Stanford professor Jeremy Bulow

Smokers buy as many cigarettes in Virginia as in New York, but New York makes six times as much as Virginia in the deal between states and cigarette makers.

Because it worked harder, New York in 2003 received $12.84 per carton and Virginia received $2.01, according to Stanford University business professor Jeremy Bulow.

New York made $510,597,469 more than it would have made through a straight tax and Virginia made $132,913,578 less, Bulow calculated in a report last year.

For this and other apparent inequities, Bulow has branded the eight-year-old Master Settlement Agreement as unlawful.

He charged in his report that it improperly allows extraterritorial taxation by states in other states. He argued that it violates antitrust law.

States that adopted laws to carry it out did not adopt them voluntarily, Bulow wrote.

He called the agreement "Byzantine." In some circumstances, he wrote, a company makes more money by losing sales to a competitor than by selling cigarettes itself.

He wrote that designers of the agreement aimed to create a national tax without it calling it that.

Bulow did not call it a tax either. He defined it as a set of 55 national taxes, counting 50 states, the District of Columbia and four territories.

He wrote that "winner states" like New York and California wanted a national deal that would require subsidies from loser states.

"However, this required disguising the deal as something other than a tax," he wrote.

Defining it as payment for damages created a problem, he wrote, because manufacturers Liggett and Commonwealth were not parties to the suits or the settlement.

Liggett had already settled with most states, he wrote.

To coax Liggett, Commonwealth and other little companies into the pact, he wrote, states and big companies granted them a windfall exemption.

To keep new companies from gaining an advantage, he wrote, states passed laws requiring those outside the agreement to deposit comparable amounts in escrow.

"Since these new firms would not have existed during the period covered by the MSA lawsuits, this also meant that settlement payments would have to be framed in large part as covering the cost of expected future torts rather than past torts, which also seems unusual at best," Bulow wrote.

States raised another barrier, he wrote, by authorizing lawsuits against wholesalers and retailers for selling cigarettes of companies outside the agreement.

All major chains exclude brands outside the agreement, Bulow wrote, and more than two thirds of all retail outlets exclude them.

State attorneys general try to defend the stifling of competition under the "state action" doctrine, he wrote, but the doctrine applies "to transactions wholly intrastate."

When California law fixes the price of cigarettes manufactured in Virginia and sold in Tennessee, he wrote, there is no intrastate component to the transaction.

He wrote that while some economists regard the payments as excise taxes, "they must technically be something else to have any prospect of being legal."

States connect the payments to Medicaid costs when it is convenient, he wrote, but some states claimed no Medicaid damages at all.

State claims included consumer protection penalties, antitrust damages and forfeiture of profits, he wrote.

The payments might represent royalties that companies give to states as settlement of future potential lawsuits, he wrote.

If so, he wrote, "…the issue arises as to whether these states now have a commercial participation in the businesses of the companies, which would again eliminate the state action exemption."

To wrap up his argument, Bulow wrote that loser states joined the deal because their citizens would pay the tax but their states would receive nothing.

He wrote that the agreement and the escrow statutes "misappropriate state sovereignty, by imposing extraterritorial taxes and forcing the legislature to sign on to legislation it otherwise would not pass."

He wrote that if each company paid each state in proportion to the company's national sales and if legislatures could opt in or out, the agreement might be legal.

He wrote that, "…each individual state's deal would mess up the market in its own state, and so its own citizens would bear the costs of its poor policies.

"If the MSA is struck down and Congress wishes to replace it with a national tax on cigarettes, is there any doubt that it could do so?"

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