Have a cigar

Posted: Feb 17, 2007 12:26 AM
Have a cigar

Nobody has ever accused government of lacking imagination when it comes to raising revenue. And flying under the radar screen for nearly a year has been a pending federal rule change whose effect will be to lighten the wallets of certain smokers.

The Alcohol and Tobacco Tax and Trade Bureau (TTB), part of the U.S. Treasury Department, is likely to redefine "little cigars," an industry term, as cigarettes. Last October 25, the TTB published a proposed rule, "Notice No. 65, Tax Classification of Cigars and Cigarettes," in the Federal Register.

It may seem an arcane distinction. But in fact much is at stake, fiscally and philosophically. And we've got some familiar dubious friends to thank for the confusion.

Last May the Attorneys General (AGs) of 39 states and Guam petitioned the TTB to close what they saw as a regulatory loophole that allowed manufacturers of small cigars to market their product as something other than cigarettes, thus avoiding marketing restrictions and higher taxes. The AGs were angered by the tobacco industry's apparent circumvention of social responsibility.

"The manufacturers of so-called 'little cigars' are deceiving and endangering consumers and our children, and federal rules allow them to get away with it," fumed California Attorney General Bill Lockyer.

The battle still rages, as the TTB has extended the comment period until this March 26. It's another round in the states' continuing battle with Demon Tobacco.

Back in the Nineties, if one remembers, the AGs launched a legal offensive against the tobacco industry. Mississippi Attorney General Mike Moore was the first out of the gate. Closely advised by trial lawyer Richard Scruggs, the State of Mississippi filed suit against major tobacco companies, seeking to force them to reimburse Medicaid expenditures for smokers. Other states soon followed with copycat suits. It seemed like an uphill battle, but some creative rule-making shifted the balance of power.

Juries up until this point consistently had rejected monetary damage claims that smokers were unaware of health risks and that smoking directly causes lung cancer and other illnesses. But in 1994, the Florida legislature passed the Medicaid Third-Party Liability Act, barring defendants, such as tobacco companies, from invoking these defenses in cases of Medicaid reimbursement. It was a legal coup, as its creators later openly admitted.

"I took a little-known statute called the Florida Medicaid recovery statute, changed a few words here and a few words there, which allowed the State of Florida to sue the tobacco companies without ever mentioning the words 'tobacco' or 'cigarettes,'" crowed Florida trial lawyer Fred Levin. "It meant it was almost a slam dunk."

Also around this time, a Mississippi judge ruled that tobacco companies could not introduce evidence alleging Medicaid costs were being offset by cigarette taxes and less-than-average life expectancies of sick smokers.

Tobacco makers eventually smelled an expensive defeat. To cap their losses, they succumbed to a backroom deal formally announced on November 23, 1998. Six manufacturers -- Brown & Williamson, Lorillard, Philip Morris, R.J. Reynolds, Commonwealth, and Liggett & Myers -- signed a consent decree with the Attorneys General of 46 states, the District of Columbia and various U.S. territories, settling all outstanding antitrust, consumer protection, negligence, and relief claims. (Florida, Minnesota, Mississippi and Texas each had coerced separate settlements).

The historic "Master Settlement Agreement" would cost the companies $246 billion over 25 years, a figure not including $13 billion payable to trial lawyers. The attorneys general wanted 20% to 25% of the settlement money to be earmarked for tobacco prevention programs. The agreement prohibited tobacco advertising aimed, intentionally or not, at minors, including via billboards and cartoon characters. Additionally, tobacco companies would be barred from lobbying in eight areas of legislation/regulation.

Yet the affected major firms also were compensated, if in a perverse way. To safeguard their newfound revenue stream, states imposed special taxes, regulations and model statutes upon smaller, "nonparticipating" tobacco companies, in effect creating a cartel.

Tobacco companies, large or small, in the meantime had to be resourceful to stay profitable. Stepping up the marketing of cigarette-like cigars, often coming in Cherry, Vanilla, Peach and other flavors, was one approach. That ingredients of cigars, unlike those of cigarettes, do not have to be reported to the Centers for Disease Control, made this strategy even more attractive. America's youth, once again, were in peril -- thus, the state AGs' petition for a federal rule change.

If the TTB responds favorably, a "cigar" would be defined as a roll of tobacco wrapped in 100% natural tobacco leaf or a substance that contains 75% or more tobacco which retains its original qualities regarding taste and other features. A "cigarette" would be defined as a roll of tobacco wrapped in paper or some substance containing tobacco, but is "likely to be offered to, or purchased by, consumers as a cigarette."

There is some serious money here. Little cigars are taxed at substantially lower rates than cigarettes, the main reason why they cost only about half at the retail counter. In California last year taxes on a carton of "little cigars" totaled $3.77, as opposed to $16.76 on a carton of cigarettes. The U.S. Department of Agriculture's Tobacco Yearbook reports that during 2000-04, taxable removals/sales of cigarettes declined by 13%, while taxable removal/sales of little cigars increased by 51%.

Now let's face it. Cigar purists -- real aficianados who know the difference between an H. Upmann Petit Corona and an Arturo Fuente Churchill Claro -- recoil at the thought of wasting money on cheap machine-made cigars containing HTL (homogenized tobacco leaf). But this is still a free country. I, for one, prefer name-brand breakfast cereals over cheap store-brand knockoffs. Yet in the end it is not for me to dictate other peoples' preferences.

The problem is that state attorneys general don't believe in consumer choice. Combining baneful aspects of populism and Puritanism, they are out to punish tobacco sale and consumption wherever they can. And with each victory, they are emboldened to take further action.

Former tobacco industry lawyer Phil Carlton in 2003 observed, "I thought these plaintiffs with badges would go away after they forced the tobacco industry to pay the largest settlement in the history of jurisprudence." Instead, he said, "the settlement just whetted the AGs appetites."

Indeed it did, and not just with tobacco. The 1998 "settlement" served as a template for lawsuits against banks, insurance companies, utilities, mutual funds and pharmaceutical companies, again with success breeding success. In May 2002, for example, New York Attorney General (now Governor) Eliot Spitzer forced Merrill Lynch into a $100 million consent decree over conflict-of-interest charges. That December he was back, wringing a $1.4 billion "global" consent decree out of 10 investment banks and brokerages, one of which was Merrill Lynch.

The AGs' battle to build a better tomorrow will continue until their corporate targets put more steel in their spine. The Competitive Enterprise Institute, a Washington, D.C.-based free-market think tank, may be pointing the way.

In August 2005, the CEI filed a suit in federal court to overturn the multi-state tobacco settlement of 1998. A U.S. district judge in Louisiana ruled in November 2006 that the action may proceed to trial. The CEI is basing its case on the Constitution's Compact Clause (Article 1, Section 10), which explicitly prohibits states from entering into any agreement or compact with any other state without the prior consent of Congress.

The war against tobacco has a larger context -- a desire to punish undesirable activity. In their self-assigned role of public benefactor, the state attorneys general believe they are positioned, if not to wipe out sin, then to promote overdue social goals. It's a zeal that our Framers had cautioned against.

In the meantime, as Pink Floyd counseled in a much different context more than 30 years ago: "Have a cigar."