Is the $200 Billion Tobacco Deal Going Up in Smoke?
The states are addicted to the money it provides. But the comically convoluted settlement is riddled with problems, and judges' patience for it is wearing thin.

(FORTUNE Magazine) – THE RECENT KEVIN BACON MOVIE The Woodsman strives to present an empathic portrayal of a child molester. In this article we venture a step beyond: an empathic portrayal of a cigarette maker.

Malcolm "Mac" Bailey is a fourth-generation tobacco farmer in Keysville, Va., in the rolling hills near the North Carolina border. "I had this idea in the back of my mind," he recalls, that "one day I'd try to see if I could take tobacco off of our farm and sell it as a cigarette." Bailey knows that cigarettes are bad for people, but he also knows that some people will smoke anyway, that cigarettes are a lawful product, and that tobacco is "the way of life in this community," as he says. "It's the only life that I really know, is tobacco."

In 1994, Bailey asked his son Steven to put together a blend of American tobaccos for a cigarette. Steven tried out several, rolling them into cigarettes with a hand-held machine and toting them around the countryside in plastic bags for local people to sample. In June 1994 the Baileys started making a cigarette commercially. They called it Bailey's, and it became a success. Today S&M Brands (for Steven and Mac) sells cigarettes in ten Southeastern states and employs about 225 people in an economically depressed rural community.

A bill now pending in the Virginia legislature might put the Baileys out of business. It would force them to raise their prices to a level at which they could no longer compete against the majors, Mac Bailey contends. "It is flat meant to put us down," he says. Similar laws have already been passed in 38 states, pushed through by a previously unthinkable but now commonly observed alliance between the major tobacco companies and the attorneys general who once sued them.

Bailey's predicament is a window into the increasingly bizarre, inequitable world that the tobacco business has become since November 1998. That's when a handful of do-gooders, contingency-fee lawyers, and "merchants of death" all got together in a conference room and struck a deal to settle the Medicaid reimbursement suits that many states had filed against the major tobacco companies in the mid-1990s. That famous but little understood pact, formally known as the Master Settlement Agreement (MSA), re-created the tobacco industry, though not always in the ways its signers envisioned. It was an experiment in which litigators assumed roles formerly thought reserved only for democratically elected legislators. They created a world in which rules are set by a document that looks like a contract, but whose obligations extend even to those who haven't signed it. Chief among those obligations is the payment of a tax that's not really a tax, the amount of which varies from participant to participant, depending on historical happenstance and political leverage. When the dust cleared, the new order's only clear winners were--predictably--the guys who had been in that conference room in November 1998. It's a system that only Ogden Nash could adequately describe and only M.C. Escher could accurately depict.

Most people assume that the six-year-old MSA is a done deal--yesterday's news. Certainly the states would like to believe that, since they are now counting on its revenues to plug big holes in their budgets for years to come. The media are understandably focused elsewhere: on the U.S. Justice Department's $280 billion RICO suit against the industry, largely defanged by a federal appeals court last month; on the $10.1 billion judgment against Philip Morris USA in a class action over light cigarettes, now under review by the Illinois Supreme Court; and on the $145 billion judgment in a Florida class action, dissolved last year but now under reconsideration by the Florida Supreme Court. (See "Tobacco's Month of Living Dangerously," on

But the MSA is also very much in play. It requires constant tinkering by state legislatures to make it work. Each adjustment prompts new court challenges, and each new challenge forces judges to take a hard look at its rickety structure, often in contexts that could theoretically lead to annulment of the whole kit and caboodle. Such an outcome would be nothing less than catastrophic for many state budgets.

From the day it was announced, the MSA was beset with suits alleging constitutional violations. But judges repeatedly found ways to uphold it, just as they had earlier found ways to let the states' Medicaid reimbursement suits go forward, despite considerable doubt in legal academia about their viability under traditional tort theory. As "merchants of death," the major cigarette makers had never come across as sympathetic parties in court, and "renegade" cigarette makers like Bailey (i.e., those that hadn't signed the MSA) fared no better. The judges were not inclined to undo a deal that, whatever else might be said about it, did advance important public health objectives.

