Heartland Policy StudyHeartland Policy StudyBy Michael E. DeBow
June 4, 1997
Click here to see the executive summary.
Michael DeBow is a Professor of Law, Cumberland School of Law, Samford University, Birmingham, Alabama.
Since May 1994, more than twenty state attorneys general have filed lawsuits against the major tobacco companies, seeking not only reimbursement of billions of dollars paid by state governments through Medicaid and other programs to cover the medical bills of smokers, 1 but also other remedies. 2
These lawsuits have received substantial media attention, and it is not difficult to understand why they are considered newsworthy. The plaintiff state attorneys general--and the scores of plaintiffs' law firms they've hired, usually on a contingent fee basis, to prosecute the suits--have created another front in the war against smoking. It is a front that holds out the prospect of forcing a pariah industry to bankroll a government welfare program--Medicaid. What could be more attractive than "free money" from an unpopular industry for a public purpose?
In recent weeks, public awareness of these suits has grown considerably. In March 1997, a settlement was announced between the plaintiff states and the Brooke Group, parent of the Liggett tobacco firm, which prompted Mississippi Attorney General Michael Moore to remark, "I think this will bring the tobacco industry to its knees." 3
At first glance, the Liggett settlement appears significant. However, Liggett has only 2 percent of the U.S. cigarette market and has consistently been a financial under-achiever. Accordingly, it was a relatively easy matter for the company to promise to turn over 25 percent of its pre-tax profits. The real prize, from the perspective of the plaintiff attorneys general, was not the financial settlement, but the cache of documents Liggett turned over. Those documents are likely to be used to press the case against the other, more profitable, tobacco companies.
In mid-April, the media reported that settlement talks were underway between the plaintiff states and the major cigarette makers, including RJR Nabisco and Philip Morris. As of this writing, details of the proposed settlement are unavailable. But a good deal of speculation is available, fairly summarized by a Wall Street Journal report that broke the story as follows:
The nation's two largest cigarette makers are in secret talks with tobacco plaintiffs about a sweeping settlement that would cover virtually all the industry's liability for smoking, in return for strict advertising curbs and an enormous payment that could total $300 billion over the next 25 years, people familiar with the negotiations say.
. . . . While [RJR and Philip Morris] have voiced interest in a settlement before, they are now for the first time negotiating the details of some long-unthinkable concessions, including accepting regulation by the Food and Drug Administration, banning cigarette billboards and ceasing to use pictures of people--such as the Marlboro Man--in ads.
In return, the cigarette makers are seeking shelter from the mounting threat of liability lawsuits, through a novel mechanism that would require an act of Congress. The plan under discussion would set up a regime somewhat akin to workers' compensation, whereby smokers could seek payments from a big industry fund, but generally would be forbidden to sue the cigarette companies. 4
While some observers doubted the settlement fund would be as large as $300 billion--The New York Times, for example, guessed "more than $250 billion"--5 the stock market reacted very favorably to the news. On the day the story broke, April 16, the price of both RJR Nabisco and Philip Morris stock surged 11 percent in heavy trading. 6
The fact that the stock market reacted so favorably to the prospect of a $300 billion tab being settled on the industry tells us something about how pessimistic the market was about the industry's chances in pursuing its litigation strategy. Market observers note favorably that the proposed $300 billion settlement would extinguish claims by individual smokers as well as by the plaintiff states. A Salomon Brothers study concluded that the specter of losing suits brought by individual smokers is a much bigger inducement to the companies to settle than the threat posed by the states' Medicaid lawsuits. 7
The new hype surrounding the settlement talks should not obscure the fact that the state Medicaid reimbursement suits are thoroughly bad ideas. They represent bad legal policy, bad public finance, and the triumph of politics over substance among a large fraction of the state attorneys general.
To the extent that the states "win" these suits, whether by further settlements or by taking them to trial, such victories will generate a number of negative effects for law and public policy. A legal precedent of uncertain but potentially wide-ranging scope will be created. A dubious alliance between the highest law enforcement officers at the state level and the activist plaintiffs' trial bar will be strengthened. The separation of powers--specifically between the judiciary and the legislature--will be further undermined. And the public may come to believe, mistakenly, that unpopular businesses can be made to finance public welfare and other programs, while smokers are made to pay what is in effect a hidden increase in state cigarette taxes.
Part 1 of this Heartland Policy Study introduces the legal theories under which 24 state attorneys general have filed Medicaid reimbursement suits against the tobacco industry. Decisions already handed down in Florida and San Francisco are explored at some length, as they illustrate the weaknesses that plague these suits. Part 2 outlines six key factors that should lead a conscientious state attorney general--one concerned less with personal political ambition and more with his or her duty to the state's citizens and their legal system--to decide against filing suit. Part 3 offers a brief summary of the paper.
The first thing to understand about the Medicaid lawsuits is that they do not fit within any pre-existing legal theories of liability. The suits are, quite literally, unprecedented. Further, they present evidentiary and due process questions of mind-boggling complexity.
