Metro Pulse/Insights/Tobacco Settlement Money

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by Joe Sullivan

Even as the state faces a prospective budget deficit of $300 million or more, special pleaders are pressing to pre-empt the use of the one existing source of revenues that could go a long way toward covering the shortfall.

Tobacco settlement payments totaling $362 million will have accumulated in the state treasury by the end of the current fiscal year, and additional payments of about $160 million annually can be projected in the years ahead. But agricultural and health care interests are trying to lay an exclusive claim to these funds that would constrict their use for their state's most pressing priorities, which start with education. Worse yet, there's a misguided move afoot to tie up much of the money in trust funds in ways that would prevent it from being spent at all.

Special committees of the state Legislature, marching to the drum of the Tennessee Farm Bureau, the Tennessee Hospital Association, anti-smoking activists and the like, are recommending all these special-purpose tie-ups. And not even the beleaguered Sundquist administration, which is still seeking to balance its budget with tax increases, wants to hurt its case for them by letting the tobacco settlement money be used to help cure the state's fiscal woes.

The $300 million or more deficit that can be anticipated when the governor submits his budget shortly for the fiscal year beginning July 1 consists of the following guesstimates: $250 million to cover the shell games that the Legislature played last year by way of inflating revenue assumptions and tapping one-time sources of funds in order to artificially balance this year's budget; $100 million at the least to try to bail out the state's sinking TennCare program; $100 million for the second of three installments on Sundquist's pledge to increase funding for higher education; $100 million for 3 percent pay raises for all state employees that become obligatory if faculty salaries are increased as part of the higher ed commitment; $50 million for K—12 education that could balloon into a whole lot more if—or rather when—the courts require equalization of teacher pay throughout the state. Projected revenue growth would cover about half of that $600 million total, but such growth assumptions are becoming increasingly tenuous as the economic slowdown worsens.

This columnist remains an ardent supporter of Sundquist's efforts to reform the state's inadequate revenue structure that drags it down even in good times. An income tax coupled with reduced dependence on the regressive, inelastic sales tax is the only way to get Tennessee on a sound fiscal footing. But not even the deeper drag that would result from a recession appears likely to cause a crisis severe enough to jolt a taxophobic majority of Tennesseans out of their opposition to an income tax. So even Sundquist has conceded that fundamental tax reform is dead for now. Yet the state desperately needs additional revenue to avoid sinking to last and least among the 50 states, especially in education.

Tobacco settlement money is far from a total solution to the problem. And there's much to be said for not letting it become a quick fix that lets legislators avoid facing up to the need for other new revenue sources. Doctors, lawyers, accountants, architects and other professionals remain the state's most artful tax dodgers. But the Legislature has never been able or willing to close the loopholes that let partners and sole proprietors escape the state's 6 percent tax on net incomes that affects all other businesses. The only form of redress that now has any traction is to increase the $200-a-year license fee that professionals pay, which might raise the grand sum of $10-$20 million.

Abject failure to come up with any alternative sources of new revenue (though not for want of trying) led to last year's reprehensible legislative recourse to inflating sales tax revenue assumptions by whatever it took to produce a phony balanced budget. While many legislators individually say they are entering the new year with a new resolve to meet recognized budgetary needs with new, non-income taxes, their track record bespeaks a collective inability to do so.

The push to divert tobacco settlement money from covering at least some of the budgetary shortfall is driven by those two classic motivations: greed and fear.

The greed factor is based on a superficially appealing rationale that because tobacco pertains to agriculture and to health, tobacco settlement money ought to be dedicated to these fields. The Legislature bought into this last year by establishing special agricultural and health committees, each charged with recommending how half of the total pot should be deployed in their respective turfdoms.

The agriculture panel, consisting primarily of legislators from rural areas, has recommended that its half of the settlement money go for programs to aid tobacco growers and to "foster long term development of Tennessee's agricultural economy." At least in part because there's no way so much money could be spent productively on such uses, the panel recommends that a projected $80 million in annual receipts for the foreseeable future be held in trust. Only the income from the trust would be expended.

If one adheres to the widely held but dubious belief that cigarette sales will decline to the detriment of tobacco growers, then subsidizing the growers for a time holds appeal. But the facts are: 1) tobacco industry analysts do not expect much of a decline in cigarette sales over the next five years; and 2) Tennessee tobacco growers are already due to get more than $30 million a year for the next 10 years with no strings attached from a separate, dedicated stream of tobacco settlement payments.

The health panel has recommended holding half of its presumed share of the money in trust and spending the other half primarily on teen smoking prevention programs and on payments to hospitals with especially heavy loads of indigent care. If prevention programs had proven effectiveness, the case for them would be compelling. But in California, which has pushed such programs harder than any other state over the past five years, the incidence of smoking among 18-to-24-year-olds rose from 16.3 percent in 1994 to 22.7 percent in 1999.

The fear factor is based on concern that tobacco settlement payments could wither or go away and that the state shouldn't become dependent on a potentially non-recurring source of revenues to fund recurring expenses. Under the 1998 Tobacco Claims Settlement Agreement, cigarette makers are bound to make these payments in perpetuity. But their annual level is tied to each year's cigarette shipment volume in the United States, and there's also a risk that bankruptcies could put a halt to them. At a base volume of 475 billion cigarettes a year, Tennessee would stand to receive about $180 million a year (to be adjusted for inflation). But in order to meet settlement payment obligations totaling about $8 billion nationally, cigarette makers raised their prices by nearly $1 a pack. As a result, cigarette shipments declined by 10 percent in 1999, causing a reduction in Tennessee's annual entitlement to the $160 million level.

There's a widespread perception on the part of state legislators and even top state officials that further declines can be expected. But such perceptions are not shared by Wall Street analysts who make a career out of tracking the tobacco industry. Two leading Wall Street firms, Goldman Sachs and Morgan Stanley Dean Witter, both project that cigarette sales will remain nearly flat over the next five years as increased smoking rates by younger people offset declines by older folks.

Nor does Wall Street foresee much danger of cigarette makers getting clobbered by lawsuit liabilities. Indeed, Morgan Stanley Dean Witter recently issued a strong buy recommendation on Philip Morris. "Our favorable investment opinion reflects what we consider to be very substantial and not fully appreciated benefits that should accrue to the U.S. tobacco industry as a result of the election of George W. Bush," the firm stated.

Trust funds are for the well-to-do, whereas Tennessee is just about the worst-off state in the country. The worst thing the state can do is start accumulating billions of dollars in trust funds at a time when TennCare is cratering, higher education is starved for resources, and a costly teacher pay equalization requirement is imminent. The tobacco settlement money should be spent as it's received—and spent on necessities, not niceties like ineffectual smoking prevention programs and agricultural welfare.