Smokers Help to Balance State Budgets

Some states punish smokers for their vice, shooing them out of workplaces and public buildings to puff. But states increasingly are relying on smokers to help balance state budgets.

As budget-writing season heats up in state legislatures, cash-strapped states once again are turning to tobacco to fill budget gaps either by tapping their tobacco settlement funds or hiking cigarette taxes. New cigarette taxes are proposed in states like New Jersey and Rhode Island, which already charge the highest tax rates of $2.05 and $1.71 a pack, and even in Southern states like Kentucky and Virginia that grow tobacco.

Relying on tobacco to help fix budget ills has been a welcome remedy, but unfortunately for states, it won’t last. Kicking the smoking habit may be good for people’s health and states’ long-term health care costs, but it’s bad for state revenues in the short run.

The 1998 tobacco settlement involving four major tobacco companies was a windfall for states. In exchange for agreeing not to sue cigarette manufacturers, states so far have reaped $37.5 billion in payments since 2000, according to the National Governors Association. Many expected states to use the money for anti-smoking and health care programs.

But last year 31 states dipped into their tobacco settlement fundsnot to address smoking– but to help balance the books for fiscal 2004, said Lee Dixon, vice president of Health Policy Tracking Service, a web-based organization that is affiliated with the National Conference of State Legislatures.

That’s more than double the 15 states that spent tobacco settlement money to fill budget gaps in the previous year. It’s too early to tell how many states will turn to their tobacco fund to bail them out for fiscal 2005.

The settlement, which led 46 states to drop a massive lawsuit against cigarette companies in exchange for sharing $206 billion over 25 years, did not require that the money be spent on anti-smoking or health care programs. (Florida, Minnesota, Mississippi and Texas aren’t part of the tobacco settlement and negotiated their own deals with cigarette manufacturers worth $40 billion.)

Contrary to expectations, only a handful of states spent all of their tobacco money for health purposes last year, including Arizona, Mississippi, South Carolina and Wyoming, according to Dixon’s Health Policy Tracking Service.

Only six states earned “A” grades from the American Lung Association in its 2004 report card for their anti-smoking programs: Arizona, Arkansas, Delaware, Hawaii, Maine and Mississippi.

But states cannot count on the tobacco settlement money to bail them out for too long.

Some states already have cashed in a big chunk of their share of the settlement, selling future tobacco payments to investors for an upfront lump-sum payment, known as securitization. California, Connecticut, New Jersey, New York, Oregon, Rhode Island, Washington and Wisconsin all have gone this route. Securitization is akin to someone winning the lottery and opting for an upfront lump sum rather than the amount spread over 25 years.

In addition, the tobacco money pot is shrinking and will continue to shrink — because fewer people are smoking. The fewer people who smoke, the less states get because their yearly allotment from the settlement fund is based on how many cigarettes are sold in the state by the tobacco companies that signed the agreement. Nationwide, the number of smokers has dropped dramatically: about 13 percent of American adults smoke, down from about half of the adult population 40 years ago.

States’ allotments also will go down as smokers turn to cigarettes from off-brand manufacturers and online retailers that don’t pay into the settlement fund, said Melissa Taylor Bell, associate director of research for The Council of State Governments in Lexington, Ky.

The result is that tobacco payments over the next nine years could be as much as $14 billion short of what states had been counting on, the CSG estimates. “The tobacco settlement may not be the financial windfall that states were expecting,” Bell said.

With tobacco settlement funds tapped out or dwindling, some states are looking for budget relief from another source of tobacco income: cigarette taxes. Raising tobacco taxes is seen as a politically safe and easy way to increase revenue without incurring the wrath of anti-tax voters, Dixon said.

Fifteen states hiked their cigarette taxes last year, according to report from the NGA and the National Association of State Budget Officers. More than a dozen are looking at jacking up cigarette taxes to balance their budgets for the coming fiscal year.

The waning political influence of tobacco is evident not only in the number of statesbut the location of states–considering higher cigarette taxes. Even tobacco-growing states in the South with the lowest taxes on cigarettes now are looking at higher rates: Kentucky, which charges 3 cents a pack, South Carolina at 7 cents, and Virginia at 2.5 cents. Smokers there could pay up to 60 cents a pack more in taxes under various proposals pending in those three statehouses.

“The tobacco industry has a lot less influence in Virginia” and other states than it did 20 years ago, said Scott Pattison, a former Virginia budget director and now NASBO’s executive director.

New Jersey and Rhode Island, which boosted their cigarette taxes last year and now charge more than other states, are eyeing yet another increase. New Jersey Gov. Jim McGreevey (D) last week proposed a cigarette tax increase of 45 cents, which would raise the per-pack tax rate to $2.50, and Rhode Island Gov. Don Carcieri (R) proposed a 75-cent tax hike up to $2.46 a pack.

Relying on higher cigarette taxes, however, is hardly a long-term fix. Studies have shown that raising cigarette taxes often causes people to stop smoking, which is good for public health. But that means states will have to turn elsewhere for a reliable source of dollars. “It’s probably not a good revenue source, three or four years down the road,” Dixon said.