That forgiving attitude may be changing. In January 2004, a federal appeals court in New York held that the MSA was not immune from antitrust challenge. In response, Moody's downgraded $18 billion worth of municipal tobacco bonds. (More than 40 states and municipalities have issued such bonds, secured by anticipated MSA payments.) Then, in September, a federal district judge enjoined enforcement of New York's latest MSA-tinkering law--similar to the Virginia bill that Bailey fears--finding that it was "discriminatory," "unnecessary for the legitimate public health needs of the state," and likely to violate antitrust laws. Yet the judge refused to enjoin the MSA itself. Attorneys for both sides claim not to understand how he could make such a distinction; the legal justifications for both are the same, and if one falls, both would seem to. Accordingly, this obscure case--still at an early stage--carries the potential to upend the entire tobacco settlement.

Frankly, we doubt the case will lead to that apocalyptic outcome. Federal antitrust challenges to state regulatory actions have to clear a daunting set of hurdles. Nevertheless, at least four other lawsuits challenging parts or all of the MSA are now working their way through the federal courts, and the current system is one that cries out for reform. In a country where laws and precedents are supposed to apply universally, we should care about the injustices being visited upon Bailey--even if he is a cigarette maker. "If the MSA was about any other industry," says Jeremy Bulow, a Stanford Business School professor and former chief economist for the FTC, "it would have been struck down long ago." The ideal solution would be for Congress to devise an equitable, internally consistent scheme. While we wait, the warped world of the MSA grows stranger every day.

LET'S QUICKLY REHEARSE how we got here. In March 1994 the attorney general of Mississippi brought the first of the Medicaid reimbursement suits, retaining contingency-fee plaintiffs lawyer Dickie Scruggs as his lead outside counsel. Over the next two years, more than a dozen other state attorneys general filed similar suits. The suits accused the major tobacco companies of conspiring over a 40-year period to suppress scientific evidence of the dangers and addictiveness of cigarettes; marketing to children; consumer fraud; false advertising; civil racketeering; and antitrust violations. There were five main defendants: Philip Morris (maker of Marlboros); R.J. Reynolds (Camels, Winstons); Brown & Williamson (Kools); Lorillard (Newports); and Liggett Group (L&Ms, a brand it later sold to Philip Morris).

In 1996, Liggett, then teetering on bankruptcy, split from the others and turned state's evidence. It handed over reams of internal documents that strengthened the states' fraud claims and in return won favorable settlement terms. As we'll see, Liggett's move later skewed the structure of the MSA in strange and significant ways.

In June 1997, in a historic capitulation, the four remaining defendants, none of which had ever had to pay a penny to a plaintiff in a cigarette lawsuit, agreed to a "global tobacco resolution" that, as originally envisioned, would have been enacted by the U.S. Congress. The majors hoped to put all industry-threatening litigation behind them and restore legitimacy to their business. The deal would have required the companies to pay the states through a framework much like the one that later emerged under the MSA, although the payments would have been higher. While the global resolution was pending before Congress, the four states whose cases against the industry were furthest along in the courts--Mississippi, Florida, Texas, and Minnesota--settled with the four majors under terms that anticipated passage of the global resolution.

But politicians were soon demanding major changes to the deal, and the companies withdrew their support. In addition, some leading public health advocates opposed the bill because it would restore respectability to the tobacco industry. A bill to enact the global resolution went down to defeat in June 1998.

The 39 states that were still suing then entered into a private settlement agreement with the companies. The majors agreed to abide by certain advertising and lobbying restrictions, to fund a foundation that would promote smoking prevention and cessation programs, and to pay "about $200 billion over 25 years" (a misleading phrase that we'll return to shortly). This was the MSA. For midwifing it, the states' outside lawyers were ultimately awarded more than $13 billion in contingency fees, according to American Lawyer. Though seven states had not yet sued the companies, they now signed on too. So today there are 46 MSA states plus the District of Columbia and five territories. The four earlier settlers--Mississippi, Florida, Texas, and Minnesota--did not sign the MSA and are known as "previously settled states."