The severe flaws that plague the lawsuits are due to the fact that the states have gone to great lengths to avoid the traditional theory for third-party reimbursement, known as "subrogation." Subrogation allows for the substitution of one party in the place of another with reference to a legal claim. For example, once your automobile insurer reimburses you for the costs of an accident you've been in, the insurance company is "subrogated" to any claims you might have against the other driver, and it can sue the other driver to recover the amounts paid out on your behalf.
In the Medicaid realm, there are express provisions under which states are required to pursue recovery from third parties by the traditional methods of subrogation. 8 Thus, if a Medicaid recipient has a valid legal claim against a third party for, say, accidental injuries, then the state is subrogated to the rights of that individual, and it may sue to recover the state's Medicaid expenses from the third party.
So why don't the states sue the tobacco companies under traditional subrogation theory? The answer is simple: Any state that sues under traditional subrogation theory is said to "step into the shoes" of the Medicaid recipient, and is thus subject to any defense that the tobacco companies could assert against the individual if he or she had brought the suit. In other words, the tobacco company can defend itself against the plaintiff state by making the same arguments that it could have used against the individual smoker as plaintiff. Since the tobacco companies have consistently won lawsuits brought by smokers, relying heavily on the defense that smokers "assumed the risk" of smoking, the prospects seem quite dim for any state that simply "steps into the shoes" of its Medicaid recipients.
The state attorneys general and their trial lawyer allies thus have been inspired to apply a number of common law and statutory theories in a novel way against the tobacco companies. Their lawsuits have included claims based on unjust enrichment, indemnity, fraud, products liability, express and implied warranty, public nuisance, antitrust, and racketeering.
The unusual application of these legal theories is not likely to succeed. An appreciation of the weakness of the states' cases can be gleaned from two recent decisions--one from the Florida Supreme Court, 9 and one from the federal district court in San Francisco. 10
Florida's experiences are relevant to a consideration of the strength of other states' lawsuits precisely because the Florida legislature went to extraordinary lengths to overturn the traditional "barriers" to Medicaid reimbursement suits posed by the common law. If Florida--which has gone much further than any other state to alter its law to accommodate litigation against the tobacco companies--still faces major hurdles in its lawsuit, then this bodes ill for suits filed under more traditional legal doctrines.
In 1994, the Florida legislature amended the state's Medicaid subrogation statute in an attempt to pave the way for the State of Florida's tobacco lawsuit. It is significant, for reasons discussed elsewhere in this Policy Study, that the Medicaid reimbursement legislation was not limited to the tobacco industry. However, in March 1995 Governor Lawton Chiles issued an Executive Order directing "the relevant executive branch officials to pursue the recovery of Medicaid expenditures from only the tobacco industry." 11
In the words of the Florida Supreme Court, the 1994 legislation rejected traditional subrogation principles in favor of a "new, independent cause of action that requires the State [in seeking Medicaid reimbursement from a third party] to prove: (1) either negligence or a defective product; (2) causation; and (3) damages." 12 Further, the 1994 legislation provided:
Despite Governor Chiles' order that only tobacco firms be sued under the statute, it was a broad-based business trade association that challenged the constitutionality of the 1994 amendments. In June 1996, the Florida Supreme Court on a 4-3 vote upheld most of the statute against a multifaceted constitutional challenge. 15 In March, the U.S. Supreme Court declined to hear an appeal from the decision, a move interpreted by the media as a significant "win" for the plaintiff states.
However, the media's focus on the U.S. Supreme Court's lack of interest in the Florida statute was misplaced. Instead, the real story is what the decision of the four-member majority of the Florida Supreme Court did to the Florida statute. The majority opinion declared the statute applicable only to causes of action that accrued after its effective date. The majority also struck down, as a denial of due process, the provision that would have allowed the state to sue without identifying each individual recipient of Medicaid payments for which it sought reimbursement. 16
Thus, even under the Florida statute, the state must identify individual Medicaid recipients/smokers; the defendant tobacco companies must be given the opportunity to show that the Medicaid payments made by the state with regard to those individuals were improper; and the state may sue under the commodious terms of the 1994 amendments only as to Medicaid payments made after the effective date of the amendments.
The Wall Street Journal speculated that the Florida court's requirement that the state identify individual Medicaid recipients "could open the door to a bottomless quagmire of case-by-case litigation." 17 This seems a very realistic assessment.
The Florida legislature was willing to throw out the common law and write new rules specifically to facilitate tobacco litigation--and still the state's suit is likely to become a "bottomless quagmire." Clearly the Florida court's decision casts significant doubt on the prospects for success in states that still recognize more traditional legal doctrines.
Similarly gloomy news for the plaintiff states came in February 1997 from San Francisco. U.S. District Judge Lowell Jensen granted the tobacco companies' motions to dismiss a suit brought by the city and county of San Francisco to recover monies spent on smokers in local health care programs. Judge Jensen dismissed all the city and county claims under seven different theories of recovery: one under the federal racketeering statute, and six under California law.
In dismissing the claims, Judge Jensen observed at several points that the city and the county had failed to allege adequately (1) that smokers had justifiably relied upon the tobacco companies' misconduct in deciding to smoke, and (2) that the tobacco companies' misconduct was the "proximate cause" of the smokers' injuries.
