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At the beginning of August, the Federal Trade Commission was asked by Representatives Martin Meehan, Henry Waxman and James Hansen, on behalf of the Congressional Task Force on Tobacco and Health, to prepare a report analyzing the impact of the proposed tobacco settlement on competition, prices, industry profits and revenues to the public sector. The Task Force is a bipartisan group of about 80 members of the U.S. House of Representatives.

The report we release today was prepared by the staff of the Federal Trade Commission and does not necessarily reflect the views of any Commissioner.

Reduced to essentials, the report addresses three questions:

(1) What is the likely impact of the proposed settlement on the prices of cigarettes,  

(2) Will revenues produced by any price increases equal or exceed the amount of the annual payments called for by the proposed settlement, and  

(3) If the revenues exceed the annual payments, where will the extra money go?

Briefly, cigarette prices are likely to rise more than the amount of the annual payments, and as things now stand, vast additional revenues will go to the tobacco companies.

For several reasons, the report concludes that revenues will at least equal the annual payments called for by the settlement and could be much greater. The reasons why cigarette price increases are likely to be higher than necessary to pay the annual payments include the history of the industry (ability in the past to pass on more than 100% of tax increases), structure of the industry (few sellers, customers who are relatively insensitive to price increases, and high barriers to new entry),

some aspects of the agreement could make the industry less competitive and, most important, the inclusion in the settlement of an antitrust exemption which, as presently drafted, could allow the tobacco companies to coordinate future price increases.

The staff report offers several illustrative calculations of future prices and profits.

  • If prices increase no more than necessary to pass through to consumers 100% of the annual payments required by the settlement, (about 57 cents per pack), operating profits for the industry would decline slightly.
  • If prices increase so as to produce revenues equal to 125% of the annual payments (about 71 cents per pack), revenues to the tobacco companies could increase $36 billion over the next 25 years.
  • If prices increase by 200% of the annual payments (about $1.14 per pack), revenues to the tobacco companies could be $123 billion higher over the next 25 years. 
     

The revenues to the companies assume a $50 billion tax credit is in place. If it is not enacted, as now seems likely, revenues to the tobacco companies would be somewhat less.

Let me elaborate on the antitrust exemption. As currently drafted, the settlement provides that "in order to achieve the goals of this agreement" the tobacco manufacturers may "jointly confer, coordinate or act in concert" despite the provisions of the antitrust laws. That provision was probably introduced in order to allow the cigarette companies to agree to certain marketing restrictions - for example, to discontinue advertising on billboards or sales through vending machines - without the risk of exposure to private antitrust suits based on some kind of boycott theory. The staff report concludes that a limited exemption designed to permit that kind of agreement is probably in the public interest. But as written, it covers all agreements designed to achieve the goals of the agreement and one of the goals of the agreement is to raise prices. Although possibly not intended, the current version would allow the tobacco companies to coordinate their behavior and raise prices far in excess of levels necessary to cover the annual payments and to keep the extra profits for themselves.

The report concludes that the $368.5 billion "face value" of the proposed settlement probably is excessive because it fails to take into account the general decline in smoking in the United States and the increase in that decline because of the proposed increase in cigarette prices.

Finally, the report concludes that public sector revenues would also increase if prices go up by an amount more than necessary to compensate for the annual payments. For example if the price increase produces revenues that are twice as great as the annual payments, public sector revenues should increase by about $73 billion over the next 25 years. In general any increases over the amount necessary to cover the annual payments would be shared so that two-thirds of the resulting additional revenues would be retained by the firms and one-third would go to the public sector - mostly in the form of corporate taxes.

News Release

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