THE MSA HAD the look and feel of a routine, if huge, legal settlement. But it was really a national tobacco tax in disguise. From 1999 forward, each company that signed was required to make an annual payment to the states. The levy, recalculated each year using a complicated formula, is currently set at about 2 cents a cigarette, roughly $4 a carton. (There are 20 cigarettes in a pack, and ten packs in a carton.) This tax, the parties understood, would be passed through to consumers in the form of increased prices, and the increased prices, in turn, would advance public health goals by discouraging cigarette consumption, especially among the young.

Where does the $200 billion figure come from? That number was reached by adding up the cumulative total of MSA taxes anticipated over the first 25 years of the settlement (plus more than $12 billion in other one-time payments). The 25-year cutoff, though, is arbitrary, because the MSA goes on forever. After 2024 the companies will keep paying the states a tax designed to yield roughly $9 billion per year--adjusted upward for inflation and downward for drops in cigarette consumption--"in perpetuity."

But no one calls the settlement a tax, for a very good reason: State attorneys general have no authority to impose a tax. Even state legislatures have no constitutional power to get together and create a national tax, which is what the MSA levy certainly resembles. In fact, one reason that journalists and lawyers alike have a hard time describing the MSA succinctly is that almost any attempt leads to formulations that sound patently unconstitutional. It would be tempting, for instance, to call the MSA an agreement among 46 states to tax and regulate the marketing of cigarettes. But the MSA can't be exactly that, because the states, under the federal Constitution's commerce clause, have no power to regulate interstate commerce. In addition, under the Constitution's compact clause they are forbidden to enter into agreements with one another to exercise national political power without congressional approval.

Of course, none of this would be an issue if the MSA applied only to its voluntary signatories, the big tobacco companies. But it doesn't--and it wouldn't work right if it did. Although the four majors commanded 97% of the cigarette market in 1997, the drafters of the MSA still had to worry about Liggett and all the tiny players that rounded out the field. If the MSA imposed no corresponding obligation on them, they would suddenly have a huge price advantage and their shares could be expected to grow explosively, reducing the states' MSA income and gradually undermining all the other goals of the MSA as well. So the challenge was to lure these other players into signing the MSA or to impose a similar financial burden on them.

The solution was a devilishly clever and maddeningly complicated array of carrot-and-stick mechanisms. The main carrot was sensible enough: Any company that signed would be assured that the MSA states could never sue it seeking Medicaid reimbursement. In addition, any wholesaler or retailer that dealt with an MSA signatory would also never have to worry about being sued by the state. In practice, this creates a powerful incentive for wholesalers and retailers to deal only with MSA signatories. (To this day, nearly all major chains of convenience stores, drugstores, discounters, and groceries refuse to handle nonparticipants' brands.)

But that wasn't going to be enough to entice Liggett, which had settled with more than 40 states and therefore already enjoyed these immunities. So the drafters of the MSA devised an extraordinary one-time incentive: If a company signed up within 90 days (by Feb. 23, 1999), it would be granted an exemption from having to pay the MSA levy as long as it stayed within its 1998 market share (or 125% of its 1997 market share, whichever was greater). If its share expanded, the company would pay the same per-cigarette levy that the majors paid, but only on those cigarettes that exceeded its protected share. The deal would give these companies an effective discount on their average per-cigarette MSA tax in perpetuity. Offered to all, it mainly benefited the two largest remaining players: Liggett and Commonwealth Brands (maker of USA Golds), which grabbed the deal, as did a handful of smaller companies. These players are now referred to as subsequent participating manufacturers (SPMs).

To eliminate any price advantage for the companies that still refused to sign--the nonparticipating manufacturers--the MSA drafters added another twist: Each MSA state, as a condition of receiving its full MSA payments, would have to pass a law requiring nonparticipants to pay a per-cigarette "escrow deposit" nearly equal to the levy on participants. (Incredibly, the MSA also specifies that if any judge strikes down an escrow law as unconstitutional, that state can lose up to 65% of its MSA payments--an incentive for elected state judges to uphold those laws.) The convoluted justification for the escrow laws boiled down to this: They would ensure that money would be available to pay damages if the states ever decided to sue the nonparticipating companies. If the states ended up not suing, each year's escrow deposits would be returned--25 years later.