Judge Jensen granted the defendants' motion to dismiss "with leave to amend"-- meaning that the plaintiff city and county governments can try to amend their complaint to address the judge's concerns and then re-file it. Nevertheless, the judge's order makes it clear that it will be very difficult for the plaintiffs to cure the defects in their complaint.
If the states' cases are so weak, why are the major tobacco companies willing, at the time of this writing, to talk settlement? A number of possible explanations suggest themselves.
First, a decision by the companies to litigate these cases would be a high-risk decision, a "bet-the-company" decision. It may be that tobacco company executives do not have the stomach for that kind of risk.
Second, it is expensive for the firms to continue to fight. One estimate places the tobacco industry's legal expenses for 1996 at $600 million, with $100 million being spent to defend the Minnesota Medicaid case alone. 18
Third, a decision to settle would likely have positive effects on the stock prices of the cigarette companies. As mentioned earlier, the news that settlement negotiations were underway sent RJR Nabisco and Philip Morris shares up 11 percent in a single day's trading. Even after that increase, Philip Morris was trading at only 12.5 times earnings, "a hefty 24 percent discount to the rest of the market." 19 Because the settlement proposals floated in mid-April involve settlement of the state suits and pending and future suits by individual smokers, such a settlement would allow the companies to get out from under a significant legal cloud and might well result in a very large jump in tobacco stock prices.
It is impossible to say where the settlement negotiations will lead. What can be said is that a settlement will not necessarily vindicate the states' decisions to sue.
The state Medicaid reimbursement suits are probably best explained by reference to two political motives.
First, state attorneys general ("AGs") are elected officials, many of whom have further political ambitions and thus can be expected to court public opinion. The AGs know the value of favorable press and publicity, and the tobacco industry is certainly a tempting target. Surely the AGs' eagerness to bring the industry "to its knees" is based, at least in part, on smoking's current unpopularity among large segments of the public, and on the seemingly sure-fire goal of getting "someone else" to kick in large amounts of money to cover the expense of a government welfare program such as Medicaid.
Of course, launching a jihad against cigarettes carries with it political risk. The AGs may alienate some smokers (approximately 20 percent of adult Americans smoke). But this means only that the litigation strategy is not risk-free. It still looks on balance to be a "winner" politically for many, if not most, state AGs. This is borne out by the recent admission of Connecticut Attorney General Richard Blumenthal that he is "astonished at how the momentum of public opinion has built relentlessly against tobacco." 20
The second political motive is related to the fact that the AGs have arranged with plaintiffs' lawyers in private practice to prosecute the tobacco suits, often through generous contingent fee agreements. According to one account, "well over 100 law firms around the country are battling the tobacco industry." 21 Assuming that these trial lawyers can be counted on for political support and contributions in future campaigns, then the tobacco lawsuits represent a golden opportunity for AGs to scratch the backs of friends in the plaintiffs' bar while scoring political points with an increasingly tobacco-hostile public.
Table 1 on the following page identifies the states that have
sued, the month and year in which the suit was filed, and the
contingent fee agreed upon by the state and law firms that are
prosecuting these actions. Eighteen of the 24 suits were brought
by Democratic AGs, and six by Republicans. The eighteen Democrats
constitute 60 percent of the thirty Democratic state AGs
nationwide. The six Republicans constitute 30 percent of the
twenty Republican state AGs. Thus, Democratic AGs to date have
proven twice as likely to file as Republican AGs. This is
consistent with both the overwhelmingly Democratic make-up of 
the trial bar, and trial lawyers' patterns of
support to political candidates.
Remarkably, the contingent fees that have been announced range from 10 percent to 25 percent of the state's recovery. 22 Given the vast sums claimed in these lawsuits, such fee arrangements are generous, to say the least. 23 And, according to rumors surrounding the settlement talks between the industry and the states, there is a chance "that the [private-practice] lawyers could earn about 3 percent of the total settlement. That would add up to one of the biggest windfalls in the annals of plaintiffs law." 24 With a settlement of $250 billion, the 3 percent payment to the plaintiffs' bar would total $7.5 billion over 25 years--$300 million per year.
Given the legal shakiness of the Medicaid cases and the less-than-admirable incentives just noted that may account for the cases brought to date, can any good reasons for these suits be identified? A conscientious AG should approach this question with Rule 11 of the Federal Rules of Civil Procedure in mind. Rule 11 (and the state rules modeled on it) requires all litigants to certify that the arguments they make are "warranted by existing law or a good faith argument for the extension, modification, or reversal of existing law. . . ."
Since, as argued earlier, no state can make a credible argument that the tobacco companies are liable under existing law, the real question is, "Can the state argue in good faith that the law should be changed to make the tobacco companies compensate the state?" or, more simply, "Should the state argue for an expansion of tort liability in this case?"
Asking a court to change the law involves asking the court to apply a new theory of liability retroactively against the losing defendant. Thus, changes in the common law entail a fairness problem--namely, imposing liability retroactively on a party that had no advance notice that its behavior would result in such liability.
