Tobacco Taxes Expected to Cut Smoking, Hurt State Finances

Sharply rising tobacco taxes may accomplish what state lawmakers largely failed to do when handed a pile of money from the nationwide tobacco settlement a decade ago: cut smoking rates.

Bloomberg News reported Feb. 19 that the new 62-cent increase in the federal tobacco tax, combined with rising state tobacco taxes, could cut U.S. tobacco consumption by up to 10 percent.

States, however, may not be celebrating. Many took the money from the 1998 tobacco settlement and used it for everything but tobacco prevention. But declining tobacco consumption could reduce the industry’s annual payout to the states by up to $500 million, and also poses a threat to the $37 billion in bonds that states issued based on expected future receipts of tobacco money. The bonds were issued so that states could get an upfront, lump-sum payout of the settlement money rather than waiting for each year’s payments, which are based on sales.

“While settlement revenues may be shrinking, most tobacco bond structures have debt service requirements with built-in increases for future years,” said Richard Larkin, an analyst at municipal-bonds firm Herbert J. Sims and Co. Some state bond issues might have to use their reserves to pay the interest on the bonds, he added.

“States that earmarked revenues from cigarette excise taxes for specific programs may be forced to make cuts to those programs or increase the cigarette excise taxes, to make up for the revenue shortfall caused by the volume decline resulting from the federal excise tax increase,” noted a recent report from Fitch Ratings.

“The striking irony of the [tobacco settlement] was that it made states dependent on the sale of a deadly product that dramatically increases their health-care costs,” said Allan M. Brandt, dean of the Graduate School of Arts and Sciences at Harvard University.