State Budgets

Tobacco Settlement Fund Gimmicks Alive and Well

States have been playing games with annual payments received as a result of the 1998 Tobacco Master Settlement Agreement for years. This budget season, officials in several states continue to use gimmicks to make tobacco settlement fund money fit their desired ends.

The many varied uses of tobacco settlement funds illustrate how, despite vast differences in size, fiscal health, budgetary priorities, and more, any state can and will manipulate the budget process. The many ways lawmakers have manipulated this one source of state budget money shows the different ways officials rely on budget gimmicks.

The Tobacco Settlement

Attorneys General in 46 states and the country’s four largest tobacco companies entered into the Tobacco Master Settlement Agreement in 1998. The states had sued to recover tax dollars lost treating tobacco-related health issues. As part of the settlement, the tobacco companies agreed to pay around $200 billion to the states over the course of 25 years. The money was to go towards smoking prevention and other health-related programs.

What the money was intended to go toward is very different from how states have actually spent it. Structurally, states have varied in what they do with the money. Shortly after the payments began, for example, Oklahoma voters approved a constitutional amendment requiring that at least 75 percent of the funds received be placed in an endowment trust fund for the purpose of financing scientific research and health care services, among other things. Others created dedicated state funds separate from the regular general fund budget, ideally to ensure that the money was spent as intended. Some folded the revenue right into the general fund budget.

As the settlement funds continue to flow to states, officials continue using budget gimmicks to divert the money for other purposes. New Mexico, New Hampshire and New York are three states that illustrate the new and varied uses for the tobacco settlement funds proposed in this recent budget season.

New Mexico

When it comes to tobacco settlement revenue, the Land of Enchantment is an example of how officials have shifted the money between funds.

A New Mexico law passed in 2000 required that 50 percent of the nearly $40 million received from the settlement each year be placed in a Tobacco Settlement Permanent Fund for investment purposes, while the other half be placed in a Tobacco Settlement Program Fund to be disbursed regularly. Once the Tobacco Settlement Permanent Fund reached a certain size, it was supposed to retain all of the annual payments and annually distribute 4.7 percent of its 5-year average market value to the program fund.

The permanent fund has not been receiving the money as intended. The required 50 percent distribution occurred in only 4 of the last 12 years. In the other 8 years, the money went to replace general fund revenues. Last year, one legislative fiscal analyst told the legislature that if distribution had followed the 2000 law, the permanent fund’s balance would be $300 million instead of the actual balance of $150 million.

New Mexico’s recently enacted fiscal year 2014 budget continues to shortchange the permanent fund. This year’s deposit into the tobacco funds will be $10 million short, with that $10 million instead being swept into the state’s lottery-financed college scholarship fund.

Governor Susana Martinez vetoed part of the budget that would have shifted $50 million from the state’s cash reserves to replenish the Tobacco Settlement Permanent Fund. The merits of that decision are difficult to judge in the vacuum of a single budget season. Its existence as an issue stems, ironically, from years worth of budget gimmicks that underfunded the tobacco settlement fund in the first place.

New Hampshire

While New Mexico’s tobacco funds gimmick is a rather simple case of shifting money between funds, New Hampshire’s budget plans involve a truly impressive financial scheme.

In 2006, the biggest tobacco companies began withholding a portion of their annual payments claiming that they were owed a refund as a result of losing market share to what are referred to as Non Participating Manufacturers (NPM’s). 17 states including New Hampshire, plus Puerto Rico and the District of Columbia, recently entered into another settlement with the companies to begin receiving the disputed payments immediately.

But there is a catch, according to New Hampshire’s Josiah Bartlett Center for Public Policy:

In exchange for a share of the disputed funds up front, states would start paying the NPM Adjustment back. While state treasuries would get a quick cash infusion from the settlement, they would have to pay back half of the amount almost immediately, and most of the rest of the settlement over the next four years.

The gimmick does not stop there. The state is scheduled to receive $30 million from the deal this month, well within fiscal year 2013. However, the state budget that passed the House last week with the support of Governor Maggie Hassan counts $21.6 million of the payment as fiscal year 2014 revenue and $2.5 million as fiscal year 2015 revenue.

Normally, this would be explained as a case of officials desperately searching for revenues to balance the 2014 budget. In this instance, many seem to be against receiving the money as part of 2013 specifically to end the fiscal year with a budget deficit.

But why? The Josiah Bartlett Center explains:

Governor Maggie Hassan wants to sweep surpluses from unidentified dedicated funds throughout state government, but the budget only gives her that authority if it’s to cover a deficit. Booking the tobacco settlement money in FY13 would create a surplus, sending money into the state’s Rainy Day Fund. Booking the money after June 30th would make it available to support General Fund spending.

New Hampshire officials intend to manipulate the fiscal calendar to create a short-term deficit, so that it can sweep money out of dedicated sources to increase general fund spending in the next fiscal year.

New York

New York receives nearly $800 million every year in payments from the tobacco settlement. Instead of creating a dedicated fund, though, the money heads straight into the state’s general fund. From there, it is allotted through the regular budget process. This approach reduces the opportunity for obvious gimmicks like those currently being employed in New Hampshire and New Mexico. It also makes it easier for lawmakers to use the funds however they wish and it makes tracking their use more difficult.

New York has been a leader in issuing debt backed by tobacco settlement funds. 2012 financial reports list $2.7 billion in outstanding Tobacco Settlement Revenue Bonds. In the approved fiscal year 2014 budget, much of New York’s tobacco settlement money has been used to service this debt, while spending on anti-smoking programs has fallen from $85 million in 2008 to $40 million.

Tobacco settlement-backed debt

New York’s history of issuing tobacco settlement-backed debt is not entirely an outlier. States and localities have combined to issue $55 billion in bonds backed by tobacco settlement funds. Debt always carries risk and is a sad substitute for responsible budgeting, but issuing tobacco settlement-backed debt in the first place is downright baffling. The settlement was intended to pay back money that the states had spent covering tobacco related health issues. The money was supposed to be spent to reduce cigarette usage. Yet as smoking rates decline, so will the amount that the tobacco companies have to give to the states each year.

According to the New York Times, the states and other governments used 40-year projections of future tobacco payments that proved too distant to predict accurately. Last year, the Times wrote that many state-backed bonds were in jeopardy of default. Indeed, Moody’s Investors Services rated $20 billion worth of tobacco bonds in 2012 and found that if cigarette purchases continued to decline at their recent pace of 3-4 percent annually, 74 percent of the bonds rated will miss payments. The decision by many states, including New York, to issue debt backed by the promise of future revenues was irresponsible and shortsighted.

These examples are just some of the most recent instances of states playing games with their tobacco settlement funds. The number of gimmicks stemming from one single source of revenue across the 46 states that receive annual payments, along with the creativity put on display, is staggering.

Sadly, it is likely that these gimmicks will continue year in and year out until the settlement payments are wound down and many of the states wake up to find themselves buried in debt and clamoring for new sources of revenue to plug the holes in their budgets created by the repeated use of gimmicks.

In Depth: State Budgets

Smart budgeting is vital to a state’s financial health. The ALEC State Budget Reform Toolkit offers more than 20 policy ideas for addressing today’s shortfalls in a forthright manner, without resorting to budget gimmicks or damaging tax increases. One way to stabilize budgets over time is to embrace…

+ State Budgets In Depth