Burning the Tobacco Windfall

California has spent hundreds of millions of dollars to persuade people to quit smoking. But now, scrambling to solve its budget shortfall, the state has developed an unexpected habit: It’s suddenly hooked on tobacco money.

Through proposals to raise the per-pack tax and to cash out the state’s share of the 1998 national tobacco litigation settlement, cigarettes are an important part of the strategy to fill the state’s nearly $24-billion projected shortfall.

Although the Davis administration and legislative leaders say the proposals are not a retreat from California’s decades-long effort to curb tobacco use, the plans have nonetheless drawn criticism along those lines from public health advocates. Budget analysts worry that the fiscal approach is misguided as well.

“It is certainly more than ironic,” said Dick Daynard, a law professor at Northeastern University in Boston and a tobacco litigation expert, “that you’re relying on money from smokers to balance the budget.”

In the $99-billion spending plan stalled in the state Assembly, Gov. Gray Davis and the Democratic-controlled Legislature would raise taxes on cigarettes by $650 million a year, cut the state’s anti-tobacco program by $46 million and, most significantly, cash out the massive tobacco litigation settlement for a one-time fix.

Rather than take the $12.5-billion settlement in installments, state leaders want to sell it to investors at a discount for a lump sum of $4.5 billion--a one-time fix that would help plug this year’s shortfall but at the cost of $8 billion over time.

Taken together, money flowing directly and indirectly from tobacco sales would erase more than one-fifth of this year’s shortfall.

California has aggressively fought tobacco use in recent years, paying for graphic anti-smoking ads and limiting the places where smoking is legal. Thanks in part to these efforts, California has the second-lowest smoking rate of any state, at 17.4%, meaning there is little political opposition to the budget proposal--at least the portion that would raise cigarette taxes.

But no money from either the tax increase or the one-time infusion of tobacco settlement money would be spent specifically to combat tobacco use.

On that point, anti-smoking activists and Big Tobacco agree.

“Clearly,” said Thomas M. Ryan, spokesman for Philip Morris U.S.A., “the state has become more reliant on the sale of tobacco products in order to balance the budget. I do believe it is ironic that the state, while trying to balance the budget ... is taking money away from tobacco control activities.”

Davis proposes to spend $88.3 million on California’s tobacco control program. That’s $46 million less than last year, partly because smoking has declined. The governor also is cutting by half the most public face of the anti-tobacco program--the high-profile anti-smoking advertising campaign that often derides tobacco companies as it seeks to discourage tobacco use .

“It is terrible,” Assemblyman Keith Richman (R-Northridge), the Legislature’s only physician, said of the spending cuts. “Money spent on tobacco prevention is well spent.”

Administration officials insist that Davis is not retreating from his anti-tobacco stand. He had no choice but to cut some of the spending given the state’s financial straits, said Press Secretary Steven Maviglio. And the rising tobacco tax will be a powerful disincentive to smoke, particularly among teenagers, who are most sensitive to price increases, he said.

California would continue to have the richest anti-tobacco program of any state because of a tax of 25 additional cents per pack imposed on cigarettes in 1988 when voters approved Proposition 99. The cigarette tax would rise 63 cents more per pack under the proposed budget, to a total of $1.50.

“If this is a question of funding more billboards and public service announcements, or making sure kids get health care this year, there is no argument,” Maviglio said. With the budget for the 2002-03 fiscal year stalled in the Assembly, the state cannot sell the bonds secured by the tobacco settlement. But once the bonds are marketed, California will count on Wall Street to conclude that bonds secured by tobacco settlement payments will be a solid long-term investment.

The strength of that investment will depend in part on people continuing to smoke. In a prospectus for one state, Wisconsin, that is already selling tobacco bonds, investors are warned that a “decline in cigarette consumption materially beyond forecasted levels may adversely affect payments” to repay the bonds.

California Department of Finance experts say the tobacco industry would be able to make the bond payments even if companies responsible for one-fourth of all tobacco sales were to go bankrupt. If tobacco companies were unable to make their full annual payments, the life of the bonds would be extended.

“Everybody would have to stop smoking” in order for investors to lose their money, said the department’s James E. Tilton.

The $4.5-billion lump-sum payment would be the largest single block of cash used to fill California’s budget shortfall. The money would go into the general fund, to be used for programs ranging from parks and education to health care. After the money was spent this year, the annual settlement payments would be used to repay the bonds for at least 23 years.

Some budget experts worry about the plan to use a one-time windfall to pay for costs that continue year after year.

“It’s the difference between taking out a mortgage to buy a house [and] using a loan to buy groceries,” said Jean Ross of the California Budget Project, a nonprofit group that has suggested more tax increases, particularly on high-income earners, as a solution. “Most people would agree that if you have other options available, you don’t borrow to pay for ongoing operation costs.”

The decision marks a turnaround from 1998, when states negotiated the $206-billion settlement with the tobacco giants. Many lawyers and health-care advocates involved in the cases predicted that states would use the money for great public good.

Davis played a key part in California’s litigation. Trial lawyers, among his political allies, suggested in 1996 that then-Lt. Gov. Davis join the plaintiffs’ suit against tobacco companies. At the time, Republican state Atty. Gen. Dan Lungren, who later became Davis’ 1998 campaign opponent, balked at joining other states in the nationwide action.

Davis added his name to the lawsuit in 1997, saying he was acting on behalf of all Californians. At a news conference announcing his action, he said: “The lawsuit I’m announcing today will force [tobacco companies] hopefully to pay for the medical costs necessary to treat tobacco-related injuries.”

American Lung Assn. lobbyist Paul Knepprath recalled that media event: “We stood alongside Mr. Davis when he filed his suit. We fully expected that if there was a settlement, any dollars would be directed toward tobacco control.”

State Sen. Joe Dunn (D-Santa Ana), among the lawyers who helped sue the industry before he won his Senate seat in 1998, pushed to set up a special tobacco settlement fund for health care within the budget. He succeeded last year when the $474-million settlement payment was spent on health-care programs for low-income families and indigents, with $20 million earmarked for youth smoking prevention. That $20-million appropriation is being eliminated this year.

Dunn, like other Senate Democrats, voted for the spending plan that includes the proposal to cash out the tobacco settlement fund. The size of the shortfall left legislators with little choice, he said. He called the decision extremely disappointing.

While the state is cashing out its settlement, said Susan Kennedy, Cabinet secretary to Davis, revenue from the tax increase on cigarettes will be used “dollar for dollar” to pay for health-care programs previously funded by the settlement.

Davis’ plan would push California’s cigarette tax to among the highest in the nation. The increase would raise about $650 million a year, bringing the state’s annual revenue from cigarette taxes to nearly $1.8 billion in a $99-billion budget.

Perhaps in future years, some of the extra tax would be spent on tobacco control, Kennedy said. But now, the state faces an emergency situation.

California’s overall tobacco control budget of $88.3 million would be down from about $134 million last year. Money earmarked for anti-tobacco ads would be cut to $21 million, down from $45 million last year. Researchers have called the ad campaign a main reason for the decline in smoking since the program began in 1989. It’s a program that the tobacco industry has long tried to blunt.