A recent proposal by the US Treasury Department to modify the tax code could have serious implications for the states that receive annual payments from the tobacco industry as part of a 1998 settlement agreement. The proposal, which aims to prevent multinational corporations from shifting profits to low-tax jurisdictions, could also affect the calculation of the payments that the tobacco companies owe to the states under the Master Settlement Agreement (MSA). This could result in a significant reduction of the funds that the states use for various public health and social programs.
What is the Master Settlement Agreement?
The MSA is a legal settlement between 46 states, the District of Columbia, and five US territories and the four largest tobacco companies in the US: Philip Morris, R.J. Reynolds, Brown & Williamson, and Lorillard. The settlement resolved several lawsuits filed by the states against the tobacco industry for the recovery of tobacco-related health care costs. Under the MSA, the tobacco companies agreed to pay the states over $200 billion over the first 25 years and continuing annual payments thereafter based on their cigarette sales. The MSA also imposed restrictions on the tobacco industry’s marketing and advertising practices, such as banning cartoon characters and targeting youth.
How does the tax code proposal affect the MSA payments?
The tax code proposal, which was released by the Treasury Department on February 22, 2024, as part of the Biden administration’s plan to overhaul the corporate tax system, includes a provision that would change the way the US taxes the foreign income of US-based multinational corporations. The provision, known as the Global Intangible Low-Taxed Income (GILTI) rule, would increase the minimum tax rate on the foreign income of these corporations from 10.5% to 21%, and would also eliminate the exemption for the first 10% return on foreign assets. The Treasury Department estimates that this provision would raise $500 billion in revenue over 10 years.
However, the tax code proposal could also have an unintended consequence for the MSA payments, as it could alter the formula that determines the amount of the payments that the tobacco companies owe to the states. The formula, which is based on the MSA and a subsequent arbitration agreement, takes into account the market share, inflation, and volume adjustments of the tobacco companies, as well as a federal offset factor. The federal offset factor reduces the MSA payments by a percentage that reflects the impact of any federal tobacco legislation on the tobacco companies’ profits. The tax code proposal could be considered as a federal tobacco legislation that affects the tobacco companies’ profits, and thus trigger the federal offset factor, which could reduce the MSA payments by up to 50%.
What are the implications for the states?
The states that receive the MSA payments rely on them for various purposes, such as funding tobacco prevention and cessation programs, health care services, education, infrastructure, and debt service. According to a report by the Campaign for Tobacco-Free Kids, the states received $6.4 billion in MSA payments in fiscal year 2023, but only spent $658 million (10.3%) on tobacco prevention and cessation programs, which is less than a third of what the Centers for Disease Control and Prevention (CDC) recommends. The report also found that 22 states and the District of Columbia used the MSA payments to fund health care programs, 20 states used them for general purposes, 16 states used them for education, 13 states used them for infrastructure, and 9 states used them for debt service.
If the tax code proposal reduces the MSA payments by half, the states could face a significant budget shortfall and have to cut spending on these programs or find alternative sources of revenue. This could have negative effects on the public health and well-being of the states’ residents, especially amid the ongoing COVID-19 pandemic, which has disproportionately affected tobacco users and exposed the need for more investment in tobacco control and health care. Moreover, the reduction of the MSA payments could also undermine the original intent of the settlement, which was to compensate the states for the tobacco-related health care costs and to reduce the tobacco use and its harms in the US.
What are the possible solutions?
The tax code proposal is still subject to congressional approval and could face opposition from some lawmakers and interest groups. Some states and tobacco companies have also expressed their concerns about the potential impact of the proposal on the MSA payments and have urged the Treasury Department to clarify or revise the provision. Alternatively, the states and the tobacco companies could negotiate a new agreement that would preserve the MSA payments and avoid litigation. Another option is for the states to securitize their future MSA payments, which means selling them to investors for a lump sum upfront. However, this option could entail legal and financial risks, as well as reduce the states’ long-term revenue stream.
