Commentary

The Tobacco Cartel Is Alive and Well

Incredible but true, the same giant tobacco companies that agreed to cough up a quarter-trillion dollars in “damages” under the November 1998 Master Settlement Agreement (MSA) are now boasting higher sales, fatter profits, and loftier stock prices. That’s because the entire deal is a protectionist racket.

Wholesale cigarette prices, excluding taxes, have risen nearly 80 percent since the agreement was signed. During that same period, the MSA restricted cigarette advertising, even while potential competitors who didn’t sign the agreement were free to ignore the restrictions. The intriguing question is: With minimal physical and financial barriers to entry, soaring cigarette prices, and rigid advertising constraints on the market leaders, why haven’t new tobacco companies and smaller companies that weren’t part of the MSA been able to grab most of the market for themselves?

Here’s the alarming answer. The MSA — negotiated by the major tobacco companies, state attorneys general, and soon-to-be-billionaire trial lawyers — transforms a competitive industry into a cartel. Then it preserves the 96-plus percent market share of the tobacco giants by keeping out competitors.

Far from being victims, the big four cigarette companies are at the very center of the plot. They managed to carve out a sweetheart deal for themselves — at the expense of smokers, of course. In effect, the MSA forces all tobacco companies — even new companies and companies that were not part of the settlement — to pay “damages,” which block meaningful price competition.

The scheme works like this: Philip Morris, R.J. Reynolds, Lorillard, and Brown & Williamson knew they would have to raise prices substantially to cover their settlement obligations. The four majors were concerned that smaller domestic manufacturers and importers might gain a substantial share of the market by under-pricing cigarettes. So the big four and their state collaborators added a provision to the settlement that requires non-signing cigarette makers to post pro-rata damages, based on sales, in escrow for 25 years to offset any liability that might later be assessed. No evidence, no trial, no verdict, no demonstrated injury to smokers, just damages — sufficient to prevent price cutting.

That was the stick. Then came the carrot. If the would-be price cutter caved in and agreed to sign the MSA, it would be allowed to increase its market share by 25 percent. Big deal. The tobacco giants already controlled virtually all of the market. So a non-signer would be permitted to grow from, say, 1 percent to a whopping 1.25 percent. Essentially, the majors arranged to protect their cartel — in perpetuity.

Naturally, MSA proponents trumpeted the settlement as a victory for public health. But that claim is a sham. Why, for example, were late MSA signers not required to pay damages even if their market share grew by up to 25 percent? Obviously, cigarettes sold by a late signer are no less harmful than cigarettes sold by Philip Morris. The critical difference is that a modest increase in sales by a small company wouldn’t threaten the cartel; a significant increase would. That’s why the carrot was extended, even though more cigarette sales presumably kill more people. It’s apparent that the MSA has less to do with public health than with securing the dominance of the tobacco giants.

The seductive thing about the settlement is that everybody at the negotiating table went home a winner. The state attorneys general collect hundreds of billions of dollars, which they can spend on their favorite “smoking-related” programs like reduced college tuition and flood control; the cigarette companies raise prices as high as their addicted customers can tolerate; and the trial lawyers get fees of $750 million per year for the first five years, and $500 million per year thereafter. The only losers are the smokers, who weren’t at the table. They don’t receive a penny for their illnesses, but they pay for the entire deal.

Private challenges to the MSA are pending before two federal courts of appeal. Without doubt, the MSA violates the antitrust laws and treats the Constitution with contempt. The Commerce Clause authorizes Congress to regulate interstate commerce; yet the MSA directs states to collect “damages” based on sales in other states, restrict interstate advertising, and exact penalties against out-of-state companies. The Compacts Clause provides that “No State shall, without the Consent of Congress, … enter into any Agreement or Compact with another State”; yet the MSA preempts key federal functions by doing precisely what that clause forbids.

The Bush Justice Department should join the pending lawsuits, or file one of its own, sending a message that this corrupt bargain must be dismantled.

Robert A. Levy is senior fellow in constitutional studies at the Cato Institute.