The Legislative Landscape

November/December 2007

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Worried about tobacco regulation? Here’s a look at where legislative issues stand—and where they’re likely to go from here.

By Jennifer Gelfand

The tobacco legislative landscape constantly shifts. Each year brings new efforts from state governments looking to fatten coffers by hiking taxes on cigarettes and tobacco. And, not be outdone, the federal government continues its threat to give regulatory control over tobacco to the Food and Drug Administration (FDA). Meanwhile Congressional leaders have been pushing State Children’s Health Insurance Program (SCHIP) legislation that would raise funds by increasing the excise tax on tobacco. President Bush has already made good on his promise to veto the SCHIP bill and Congress has proved unable to override that veto—yet.

In short, whether Congress will manage to take action on either front is up for debate. Tom Briant, executive director of the National Association of Tobacco Outlets, sums up the situation with one word: “uncertain.” (See “NATO News,” p. 16.)

FDA On the Way?

While the bill to give the FDA regulatory authority over cigarettes and smokeless tobacco products has yet to pass the Senate or the House, it has now passed the Senate Health, Education, Labor and Pensions Committee. Congress, however, has a very full plate in the current session, which makes consideration of the FDA legislation by the Senate or House unlikely. “We do not think the FDA bill will be given serious consideration for passage this year,” says Briant. “In 2008, it will really depend on who is elected to the presidency. If a Democrat comes into office, the bill will probably be held over until he or she takes office, since having a Democratic president would increase the likelihood of support from the White House.”

Manufacturers have been watching the scene unfold with apprehension—and some degree of consternation. “Sometimes it seems there is momentum behind FDA legislation from certain legislators who are keen on it,” notes Ron Denman, vice president of General Tobacco. “Then other times you look at comments from groups—including the FDA—that indicate that this will be a burdensome task for them. So it’s hard to tell what will happen.”

Most retailers and manufacturers, however, agree that FDA regulation would ultimately add an expensive layer of bureaucracy to the industry with little to no benefit for consumers. “Manufacturers will pass on whatever expense they incur in price hikes, which means it’s the consumer who will pay in the end,” says a retailer who wishes to remain anonymous. “And what will they gain? Some extra words on the package?”

Still, it seems unlikely that the FDA legislation—which has become something of a fixture on the legislative landscape—will simply fade away. And that means retailers would do well to monitor new developments by subscribing to the NATO E-News Bulletin, which offers regular updates as well as support for retailers in getting their voices heard on the issue.

The SCHIP Situation

While the Senate and the House originally passed different forms of legislation extending the SCHIP program, the differences in those two versions were reconciled in a compromise bill negotiated by Senate and House leaders. The compromise version of the legislation sought to fund the $35 billion expansion of SCHIP by substantially increasing the federal excise taxes on cigarettes, cigars, pipe tobacco, smokeless tobacco and roll-your-own tobacco. This would likely result in significant sales declines for outlet businesses. Particularly worrisome is the bill’s “floor stocks tax provision” which, according to Briant, would require “retailers to pay the difference between the current tax and the new tax on every tobacco product in inventory except large cigars.” That provision alone could force many retailers out of business.

The SCHIP legislation carries an especially punitive tax hike on handmade cigars, from 5 cents to as much as $10 per cigar by some estimates. This federal cigar tax is the single biggest threat the cigar industry has ever faced, say major players.

“While we understand the need for federal government to raise revenue to operate, I think all cigar manufacturers agree that the level of taxation being discussed on cigars has been absurd,” says Aaron Guenther, director of marketing, Toraño Cigars. “We’re looking for fair and reasonable taxes in government, not the opportunity to fund every project of Congress with ridiculous numbers.”

Fortunately, President Bush vetoed the bill, expressing apprehension about “legislation that would raise taxes on working people, and would raise spending by between $35 billion and $50 billion.” Congress then attempted to override the president’s veto on October 18, but failed. Still, industry veterans are concerned about Congress continuing to press on the bill.

“When [politicians] set their minds on something, it is very hard to persuade them,” notes Larry Sherman, EVP of Nat Sherman. “It’s unfortunate that these Congressmen buy into the illusion that tobacco products are elastic and that they can continue to tax them at an increasing rate without affecting [sales]. There are so many livelihoods dependent on this business and so many people who are passionate about what they do who are simply not represented when you hear talk about this bill.”

Debate on the SCHIP is expected to continue well into 2008, with an interim measure extending the programming temporarily without any cigarette or tobacco tax increases.

Tom Briant of NATO, who has been following the bill closely since its inception and will continue to keep NATO members informed about new developments, says that response within the industry has been vigorous. And that, says Jon A. Huber, chief marketing officer of CAO International, is one of the few positive developments of the challenging legal environment.

“The current legislation, and specifically SCHIP, looms over not only this industry, but also over the very choice or capacity that a citizen of this country will potentially have to enjoy a once-affordable luxury such as a premium cigar,” points out Huber. “I suppose the upside of the situation at hand is that it has really bonded the industry together and provoked us to have a unified force in order to combat this egregious tax and preserve the rights of cigar lovers to continue to enjoy their passion at a reasonable cost.”