Under the circumstances, is it fair to tag the tobacco companies retroactively for their manufacture and sale of cigarettes? On one side of the scale, the plaintiff AGs point to a growing mass of evidence of foul behavior by tobacco company executives down through the years. Should the executives' actions tip the balance in favor of bringing suit?
On the other side of the scale, there are six factors that should lead a conscientious AG to decide against filing a Medicaid reimbursement suit.
Changing the law to snare the tobacco companies will set in motion other changes in the law, and will likely result in similar suits being brought in the future against other firms that sell products that increase state Medicaid expenditures. Liquor and beer companies spring to mind as likely defendants, and fast-food firms are only a bit less obvious targets.
Significantly, any mention of future reimbursement suits against the liquor or fast-food industries tends to trigger a heated response from the plaintiff AGs and their trial lawyer allies. They vehemently deny that the tobacco case is close enough factually to other products to serve as precedent for future suits against other industries. They tend to dismiss such speculation as fanciful.
To accept their response involves accepting the notion that the plaintiffs' bar will be willing to push itself back from the table once the tobacco litigation is over--even if the suits are successful--and refrain from suing other industries whose products arguably increase public health expenditures. Given the amounts of money that would be at stake in such litigation, it seems foolish to count on the future self-restraint of state AGs and their plaintiff lawyer allies. On this point, recall that the Florida statute does not limit its new cause of action for Medicaid reimbursement to tobacco company defendants. Obviously, had the Florida Legislature wished to limit the scope of the statute, it could easily have done so. This suggests that the political forces behind the statute did not wish to limit it to tobacco cases alone.
The theory of the tobacco suits will not simply disappear when those suits end. And a win by the states--through settlement or trial--will create a huge new area of potential tort liability. A conscientious AG should take these facts into account in deciding whether to bring a Medicaid reimbursement action. Is this really a direction in which tort law should develop as a general matter? Because of the related retroactivity and notice problems outlined earlier, the better answer to this question is "no." Even if those problems do not completely overwhelm the case against the tobacco companies, they would be much more compelling with respect to producers of products less dangerous than cigarettes. Tort law should not start down this path.
People have known for a very long time that smoking is very dangerous. In fact, there is good evidence that people tend to overestimate the health dangers of smoking. Harvard economist Kip Viscusi's survey research among smokers and nonsmokers from age 16 up shows "that not only is there substantial awareness of the smoking hazards, but overall individuals appear to overestimate the [lung cancer] risks as compared with the levels in the scientific evidence." With regard to health risks other than lung cancer, Viscusi found that "there is less of a tendency to overestimate the total mortality risk of smoking or the adverse effect of smoking on life expectancy, although these are somewhat overestimated as well." 25
The widespread public knowledge of the dangers of smoking has to be kept in mind when reviewing whatever evidence is produced as to tobacco companies' misbehavior with respect to withholding information and attempting to mislead the public about the dangers of smoking. To put this idea into lawyers' language, can it really be said that smokers "relied" on the representations of the cigarette companies in deciding to smoke? Can it really be said that the companies "caused" smokers to choose to smoke? Regardless of any duplicity on the part of the tobacco companies, the plaintiff states will face an uphill fight on these questions, as well they should.
The states have long been "partners" with the tobacco firms as a result of state taxation of cigarettes and other tobacco products and have, in their way, "profited" from the sale of cigarettes. It seems somewhat churlish for the state governments to demand a further set of payments from their former--and current--partners. A related legal concept is that parties who ask a court to "do equity"--as the state suits ask--must not come before the court with "unclean hands" themselves. This point is related to a larger question about the extent of the states' damages, if any, from smoking.
There are serious questions as to whether the state governments have suffered any loss from smoking. It is a basic precept of law that no cause of action exists where the would-be plaintiff has suffered no damage. 26 Therefore, unless a state can argue in good faith that its treasury has been harmed by the activities of the tobacco companies, it cannot in good conscience commence a legal action against them. It is therefore significant that an impressive body of research shows rather clearly that smoking does not impose a net financial injury on state treasuries.
The injury claimed by the plaintiff states can be characterized as a form of externality. Private behavior (the manufacture, sale, and consumption of cigarettes and other products) is said to result in costs that are borne by the public--the medical costs that are covered by Medicaid and other programs. However, there are several problems with this claim.
The first problem is that the plaintiff states' initial estimates of their damages appear to be far too high. Although the complaints filed to date tend to be pretty vague as to the damages sought, it appears that the states arrived at their estimates simply by totaling up the amounts they have spent on smokers through the Medicaid program. (Recall that the Florida state government apparently thinks that it should recover "$400 to $450 million a year that some state officials estimate is spent treating Medicaid recipients with smoking-related ailments.") Such an approach vastly overestimates the damage inflicted on state treasuries by smoking.
