Cheap cigarettes from little tobacco companies have fouled up the deal that big tobacco companies made with taxpayers.
Little companies grabbed eight percent of the market from 1997 to 2003, according to a March 27 report from the Brattle Group in San Francisco.
The report could trigger a reduction of annual payments from tobacco companies to the 46 states that signed the 25-year agreement.
Companies have paid $41 billion so far, according to the March 28 Financial Times.
The agreement calls for companies to pay $6.5 billion on April 17, but it also requires adjustment if states have failed to enforce laws that should cripple competition.
Under identical law in 46 states, companies that did not sign the agreement gain no financial advantage by staying out. Outsiders must pay into escrow accounts.
Outsiders get their escrow back in 25 years, if no state successfully sues them.
From an outsider's angle, the agreement looks like a state sponsored cartel.
"The agreement made states directly interested in the profits of the big companies," said Everett Gee, general counsel of S & M Brands Inc. in Keysville, Va.
"Their volume is down but they are making record profits," Gee said. "That does not compute without a cartel."
S & M Brands makes Bailey cigarettes. Gee said the Bailey family has grown tobacco for five generations. He said they started making cigarettes in 1994.
Gee disputed the Brattle Group's finding that companies lost market share because of the agreement. He said they lost market share because of greed.
He said they increased prices more than enough to pay the states. He said, "These prices shocked the consumer."
Some companies make money by nickels and dimes instead of dollars, he said.
He said signers of the agreement would have lost more than eight percent of the market if states had not protected them.
"At those prices you would expect 60 to 70 percent," he said.
In 1998, Gee said, the Baileys received a letter from a law firm giving five days to sign the master settlement agreement.
"We would have had to pay in states where we never sold a cigarette," he said.
The Baileys did not sign. They started making escrow payments.
"We have paid our escrow always," Gee said. "We are under the largest scrutiny."
He estimated the escrow at $4.35 per carton, but won't know until next year.
Like households paying income tax, cigarette makers compute the escrow at year's end and send payment in April.
For companies that signed the agreement, the Brattle Group report gave owners three weeks to decide whether to adjust payments.
R.J. Reynolds in Winston-Salem, N.C., had not decided as of April 5.
Spokesman David Howard said the company might apply an offset of its 2003 payment to its 2005 return. He said the report would support an offset.
If the company applies the offset and states challenge it, he said, the agreement would require binding arbitration.
He said states would have to prove to arbitrators that they diligently enforced the laws.
States and companies that signed the agreement jointly hired the Brattle Group. States do not permit taxpayers to read the report.
States and companies that signed the agreement jointly employ Price Waterhouse to calculate market shares. States do not permit taxpayers to read the report.
"Price Waterhouse bills the major manufacturers and the information is not shared. The attorney generals told us it was none of our business," said Gee.
Attorney generals who have paraded as heroes for raking in tobacco money suddenly occupy a sticky spot.
Legislators and governors have built budgets on the tobacco deal. Communities have borrowed billions against it.
From the attorney general's angle, however, the agreement counts as a health program rather than a revenue program.
The agreement bans merchandising and billboards. It bars youth in advertising. It pays for commercials to discourage smoking and clinics to break the addiction.
These measures have apparently worked.
The National Association of Attorneys General announced March 8 that Americans smoked fewer cigarettes in 2005 than in any year since 1951.
The association reported a 21 percent decline in cigarette sales under the agreement.
"The states applaud the decline in cigarette sales," said Iowa Attorney General Tom Miller.
He said the cost of treatment far exceeds the proceeds of the settlement and tobacco taxes.
The association's press release did not discuss the revenue impact of the decline or changes in market share.
Later in March, the association sent states a warning that their payments might fall by 18 percent.
An 18 percent drop would cut the overall payment from $6.5 billion to $5.3 billion.
When the Brattle Group issued its report, Connecticut Attorney General Richard Blumenthal said the companies were "shamelessly shirking" their obligations.
Gee said states did everything big tobacco companies asked and more.
He said, "The states did their work for them and now they want their money back."