Big Tobacco's Showdown In The West

Barring a PR miracle, California is about to add $2.60 in tax per pack of smokes

In California, ads for the Nov. 7 elections normally wouldn't make it to TV before Labor Day. But for Proposition 86, tobacco companies got a big head start. The measure would impose the largest one-time cigarette tax hike ever -- adding $2.60 to a pack of smokes, on top of an existing 87 cents excise tax, bringing the average price per pack to $6.55. So, by early August, viewers were blitzed with a $7 million ad campaign criticizing the hospital corporations that helped write the proposal. By itself, Altria Group Inc.'s (MO ) Philip Morris, maker of No. 1 brand Marlboro, has put more than $17 million toward fighting the measure.

A loss on Prop 86 would add to a series of statehouse setbacks for Big Tobacco. Of late, cigarette makers have won some major legal battles, including drastically reducing the Justice Dept.'s once-mammoth suit against the industry. But tobacco companies may yet lose the war. Price increases are a singularly effective smoking deterrent, especially among the young. And since 2002, according to the Campaign for Tobacco-Free Kids, 42 states have raised smoking taxes, as have Washington, D.C., Puerto Rico, and Guam.

That's despite the states' generally good financial shape, and despite the tobacco industry's famously vigorous lobbying efforts. A $1 hike approved in Texas in May was fought by 52 separate lobbyists paid for by industry (15 of them by Philip Morris alone), according to Texans for Public Justice, a state lobbying watchdog. When the mostly nonsmoking general public votes, Big Tobacco has proved a particularly easy mark. Citigroup (C ) analyst Bonnie Herzog expects California's measure to pass handily, constraining cigarette makers' ability to raise prices, as they have the past two years.


California is home to 9% of all U.S. smokers, and a successful Prop 86 would certainly dent tobacco companies' bottom lines. An analysis by the Tobacco Control Section of the California Health Services Dept. expects that it could cut cigarette sales by 312 million packs a year. Let's estimate, conservatively, that Philip Morris makes a profit of 20 cents per pack. Given its 51% market share, that's a $32 million hit. Plus, the Tobacco Control Section predicts the smoking rate among high school students will drop from 13.2% in 2004 to 7.6%.

Cigarette makers argue that Proposition 86 doesn't require all tax money to be spent on programs to help smokers quit or on treating smokers' illnesses, and that the measure needlessly includes an antitrust exemption for hospital companies. "It's irresponsible spending of the public's money," says Fredrick McConnell, a spokesman for R.J. Reynolds Tobacco Co. (RAI ), maker of Camel cigarettes, which is spending $40 million this year to fight tax hikes and smoking bans in four states.

Prop 86 backers promise $2 billion in new tax revenue and a $16.5 billion long-term decline in health-care costs. But McConnell argues that untaxed counterfeits and buying from other states will hurt sales, ultimately undermining tobacco tax revenue and shrinking the $1 billion California now gets yearly from the companies' 1998 Master Settlement Agreement.

Proponents -- including the American Cancer Society, American Lung Assn., and others -- argue that every state that has increased the tax has come out ahead in the long run. But to them, the key issue is the smoking rate. "If you raise the price by 10%, it should reduce overall consumption by about 4% and reduce youth smoking by 6% or 7%," says Eric Lindblom, director for policy research at the Campaign for Tobacco-Free Kids. Ultimately, they say, that's what gives the industry the jitters.

By Nanette Byrnes

    Before it's here, it's on the Bloomberg Terminal.