The reason is simple, but it has gone unremarked in the debate over these lawsuits. Even if Medicaid patients were not smokers, and thus did not get sick and/or die early as a result of smoking, they would nonetheless die sometime in the future. If they are covered by Medicaid at the time of their smoking-related death (illness), there is a high probability that they would also be Medicaid recipients at the time of any future, hypothetical non-smoking-induced death or illness. So the state is only "harmed" to the extent that it has to pay out money through these programs earlier rather than later. The state is not harmed in the absolute amount of money spent on smoking-related illnesses, but rather on the difference in the amount spent earlier versus the amount that would have to be spent later had the Medicaid recipient not been a smoker and, allegedly, lived longer. 27
But correcting this overcounting and claiming only the time value of Medicaid money spent on smokers is only one needed adjustment to the states' claimed losses. The other two adjustments are more controversial. The first is to take into account the tax revenues collected by states from the sale of cigarettes; the second is to take into account Medicaid savings from the premature mortality of smokers.
As to the first, cigarettes are legal products, and they are heavily taxed by the federal and state governments. According to a 1995 study by Professor Viscusi, total cigarette taxes, federal and state, averaged 52.6 cents per pack in 1993, an amount equal to 31.4 percent of the retail price of cigarettes. The federal tax collected $5.5 billion, or an average of 24 cents per pack, while the state taxes collected $6.2 billion, or 28.6 cents per pack. 28
How do the substantial tax benefits that the sale of cigarettes produces for the states compare with the alleged social costs of smoking? Professor Viscusi's article addressed just this question by updating a widely respected 1991 RAND study. 29 Viscusi concluded that in 1993 dollars, the costs for medical care imposed on society by smokers were in the range of 50 to 55 cents per pack. 30 Since, as noted earlier, the 1993 average tax on cigarettes is 52.6 cents per pack, it appears that as of the early 1990s smokers were paying taxes each year sufficient to cover the Medicaid outlays for patients who smoke. At current tax rates and current levels of Medicaid spending, smokers as a group in most, if not all, states are "paying their own way" from year to year with respect to publicly funded health care. 31
The plaintiff AGs argue strenuously that the states' cigarette tax revenues should not be viewed as an "offset" against the tobacco companies' potential liability. They point out that the cigarette tax revenues are not earmarked for the Medicaid program, and thus should not be counted as if they were used to help defray the health care costs of smokers.
But this argument gets it exactly backwards. Smoking is, if you will, the "but for" cause of the tax collection. If cigarettes were banned, there is no way a state could raise millions of dollars each year from these same people--since there would be no other way to identify this group. The fact that the revenue is currently diverted from the use of smokers towards more general uses should be seen as a reason for giving smokers the benefit of viewing their cigarette tax payments as offsets against the tobacco companies' liability, especially since smokers will pay much of any "recovery" by the states in the Medicaid lawsuits.
The second controversial adjustment that should be made to any state claim of financial damage from smoking is one that takes into account the savings to the state government from the premature deaths of smokers. Professor Viscusi's reworking of the RAND data puts the point very clearly: "The financial savings from premature mortality in terms of lower nursing home costs and retirement pensions exceed the higher medical care and life insurance costs generated." 32 In another 1995 article, Viscusi reported that smokers in fact save society 20 cents per pack in nursing home care and $1.00 per pack in terms of lower pension and Social Security costs. On balance, smokers save society 27 cents per pack from an insurance standpoint. This amount excludes the role of the taxes smokers pay, which average 53 cents per pack of cigarettes. 33 (emphasis added)
Put bluntly, the state treasuries are probably benefitted by smoking, since the early deaths of smokers reduce state health care outlays through Medicaid in later years, particularly in nursing home costs.
But should such effects be taken into consideration by the conscientious AG trying to decide whether to sue the tobacco companies? The judge hearing the Mississippi case apparently rejected that argument. 34 But Professor Viscusi contends that public policy-makers should not ignore this information:
[W]hen one is assessing these externalities [of smoking], it is certainly not appropriate to tally only the potential adverse consequences of smoking, such as the effects on Medicare or health insurance costs, and to neglect systematically the estimated cost savings to society. Proper assessment requires that all legitimate effects be considered. 35
Even if one is not prepared to take the savings on pensions and nursing home care into account, 36 the fact that smokers pay to the state and federal governments cigarette taxes that equal or exceed the most widely cited estimates of the publicly financed costs of medical care for smokers should be enough to convince a fair-minded person that the claims being asserted by the states against the tobacco companies are of dubious value. 37
Any state recovery in these Medicaid lawsuits would be to a large extent functionally equivalent to a tax increase on cigarettes. If this is what the plaintiff AGs are after, a simpler and more constitutionally sound route would be through their state legislatures.
Assume a state successfully sues the tobacco companies for Medicaid reimbursement-- either it settles with the defendants or prevails at trial. Assume further that the settlement or litigated judgment directs the defendant firms to pay money into a state's treasury, and that the settlement or judgment directs the companies to pay two amounts: 1) a lump sum compensatory amount for past state expenditures on Medicaid; and 2) an additional amount each year in the future to compensate the state for future Medicaid expenditures.
Who will really pay these amounts?
This at first seems an odd question with an obvious answer: The tobacco companies will write the check out to the state, so they will be paying the tab. That, at least, seems to be one of the primary objectives of these lawsuits. Thus, the State of Florida's contract with its outside attorneys declares that one reason for the lawsuit is to force the tobacco companies to pay:
[C]onsumers and smokers pay tobacco taxes, not the tobacco companies. The tobacco companies, not smokers, should pay for the damage caused by tobacco companies' unlawful conduct.
