tobaccoweb (1).doc - The Tobacco Deal Jeremy Bulow Graduate...

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The Tobacco Deal Jeremy Bulow Graduate School of Business, Stanford University, USA Tel: 650 723 2160 Fax: 650 725 0468 Email: [email protected] and Paul Klemperer Nuffield College, Oxford University, UK Int Tel: + 44 1865 278588 Int Te: +44 1865 278557 Email: [email protected] August 1998 Abstract We analyse the major economic issues raised by the 1997 Tobacco Resolution and the ensuing proposed legislation that were intended to settle tobacco litigation in the United States. By settling litigation largely in return for tax increases, the Resolution was a superb example of a "win-win" deal. The taxes would cost the companies about $1 billion per year, but yield the government about $13 billion per year, and allow the lawyers to claim fees based on hundreds of billions in “damages”. Only consumers, in whose name many of the lawsuits were filed, lost out. Though the strategy seems brilliant for the parties involved, the execution was less intelligent. We show that alternative taxes would be considerably superior to those proposed, and explain problems with the damage payments required from the firms, and the legal protections offered to them. We argue that the legislation was not particularly focused on youth smoking, despite the rhetoric. However, contrary to conventional wisdom, youth smokers are not especially valuable to the companies, so marketing restrictions are a sensible part of any deal. The individual state settlements, if allowed to stand, open up unprecedented opportunities for collusion throughout the economy. The fees proposed for the lawyers (around $15 billion) and the equally remarkable proposed payoff for Liggett (perhaps $400 million annually, for a company with a prior market value of about $100 million) also set terrible examples. We conclude with some views about how public policy might do better.
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The Tobacco Deal Q. Could you please explain the recent historic tobacco settlement? A. Sure. Basically, the tobacco industry has admitted that it is killing people by the millions, and has agreed that from now on it will do this under the strict supervision of the federal government. –Dave Barry 1 On June 20, 1997 the largest cigarette companies, most state attorneys general, and trial lawyers agreed a comprehensive settlement of tobacco litigation: the Tobacco Resolution. By settling litigation largely in return for tax increases, the Resolution was a superb example of a “win-win” deal. Agreeing to a tax increase that would cost the companies about $1 billion per year in lost profits and yield the government about $13 billion per year in revenues 2 made everybody happy. The companies settled lawsuits cheaply, smoking would decline because of the price rise, state governments raised taxes under the name of “settlement payments”, and the lawyers were able to argue for contingency fees calculated based on tax collections instead of the much smaller cost to companies. Only consumers, in whose name class action suits were filed, lost out.
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