Even assuming that these laws made sense, they created still another inequity among competitors. Escrow deposits are not generally tax-deductible, while MSA payments are. Nonparticipants claim that a $4-per-carton nondeductible escrow payment is equal to a $5.45 per carton MSA levy. The attorneys general dispute that and claim there are ways to structure escrow payments to make them deductible--but no one really knows.

NOT SURPRISINGLY, this improbable, jerry-rigged, Rube Goldberg--like quasi tax seemed preposterously unfair to manufacturers like Mac Bailey. But it also turned out to have some weak spots, and it didn't take long for folks like Bailey to find them.

"In 19-and-98," says Bailey, "the thing that really, really hit upon us tight was the decision with the MSA." Bailey got a letter from plaintiffs lawyer Joe Rice, who had taken the lead in negotiating the MSA on behalf of the attorneys general. (See "Welcome to the New Asbestos Scandal," on "I was offered--ordered, almost--to come to New York and sign this document," Bailey continues, referring to the MSA. "I had a matter of a few days to sign, and I'm looking at a stack that's probably--I don't think I'd exaggerate--an inch-and-a-half thick." (The MSA's text is about 150 pages, and 21 exhibits are appended to it.)

Bailey got an extension so he could have an outside attorney read the document. Bailey saw that the protected share being offered him wasn't going to mean anything, because S&M Brands was then only at the breakeven point and would have to grow substantially to stay in business. Bailey's attorney (and stepson), Everett Gee, also thought it was wrong for a company that hadn't been accused of wrongdoing to pay the same amount as those that had been sued for a long litany of sins. But Bailey did see a glimmer of light. "My attorney read and highlighted a paragraph in the MSA out of all those pages that I felt like dealt with me," Bailey recalls. "And that paragraph says that you'll pay no more as a nonmember to any state than you would as a member."

That provision turned out to have enormous consequences for regional companies like S&M Brands. Bailey was actually better off not signing, as long as he was willing to stay regional. The anomaly arises from the way the MSA computes its signatory companies' obligations: Levies are imposed on nationwide sales, with each MSA state taking a fixed share; Virginia, for example, gets 2%. The end result was that if Bailey operated solely in Virginia as a nonsignatory and had to make $1 million in escrow payments, he would immediately qualify for a refund of 98% of that amount, since only 2% would go to Virginia if he were an MSA signatory. With a refund like that, Bailey could afford the escrow obligation.

Bailey decided not to sign. "Makes no sense for me to pay all these states I don't even sell in," he says. "I haven't done anything wrong. And I tell you another reason," Bailey adds. "I was brought up with the philosophy from my parents which is, you don't associate with the wrong crowd. If this group is in trouble and they're being sued by all these states, my philosophy is, why do I want to be involved with them?" So in Virginia today, where a carton of Marlboros sells for about $24.50, a carton of Bailey's goes for a competitive $18. Foreign-made superdiscount brands sell for as little as $13 to $15.

CRITICS OF THE MSA charge that its convoluted structure actually created a cartel that allows the majors to raise prices without fear of competition--a claim hotly contested by the majors and many discounters alike. But there is no question that the majors did hike prices dramatically. In November 1998, when the MSA took effect, all the major cigarette manufacturers announced, in concert, a wholesale price increase of $4.50 a carton, which analysts said was much more than they needed to meet their MSA obligations. In August 1999 the majors raised wholesale prices another $1.80 a carton. The following year they imposed three more hikes, totaling $2.30. They tacked on another $1.40 in April 2001 and $1.20 in April 2002, bringing the cumulative hike to $11.20 since 1998 and putting wholesale prices at close to double their pre-MSA levels.

Retail prices rose even faster. As the economy nosedived in 2000, gaping shortfalls opened up in the states' budgets. State officials began looking to their MSA payments to make up the difference (enraging antitobacco advocates, who had hoped the money would go for antismoking programs). When even those funds proved insufficient, state legislators began hiking cigarette excise taxes. By now, more than 35 states have raised excise taxes, with the average jumping from $3.46 a carton in 1998 to $6.41 a carton in 2004. Eighteen states impose more than $10-per-carton taxes, with Rhode Island out in front at $24.60. New York City adds its own levy, bringing the price of a carton of Marlboros to about $70, with state and local excise taxes accounting for $30 of that. Even Virginia raised its puny tax from 25 cents to $2 a carton last year. And Congress upped the federal excise tax from $2.40 in 1998 to $3.90 a carton in 2002.