However, contrary to the State of Florida's expressed wishes, the courts cannot stop the tobacco companies from passing along a substantial portion of any recovery in such cases to their customers.
The amount of any judgment paid to any state in future years would represent an increase in the tobacco companies' cost of doing business--just like an increase in the costs of labor or raw materials. Presumably, the companies would treat the prospective payments to the state as they would any other cost increase, and pass as much of it along to their customers as the market will bear.
This strategy for passing on the costs of litigation was widely discussed in press reports of the settlement negotiations in mid-April. The price increase most often mentioned was 50 cents per pack. 38
Clearly, the price of cigarettes would increase by some amount. The size of the price increase would depend on what economists call the "elasticity of demand" for cigarettes. Demand for cigarettes tends to be relatively inelastic (price-insensitive); thus, a relatively large share of a cigarette tax increase is likely to be passed along to smokers in the form of higher prices. 39 Indeed, "[e]mpirical evidence suggests that excise tax increases are in fact passed on to smokers." 40
Since any prospective payments by the tobacco companies to a state would be identical to an increase in the excise tax paid on cigarette purchases, it is clear that a large portion of any future payments from tobacco companies to the state's treasury is likely to come from the pockets of the state's smokers.
Whether all or a portion of any once-and-for-all payment to the treasury for past Medicaid expenditures would also be passed along to smokers is a more complex question. It might have the effect of a "lump-sum tax," which economists define as a one-time occurrence that the subject companies have difficulty passing along to consumers.
However, in our hypothetical settlement/judgment scenario, this payment would be made by the tobacco companies in conjunction with a promise to make future payments. Under these circumstances, it would be easier for any given company to add the lump-sum amount into the amount by which it wishes to raise its retail prices, with a strong suspicion that the other tobacco firms will do likewise. In this setting, then, even a portion of a retrospective, lump-sum payment may well be passed along to consumers by the tobacco companies.
Simply put, smokers will pay a large share of any state recovery in these suits--much as they would pay for an increase in the state tax on cigarettes.
A final set of arguments against the Medicaid suits focuses on the constitutional and jurisprudential problems they present. As to the former, once the suits are seen as likely, if successful, to result in something very like a tax increase on cigarettes, then the better course is to leave this question to the statelegislatures. Tax policy is constitutionally the responsibility of the legislative branch; it should not be handed to the judicial branch in the guise of a lawsuit.
One possible area of jurisprudential fallout from these cases has already been noted--namely, the creation of a new, potentially very large range of tort liability for manufacturers and sellers of legal products that have a statistically significant negative effect on the health of the public. Another potential negative effect on a state's legal system can be identified: the alignment of its attorney general, the state's chief law enforcement officer, with the activist elements of the plaintiffs' trial bar.
It is singularly unwise for a state AG's office to take the same attitude toward the law as does the plaintiffs' bar. A responsible state AG is concerned with the orderly and rational development of the state's laws and the maintenance of the state's constitutional order, including the separation of powers. The most thoughtful and ethical plaintiff's lawyer has, by design, less interest in these than the attorney general should, while the practice of the most aggressive plaintiffs' lawyers seems at times to mock the very idea of stability and predictability in the legal system. For the AG to adopt a push-the-envelope, win-at-all-costs attitude, and have no more concern than would a contingent fee attorney in private practice for the proper functioning of the legal system, would be a bad decision indeed. 41 The alliance between the AGs and the plaintiffs' bar threatens to be an unholy one, and should be avoided.
As a matter of legal policy, the states' Medicaid reimbursement suits are a bad idea and should fail. As a matter of public finance, smokers cannot be shown to impose a net social cost on the public treasury. Further, any recovery the states receive from the tobacco companies could and would be largely passed through to smokers. This would amount to a disguised increase in the state tax on cigarettes. The "free money" aspect of these lawsuits touted by the plaintiff AGs and their trial lawyer allies is largely an illusion.
If a state government wishes to raise additional moneys to cover the smoking-related charges against its Medicaid program, its legislature can raise the state's cigarette tax, unless that tax is already so high that any further increase will have a negative effect on tax revenue. 42 (If this is the case, however, then a successful suit by that state to "recover" Medicaid money will also have a negative effect on tax revenue.)
The costs of a tax increase would fall largely on the same people--smokers--as would the costs of a successful Medicaid lawsuit. No bounty need be paid to the plaintiffs' bar. In addition, a cigarette tax increase would be much simpler, much cheaper, and much quicker than a lawsuit against the tobacco companies, and would pose no danger to a state's constitutional order or the rest of its legal system.
1. I have reviewed the complaints filed by the states of Connecticut, Florida, Louisiana, Maryland, Massachusetts, Minnesota, Mississippi, Texas, Washington, and West Virginia. These materials, and much more information on the states' lawsuits, can be found at the "State Tobacco Information Center" web page, maintained by Northeastern University, at http://www.stic.neu.edu.
