA's financial penalties, small manufacturers such as the Virginia-based S&M Brands, maker of Bailey's cigarettes, have managed to lure away smokers with lower prices.

Jacob Sullum

Jacob Sullum is a senior editor at Reason magazine and a contributing columnist on Townhall.com.
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