Insanity at the State Level

If the federal front is uncertain, the state regulatory climate is a muddle of ill-advised proposals intended to boost revenues and balance state budgets, but which industry experts point out are just as likely to backfire. “On the state level, we still see state governments looking to cigarettes and tobacco taxes to fund more and more programs, including health care coverage,” notes Briant. “And with the cigarette and tobacco tax rates becoming so high, we now have evidence that states with the highest tax rates are collecting less than they did before their most recent tax increases.”

The states collected $21 billion in state excise taxes and settlement payments in Fiscal Year 2006 alone. That’s nearly triple the $7.2 billion they collected just a decade before. But as it turns out, the law of diminishing returns applies to tobacco tax. According to the Asbury Park Press, New Jersey was the first state in the country to experience a decline in cigarette tax revenues after hiking cigarette taxes in 2007. New Jersey boosted cigarette taxes from $2.40 to $2.57 per pack in 2007—the highest in the country—fully expecting the increase to bring in additional revenues that would balance the state’s budget. Instead, New Jersey collected $23 million less in revenue than it did the prior year when the tax was lower.

A similar scenario occurred in South Dakota, where a ballot questions authorized raising the cigarette tax by $1 per pack. The department of treasury in Dakota subsequently reported that the resulting revenue is $300,000 less than what they had expected in the first three months that the new tax rate was in effect alone.

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Why the disconnect between expectations and results? “There are a few reasons,” says Briant. “First, consumers go across borders to neighboring states with lower taxes on cigarettes or purchase more cigarettes at Native American reservations, which pay lower taxes. They also turn to the Internet and the black market.”

Meanwhile, state authorities simply don’t have the manpower to enforce the tax laws. “Do you really want the [Department of Revenue and Regulation] to be stopping cross-border traffic… to check for unstamped cigarettes?” asked Revenue Secretary Paul Kinsman in an interview with the Sioux Falls Argus Leader. “It would be a huge undertaking…”

Ultimately, both the federal and state governments may need to rethink their fund-raising efforts. “There comes a breaking point where you don’t accomplish your funding goals because people start to find other ways to get that product,” notes Sherman. “We’ve seen increased theft of cigarettes, more counterfeit cigarettes, and an increase in contraband.”

The development of a black market is particularly worrisome for those who work in the industry. The more profitable black market trafficking of untaxed cigarettes becomes, the more attractive it is to serious criminals, notes Andy Kerstein, owner of Sea Bright, New Jersey-based Smoker’s Haven and vice president of NATO. “Tax increases in recent years have virtually doubled the price of cigarettes in New Jersey,” he says. “So naturally you have a much bigger black market.” Retail store break-ins and holdups will only become more prevalent as taxes rise, he adds. Similarly, for manufacturers the prospect of a warehouse theft or truck hijacking rises in direct proportion to the market cost of cigarettes.

Finally, an increasing number of states and municipal governments have also been seeking to pass bans on smoking in public places. There are now more than 2,216 U.S. municipalities with smoking restrictions, with 461 stipulating a total ban on smoking in private workplaces, government buildings, restaurants, and/or bars. What’s more, hundreds of localities have also adopted restrictions such as limiting the distribution of tobacco product samples and restricting or prohibiting self-service displays.

Thus far, organizations like NATO have been successful in defending many recent attempted smoking bans. In 2007, for example, of 25 states that considered statewide smoking restrictions, only nine were adopted. That’s an admirable track record, but it still means nine more states enacted bans of some sort—which is far from good news for tobacco outlet retailers. •

TAX RATES BY STATE

NATO Drives Letter Campaign

Retailers are encouraged to write to newspapers and politicians.

The National Association of Tobacco Outlets (NATO) has been driving a letter campaign encouraging its retail members to express their concerns about proposed legislation that will impact the outlet industry. Letters to both local newspapers and legislators can help educate the public and elected officials about the potential affect of excessive tax increases on consumers and the industry, points out Tom Briant, executive director of NATO.

NATO members responded to the request with enthusiasm, reported Briant in a recent edition of the NATO E-News Bulletin. “Examples include Terry Long of Smokin’ Joe’s in Salt Lake City, Utah; Kenneth Young, Jr. of Young’s Tobacco Stores in Port Neches, Texas; and John Dan Gielen of Tobacco Plus Discount Outlets in Crowley, Louisiana. NATO facilitated the letter campaign by providing the text for the letters, as well as contact information for the appropriate state legislators.

Several retailers were successful in getting their letters printed in local newspapers. Young of Young’s Tobacco Stores in Port Neches, Texas, e-mailed a letter to four of his local newspapers that was subsequently printed in the Beaumont Texas Enterprise newspaper. Young’s letter—which used text supplied by NATO—commented on the proposed SCHIP legislation passed by Senate as follows: “In the history of the United States, there has never been such an enormous tax increase on a single product.”

NATO also coordinated a joint letter effort by partnering with eight national and regional trade associations, including the American Wholesale Marketers Association (AWMA), the Cigar Association of America (CAA), the National Association of Convenience Stores (NACS), the National Association of Truck Stop Operators (NATSO), the National Grocers Association (NGA), the Petroleum Marketers Association of America (PMAA), the Retail Tobacco Dealers of America (RTDA) and the Southern Association of Wholesale Distributors (SAWD). Campaigns like these ensure that the industry’s voice is heard on essential issues impacting tobacco outlets. TOB encourages retailers to stay up to date on new developments and participate in such letter and call campaigns. •