My work on this subject was undertaken while I was a member of a task force appointed in 1996 by Alabama Governor Fob James and then-Attorney General Jeff Sessions to render advice as to whether the State of Alabama should file a Medicaid reimbursement suit. The task force's report recommended against filing suit. In January 1997, Jeff Sessions was sworn in as a U.S. Senator from Alabama, and William Pryor became Attorney General. Pryor had chaired the task force in his capacity as Deputy Attorney General. He has since announced that he does not intend to file suit against the tobacco companies.
The task force's report will be reprinted in a forthcoming issue of the Cumberland Law Review. To order a copy, call 205/870-2757.
2. Of the ten states I reviewed, six--Connecticut, Louisiana, Maryland, Mississippi, Texas, and West Virginia--have specifically asked for punitive damages, and Florida has announced its intention to amend its complaint at a future date to seek punitives. In addition, a class-action suit filed by Alabama Lieutenant Governor Don Seigelman in August 1996 seeks punitive damages.
3. Milo Geyelin and Suein L. Hwang, "Liggett to Settle 22 States' Tobacco Suits," The Wall Street Journal, March 21, 1997, page A12.
4. Alix M. Freedman and Suein L. Hwang, "Philip Morris, RJR and Tobacco Plaintiffs Discuss a Settlement," The Wall Street Journal, April 16, 1997, page A1.
5. John M. Broder, "2 Top Cigarette Makers Seek Settlement," The New York Times, April 17, 1997, page A1.
6. Susan Pulliam, "Investors Buy Tobacco Stocks and Guess a Pact Wouldn't Be Smoke and Mirrors," The Wall Street Journal, April 17, 1997, page C1.
7. Eddie Dominguez, "Tobacco Considers Lawsuit Settlements to Guard Its Stocks," Birmingham News, April 17, 1997, page 1C.
8. See 42 C.F.R. §§433.137(a), 433.145-46(a) (1995).
9. Agency for Health Care Admin. v. Associated Industries of Florida, 678 So.2d 1239 (Fla. 1996), cert. denied, 117 S.Ct. 1245 (1997).
10. City and County of San Francisco v. Philip Morris, Inc., 1997 WL 102504 (N.D. Cal. 1997).
11. Agency for Health Care Admin., 678 So.2d at 1246.
12. Agency for Health Care Admin., 678 So.2d at 1250.
13. This refers to a defendant's ability to argue that the relevant statute of limitations period has run, thus barring the plaintiff's suit.
14. Agency for Health Care Admin., 678 So.2d at 1249-50.
15. For critical commentary on the Florida statute, see Richard N. Pearson, "The Florida Medicaid Third-Party Liability Act, Florida Law Review 46 (1995), pages 609-634; and William Van Alstyne, "Denying Due Process in the Florida Courts: A Commentary on the 1994 Medicaid Third-Party Liability Act of Florida, Florida Law Review 46 (1995), pages 563-589. For commentary in favor of the statute, see Elizabeth A. Frohlich, "Statutes Aiding States' Recovery of Medicaid Costs from Tobacco Companies: A Better Strategy for Redressing an Identifiable Harm?" American Journal of Law and Medicine 31 (1995), pages 445-472; and Jonathan S. Massey, "The Florida Tobacco Liability Law: Fairy Tale Objections to a Reasonable Solution to Florida's Medicaid Crisis," Florida Law Review 46 (1995), pages 591-607.
16. Agency for Health Care Admin., 678 So.2d at 1256, 1253-54. The three dissenting justices, in a strongly worded dissent, argue that the 1994 amendments' abrogation of affirmative defenses and provision for the joinder of claims also are unconstitutional. Agency for Health Care Admin., 678 So.2d at 1258-61.
17. Milo Geyelin, "Florida Court Upholds Most of a Law Making Tobacco Firms Pay for Illnesses," The Wall Street Journal, June 28, 1996, page B5.
18. Barnaby J. Feder, "Multitude of Tobacco Lawsuits Provides Bargaining Chips for Negotiators," The New York Times, April 17, 1997, page A13.
19. Susan Pulliam, supra note 6.
20. Quoted in Milo Geyelin and Suein L. Hwang, "What Brought Big Tobacco to the Table," The Wall Street Journal, April 18, 1997, page B1.
21. Alix M. Freedman and Suein L. Hwang, supra note 4.
22. Note also that it appears that the private attorneys representing West Virginia are working pro bono--that is, without pay. This might make sense from the attorneys' point of view if they expect the state's litigation to make easier their representation of individual smokers suing the tobacco companies.
23. For example, according to The Wall Street Journal, the Florida suit was designed with the idea of "recover[ing] the $400 to $450 million a year that some state officials estimate is spent treating Medicaid recipients with smoking-related ailments." (emphasis added) See Milo Geyelin, supra note 17. This article also states that the Florida Supreme Court's denial of any retroactive effect to the Florida Medicaid statute "would vastly reduce the $1.4 billion in damages the state had originally sought." Florida has agreed to hand over 25 percent of its recovery to the trial lawyers who are handling the case.
