Justice Department Move Threatens State Revenues

Published November 1, 2003

The Justice Department’s decision to continue to pursue the Clinton-era civil suit against the nation’s largest tobacco companies represents poor legal thinking and questionable economic policy, according to analysts at the Institute for Research on the Economics of Taxation (IRET) and Cato Institute. IRET and Cato are think tanks located in Washington, DC.

The lawsuit demands a $289 billion fine from nine tobacco companies. To put that figure in perspective, if successful, the suit would put back into the federal government’s coffers more than 80 percent of the 10-year cost of the 2003 tax cut.

The Justice Department’s federal tobacco claim is on top of the 25-year $280 billion settlement the companies reached with the states in 1998. President Bill Clinton pushed for a federal lawsuit, which IRET labeled at the time “taxation through litigation instead of legislation.” That suit was apparently laid to rest, but has arisen undead and with impressive fangs.

“This lawsuit is a loser in many respects,” said attorney Robert Levy at a forum on the case held earlier this year at Cato. “It is based upon bad law and is certainly bad public policy. The American public, voters, and juries need to know our legal system is rapidly becoming a tool for extortion.”

A former Justice Department official involved in the initial examination of the case said the matter is not politically motivated. He noted it was permanent Justice Department staff–not political appointees–who recommended pursuing the charges.

Bad Economics

Legal and political considerations aside, the Justice Department action is ill-considered as economic policy.

  • The Justice Department claim would act like a selective excise tax on cigarette consumers and producers. Since the companies cannot print money or operate at a loss, the entire fine (if the matter survives a trial) would have to be paid by several tens of millions of cigarette smokers (who would pay higher retail prices), tobacco farmers (lower commodity prices), company employees (lower wages), and shareholders (lower dividends).
  • Although the tobacco tax, or its “fine” equivalent, is widely regarded as falling on consumption, not income, increasing it would still be bad for the economy. Excise taxes are bad tax policy; because they fall on a single product, they distort economic behavior.
  • Excise tax revenues drop if fewer packs are sold. The fine, however, would not be based on the number of packs sold. As the penalty-induced price hikes caused people to smoke less, the companies would still owe the full fine and would have to boost prices all the more to keep paying Washington.

The Justice Department may not care that several states have spent themselves into financial holes lately. But it should note that fining tobacco companies would reduce cigarette sales volume and state tobacco tax revenues. The states have already started down that road by imposing major tobacco tax hikes in the last year to fight their budget deficits. They are finding that cigarette sales–at least, legal sales excluding smuggling–are much more responsive to predatory taxation than they assumed.

Stephen J. Entin is president and executive director of the Institute for Research of the Economics of Taxation in Washington, DC. His email address is [email protected].