As prices went up, cigarette consumption, predictably, went down, achieving the public health objective of the MSA. Though cigarette sales in the U.S. have been steadily declining since 1981, they fell an unprecedented 10.3% in 1999. Sales have continued falling more gradually since, but still at a faster clip than before the MSA. The MSA seems to have helped curtail youthful smoking as well. Though smoking among high school students rose 33% from 1991 to 1997, it has dropped almost 40% since then. (But smoking among young adults 18 to 25 went up 24% from 1991 to 2002.)

Despite declining sales, the major tobacco companies thrived in the early years of the MSA, thanks to higher prices. Though Philip Morris's operating income (excluding charges) from its domestic tobacco business dipped from $5.2 billion in 1998 to $5 billion the following year, it climbed to nearly $5.8 billion by 2001. (Philip Morris commands about 50% of the domestic market.)

By 2002, with the economy slumping, the price hikes began to bite. Smokers started defecting in large numbers to discount and superdiscount brands, sold mainly by subsequent participating manufacturers and nonparticipants. In response, the majors resorted to costly discounts and promotions like "Buy one, get one free." As a result, Philip Morris's operating income from domestic tobacco sales fell 13.1% in 2002, to $5 billion, and then plummeted another 22.4% in 2003, to $3.9 billion. (Philip Morris changed its name to Altria Group in 2003; its domestic tobacco unit is known as Philip Morris USA.)

Part of the majors' share was going to the smaller signatories--mainly Liggett (now part of Vector Group) and Commonwealth. From 1997 to 2003, such firms doubled their sales and increased their share from 2.6% to 7.3%. The big break given to these companies to entice them into the MSA--their grandfathered shares--was now paying dividends. In 2002, for instance, Liggett sold 9.7 billion cigarettes but paid the levy only on the last 2.8 billion. That year, when most MSA signatories were paying around $3.28 a carton, Liggett's average was $0.94.

But the majors were losing even more share to the nonparticipants, which sold more than 33 billion cigarettes in 2003, up from 2.5 billion in 1997, increasing their share more than 20-fold, from 0.37% to 8.1%. Why weren't the escrow laws hobbling them? Some nonparticipants were simply violating them. Others--particularly foreign firms--were playing corporate shell games to evade them. Still others, like Bailey's S&M Brands, were staying regional to keep their levies down.

The drop in cigarette consumption and the majors' share losses meant dramatic declines in payments to the states. Had the majors' sales remained constant, they would have owed $9.3 billion in 2003; the actual payment came in at $5.78 billion. In one sense, the attorneys general were in no position to complain, because the falloff stemmed largely from declining cigarette consumption. That was one of the goals of the MSA, remember?

But there was something the attorneys general could complain about: the inroads made by the nonparticipating manufacturers. "Increasing sales by [nonparticipating manufacturers] will sharply reduce the next scheduled payments," Vermont attorney general William Sorrell wrote in a memo to all state attorneys general in September 2003. Sorrell then chaired the committee overseeing enforcement of the MSA. "These results underscore the urgency of all states taking steps to deal with the proliferation of [nonparticipant] sales.... [Nonparticipant] sales in any state reduce payments to any other state."

Sorrell estimated that the lost MSA revenue from nonparticipant sales in 2003 came to $600 million. He also warned that the states were flirting with exposure to a draconian provision in the MSA: If a state's lax enforcement of the MSA contributes to loss of share by participating manufacturers, that state can suffer whopping penalties that could easily wipe out its entire annual MSA payment.

Acting under this sword of Damocles, in 2001 the states--with the enthusiastic backing of the majors--began enacting a wave of laws aimed at curbing evasion of the escrow requirement, especially by foreign manufacturers. Forty-three states have now passed such laws. In 2003, when the nonparticipants were still increasing their market share, the attorneys general and the majors began pressing the states to end the refund provision that manufacturers like Bailey had been relying on, which the attorneys general now called a "loophole." Eighteen states enacted such laws in 2003, and another 20 passed them last year.