24. Alix M. Freedman and Suein L. Hwang, supra note 4.
25. W. Kip Viscusi, Smoking: Making the Risky Decision (New York, NY: Oxford University Press, 1992), page 7.
26. A Latin term sums up this bedrock idea. Injuria absque damno translates as "Injury or wrong without damage. A wrong done, but from which no loss or damage results and which, therefore, will not sustain an action." Black's Law Dictionary 924 (West Pub. Co., revised 4th edition, 1968). See generally 22 Am. Jur. Damages §4, 1 Am. Jur. Actions §56.
27. A simple example will illustrate the point. Assume that John Doe, a smoker, is hospitalized and eventually dies in 1997 from a smoking-related illness, and that the state pays $10,000 toward his medical bills through Medicaid. Assume also that we can predict that Doe, were he not a smoker, would have lived another four years. Assume in that case that the state would have paid $10,000 toward his medical bills in the year 2001 through Medicaid. The only loss to the state is the "time value" of this $10,000 for the four-year period from 1997 to 2001. The time value of money is typically thought of in terms of lost interest. Thus, the state has, in a sense, "lost" the interest on $10,000 for four years, as a result of the fact that John Doe was a smoker, and died earlier rather than later. The state has not "lost" $10,000 as a result of Doe's smoking. Thus, simply adding up Medicaid moneys expended on smokers greatly overstates the state government's "loss."
28. W. Kip Viscusi, "Cigarette Taxation and the Social Consequences of Smoking," in James Poterba, editor, Tax Policy and the Economy, Volume 9 (Cambridge, Massachusetts: MIT Press, 1995), page 57.
29. Willard G. Manning et al., The Costs of Poor Health Habits (Cambridge, Massachusetts: Harvard University Press, 1991).
30. W. Kip Viscusi, supra note 28, pages 73-75.
31. It should be noted that the "pay their way" point is not meant in an insurance sense. That is, the cigarette tax receipts are not put into an insurance fund to cover the future Medicaid claims of today's smokers. There is no reason why this could not be done, however.
32. W. Kip Viscusi, supra note 28, page 51.
33. W. Kip Viscusi, "Secondhand Smoke: Facts and Fantasy," Regulation (1995 No. 3), page 46.
34. Alix M. Freedman, Suein L. Hwang, and Milo Geyelin, "Tobacco Firms Offer to Disclose Research," The Wall Street Journal, April 17, 1997, page A2.
35. W. Kip Viscusi, supra note 28, page 72.
36. This is not to suggest that savings on pensions and nursing home costs are the only financial benefits that state governments may reap from the early deaths of smokers. For another possible saving, consider that the costs of medical care have for many years increased at a rate faster than the rate of inflation. The effect of the increasing costs of medical care may outweigh the foregone interest involved in the state's paying for earlier deaths.
37. One study, which is now touted heavily by the lawyers for the plaintiff states, puts the publicly financed cost of smokers' medical care at 89 cents per pack. See Centers for Disease Control, "Current Trends: Medical-Care Expenditures Attributable to Cigarette Smoking--United States, 1993," Morbidity & Mortality Weekly Report 43 (1994), pages 469-472. Because this study is only four pages long, it is difficult for the non-specialist to decipher. Its estimate is much larger than the estimates of the two, much-longer RAND and Viscusi studies, both of which are quite highly respected. Further, a 1994 report by the Congressional Research Service noted that the methodology of the RAND report "was the most thorough and its 'spillover' cost figure of thirty-three cents a pack was the median for all studies on the subject." See Richard Kluger, Ashes to Ashes: America's Hundred-Year Cigarette War, the Public Health, and the Unabashed Triumph of Philip Morris (New York, NY: Alfred A. Knopf, 1996), page 736. Finally, the fact that Professor Viscusi does not discuss the CDC study in his 1995 publications raises the question whether these CDC numbers are taken seriously by researchers in the field.
38. See Alix M. Freedman and Suein L. Hwang, supra note 4; John M. Broder, supra note 5; Susan Pulliam, supra note 6; and Steve Bailey and Steven Syre, "Boston Capital: $300b Settlement Wouldn't Likely Choke Tobacco Firms," Boston Globe, April 17, 1997, page D1.
39. Richard A. Musgrave and Peggy B. Musgrave, Public Finance in Theory and Practice, 5th edition (New York, NY: McGraw-Hill Book Co., 1989), pages 250-254.
40. Willard G. Manning, supra note 29, page 170.
41. For a similar assessment, see Max Boot, "The Plaintiff's Bar Targets Tobacco Companies," The Wall Street Journal, March 20, 1996, page A15. Boot warns, "States shouldn't sink into the contingency fee swamp."
42. Obviously, there comes a point where further increases in an excise tax have such a negative effect on consumption as to be counterproductive. In short, there is a Laffer curve for cigarette taxes, just as there is for other kinds of taxes, and a state legislature ignores this fact at its peril. For a thorough discussion of the effects of cigarette tax increases on consumption and smuggling, see John D. Jackson and Richard P. Saba, "Some Limits on Taxing Sin: Cigarette Taxation and Health Care Finance," Southern Economic Journal 63 (1997), pages 761-775.
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