Turbulent Times for Tobacco

Fasten your seat belts because 2009 will likely be one of the most turbulent years for the tobacco industry in recent memory. The outcome of the federal elections has further cemented Democratic control in both the U.S. Senate and the U.S. House and ushered in a new liberal administration with President-elect Obama waiting to be inaugurated on January 20th.

At the time this article was written, the split in the U.S. Senate was 58 Democrats, 40 Republicans and 2 undecided seats. This means the Democrats do not yet have a true “super majority” of 60 votes that is needed to overcome a filibuster, that time-honored rule that allows unending speeches on superfluous matters and brings formal Senate action to a halt.

In the U.S. House, 254 seats are held by Democrats with 173 seats held by Republicans and 8 seats in the undecided column. This Democratic majority falls short of the 287 votes needed to override a presidential veto. However, with President-Elect Obama taking office in January, there may not be much need for Congress to resort to an override vote.

The agenda for the upcoming 111th Congress will surely include two major issues that have the potential, if enacted, to dramatically impact and substantially change tobacco retailing. These issues are the expansion of the State Children’s Health Insurance Program (SCHIP) and regulation of the tobacco industry by the Food and Drug Administration.

SCHIP Spells “T-A-X-E-S”
The expansion of the SCHIP program is a top priority for the Democrats and may result in the single largest tax increase on one industry’s products in the history of the United States. With President-Elect Obama a supporter of SCHIP expansion, the possibility of a tobacco tax increase to fund the expansion looms even larger.

Enacted in 1997, SCHIP provides federal money to states to subsidize health insurance for children from families with low incomes. In the fall of 2007, the Democrats twice passed a bill expanding SCHIP by $35 billion, only to have President Bush veto the legislation both times and two attempts by the House to override the vetoes failed.

To fund the $35 billion expansion, the 2007 SCHIP bills proposed large increases in the federal cigarette and tobacco excise tax rates. These higher tax rates as shown in the table below ranged from a 156% increase in the cigarette tax up to a 6,000% rise in the tax on large cigars.

With the SCHIP program scheduled to expire on March 31, 2009, House Speaker Nancy Pelosi stated in an interview on Nov. 5th with National Public Radio that SCHIP expansion “will probably be one of the first bills on President Obama’s desk.”

However, a problem has arisen with the cost of the SCHIP expansion. In early August, the Congressional Budget Office released a report which found that the cost of a five-year expansion of SCHIP has increased from $35 billion to $45 billion and, even more troublesome, that the proposed cigarette and tobacco tax increases shown in the chart above will fall $1.6 billion short of raising even $35 billion.

With the prospect of a $1.6 billion dollar shortfall plus a $10 billion dollar higher price tag, Congress will need to assess other options to expand SCHIP. The options may include reducing the number of children covered by the SCHIP program, increasing cigarette and tobacco tax rates even further in an attempt to raise yet more revenue, or spreading the tax burden by increasing federal tax rates on other non-tobacco products.

The fallout from an SCHIP expansion bill will likely include significant cigarette and tobacco sales reductions, large increases in the number of store robberies because the value of tobacco products would be so high, a floor stocks tax on cigarette and tobacco inventory adding up to an estimated $5,000 per store, employee layoffs and even potential store closings.

FDA and Retailers
Besides SCHIP, retailers should be concerned about provisions in a future FDA bill that could have a severe impact on their retail operations.

First, the bill grants the FDA the power to adopt any regulation or restriction related to the access, advertising and sale of tobacco products “if the Secretary determines that such regulation would be appropriate for the protection of the public health.” An example of such a restriction would be Canada’s recent regulation that all tobacco products must be stored in drawers underneath store counters and out of the sight of customers.

Second, the FDA bill would ban all color advertising of tobacco products and allow only “tombstone advertising” which would consist of a white board with black letters to spell out the name of a tobacco product and the price.

Third, and perhaps most important, the FDA bill would grant all federal government agencies (except the FDA), states, counties and cities the power to prohibit “the sale, distribution, possession, exposure to, access to, advertising and promotion of, or use of tobacco products by individuals of any age.” That is, numerous federal agencies, states, counties, cities and towns would have the power to outright ban the sale of tobacco products.

While states, counties and cities have always had an implied power to regulate products to protect the health and welfare of citizens, federal government agencies have never had the power to ban the sale of tobacco products. Moreover, with a literal federal grant of the power to ban tobacco sales, anti-tobacco organizations would lobby local elected officials to enact total sales bans.

If the FDA bill is passed, one could envision the U.S. Department of Education adopting a regulation banning the sale of tobacco products within 1,000 feet of every public school. Or, the Department of Health and Human Services could prohibit the sale of tobacco products within 1,000 feet of every hospital, clinic, doctor’s office or other medical facility. Such regulations would result in an untold number of retailers that sell tobacco being forced out of business.

Killing the Golden Goose
For the past 18 months, a growing number of states have continued to raise cigarette and OTP taxes only to subsequently discover that revenue collections are either less than before the tax increase or substantially below estimated revenue projections. In short, states have been strangling, if not killing, the goose that lays the golden tobacco eggs.

This year, budget deficits may cause state legislatures to once again consider raising cigarette and OTP tax rates in an increasingly vain attempt to fill budget gaps. Specifically, the Center on Budget and Policy Priorities has identified some 27 states which have aggregate Fiscal Year 2009 budget deficits that total $49 billion dollars. The magnitude of the budget deficits is shown below:

With the economy spiraling downward into a deeper recession, lawmakers in these states will be looking for additional revenue including higher tobacco taxes to continue funding state programs or to implement new programs.

In sum, the recent national election outcome will surely result in Congress continuing to consider tobacco-related legislation including SCHIP expansion and FDA regulation. Likewise, state legislatures will continue to look to tobacco products as a source of funding.

Retailers need to be proactive and become involved in the legislative process so that their concerns are heard. Taking action by calling, faxing or e-mailing U.S. Senators and U.S. Representatives is a critical step toward educating lawmakers on how SCHIP and FDA regulation will impact retail stores. Otherwise, given the tobacco legislative threats on the horizon, taking no action ensures that the future of tobacco retail will be drastically altered.

Thomas Briant is the Executive Director of the National Association of Tobacco Outlets (NATO). He can be reached at abriant@sprynet.com.


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