The majors are delighted with the results. Philip Morris's operating income for domestic tobacco went up 13.3% in 2004, as the volume of cheap imported cigarettes slowed and the company's effective cigarette prices--taking into account reduced discounting and giveaways--began rising again. In public statements Altria CEO Louis Camilleri and CFO Dinyar DeVitre each linked the unit's brightening profit outlook to its success in getting the two waves of MSA-related laws passed.

Those laws work, of course, by squeezing firms like Bailey's. Strangely enough, Bailey claims he couldn't join the MSA now even if he wanted to. To sign now, the MSA requires him not only to turn over all his escrowed money but also to pay the additional money he would have owed had he been a signatory all along--a total of more than $115 million. "All that money ... goes to states where we have never sold cigarettes," notes Gee, S&M's general counsel.

THE ATTEMPT by the attorneys general to close the MSA's refund "loophole" has attracted far more judicial scrutiny than the first wave of MSA-tinkering laws. It faces at least four federal court challenges. Louisiana's refund repeal statute was just upheld in February, but New York's has been preliminarily enjoined, and the state of Oklahoma has agreed to suspend enforcement of its law, pending a ruling there. Though the suits take aim at the repeal law, they inevitably tend to call into question the MSA itself. The suits are being brought on many grounds, but the most fruitful so far has been an antitrust argument.

"This is the most successful output cartel in the history of the Sherman Act," claims attorney David Dobbins, who is bringing that suit. "You just can't get any better than this." Dobbins, 76, has been an antitrust litigator for more than 40 years. The notion that the deal might violate the antitrust laws has been haunting the MSA since before its inception. In 1997, when the attorneys general and the tobacco companies asked Congress to enact the global resolution, they had included an express antitrust exemption in their proposal. So when the global resolution failed to pass and the MSA was signed--without the exemption--everyone understood that some ticklish antitrust issues might arise.

For instance, an agreement among competitors not to advertise--one prominent component of the MSA--would ordinarily violate the antitrust laws. Similarly, the tacit understanding among the majors that MSA levies would be passed along to consumers also might raise antitrust issues. Even the provisions of the MSA that call for twice-a-year powwows among all the signatories might at least create opportunities for abuse. On the other hand, when states enact a regulatory scheme, which is what the MSA essentially is, they are allowed to authorize some anticompetitive arrangements. It was likely, therefore, that small-scale antitrust problems would survive legal scrutiny.

The more pressing question is whether the MSA created an output cartel, as many conservative critics have long claimed. An output cartel--OPEC is the obvious example--is an agreement among competitors to hold down production to inflate prices. Critics claim that under the MSA the states are enabling the majors to crank up prices at will, squelching competition from discounters, and then skimming off half the anticompetitive profits as their reward. If the courts were to determine that the MSA led to an output cartel, even the states' involvement might not immunize it.

Attorney Dobbins, whose son is general counsel to a nonparticipating manufacturer, filed his first suit to strike down the MSA in early 1999. A federal appeals court in Philadelphia dismissed it in 2001, ruling that even if the MSA had created a cartel, it was immunized because it was part of a state regulatory scheme. Dobbins's second suit, in the District of Columbia, was thrown out on procedural grounds. His third, filed in Manhattan on behalf of two importers of nonparticipant cigarettes, was also initially dismissed. But in January of 2004, Dobbins seemed to hit pay dirt. In a thundering opinion by Judge Ralph Winter, a longtime professor at Yale Law School, the federal appeals court in New York reinstated the case, which is known as Freedom Holdings v. Spitzer. Winter not only ruled that an output cartel would not be protected by immunity but also seemed to go out of his way to signal his eagerness to junk the MSA. "Had the executives of the major tobacco companies entered into such an arrangement without the involvement of the states and their attorneys general," Judge Winter wrote, "those executives would long ago have had depressing conversations with their attorneys about the United States Sentencing Guidelines." In rejecting the theory that the states' involvement might make the arrangement legal, he continued: "States may not shield private parties from competition solely to benefit those parties. The conflict with the Sherman Act is arguably not lessened by the fact that the private parties pay the state a share of their monopoly revenues for that protection." Judge Winter sent the case back to U.S. district judge Alvin Hellerstein for trial.

As forceful as Judge Winter's ruling was, it appears to have been based in significant part upon a misunderstanding of how the gnarly arithmetic of the MSA works. Winter thought the MSA penalized subsequent participating manufacturers for taking share from the majors by increasing their per-cigarette MSA levies--eventually to the point where they would exceed the majors' levies. In subsequent proceedings, however, the attorneys general, backed by an MIT economist, have argued that Winter's math was wrong. (Even Dobbins has not come to Winter's defense.) Once the apparent math error is cleared up, it's unclear whether Judge Winter's rage--or that of any other judge--will burn as bright.

In September, Judge Hellerstein issued his baby-splitting decision, enjoining enforcement of New York's repeal of the escrow-refund provision while leaving everything else intact. (Hellerstein stressed that the empirical evidence showed that MSA itself was having a procompetitive effect, not an anticompetitive one, since the majors' market share had fallen from 97% to 85% since the MSA began.) Dobbins's appeal of the adverse aspects of that ruling was heard by the appeals court on Feb. 1. Meanwhile the case is proceeding before Judge Hellerstein, though no trial has yet been scheduled.

AS WE AWAIT further rulings, the cigarette industry's already inequitable landscape is continually accumulating fresh layers of irrationality. Minnesota, for example, has enacted its own special "cigarette fee" law. As one of the four states that made separate deals with the majors before the MSA, Minnesota received no money from "subsequent signers" like Commonwealth and has enacted no escrow law to impose costs on the non-signers. Now it has decided to impose its own direct $3.50-per-carton fee on subsequent signers and nonparticipants. But subsequent signers are already paying the MSA levy on their Minnesota sales--even though none of that money goes to Minnesota. That's because the MSA imposes its levies on all sales nationwide, including those in Minnesota, then divvies up the money only among the 46 states that signed the MSA. Thus Minnesota's new law effectively forces subsequent signers to pay twice. "So we're paying $7.50 per carton in Minnesota," says Rob Wilkey, general counsel of Commonwealth Brands--$4 to the MSA states and $3.50 to Minnesota. In contrast, the majors pay about $4.25 per carton there, while nonparticipants pay $3.50 per carton. Despite the seeming inequity, the law has already been upheld by one Minnesota appeals court, and similar laws are under consideration in the three other states that settled before the MSA: Florida, Mississippi, and Texas.

Meanwhile, MSA states Alaska, Michigan, and Utah have each determined that merely imposing escrow laws on nonparticipant manufacturers is inadequate, since escrow moneys do not go directly into state coffers. Accordingly, these states have hit nonparticipants with direct fees in addition to their escrow obligations--$3.50 a carton in Michigan and Utah, $2.50 a carton in Alaska. Obviously the escrow laws no longer make any sense in those states: Why create a contingent reserve fund from which to recover Medicaid reimbursements in the future if you are already collecting that money now? A Michigan court is now reviewing a challenge to that state's law.

It has been so long since cigarette-related laws have made any sense that we've entered a free-for-all situation. How long can this farce go on? Judges abhor a constitutional vacuum, and this one can't persist indefinitely.

There is a solution, and it's breathtakingly simple. Congress needs to take cigarette regulation out of the closet. First, it should replace the phony MSA tax with a real one: a $4-per-carton hike in the federal excise tax on tobacco--affecting all competitors equally. The proceeds would be distributed to the states in proportion to their tobacco-related Medicaid expenditures. Second, Congress would impose advertising restrictions equivalent to those that have already been "voluntarily" adopted by the companies that have been bribed, cajoled, harassed, or coerced into signing the MSA. That's basically it. And you know what the best thing about this hypothetical solution would be? Congress wouldn't need to pay any attorneys' fees for the privilege of passing it.

Simple, yes. Sensible, yes. But if getting it through Congress were as easy as describing it, we wouldn't be in this mess in the first place. ■