RECOVERING TOBACCO-CAUSED PUBLIC EXPENDITURES FROM THE TOBACCO INDUSTRY:

Options for Provincial Governments

Eric LeGresley, Legal Counsel
Smoking and Health Action Foundation
March, 1998

RATIONALE FOR COST RECOVERY

Cost recovery is about fairness. Government of Canada studies calculate tobacco-caused losses for Canadian society at $15 billion per annum,(1) and combined federal and provincial tobacco taxes at only about $3.5 billion. Quite apart from making products which kill Canadians, the tobacco industry, it seems, is not paying its way.

However, the unfairness goes deeper. Almost all of the tobacco taxes collected in Canada are paid by tobacco consumers, not the cigarette companies. In reality, the companies pay almost none of the societal costs their products create.

This ongoing ability of the cigarette companies to externalize the inevitable costs of their business practices produces four undesirable effects: (i) it unjustly foists a significant economic burden onto those taxpayers who did not contribute to the problem; (ii) it strengthens the tobacco companies financially; (iii) it emboldens the tobacco companies, leading them to believe they can evade political and economic realities other manufacturers must face; and (iv) it distorts the marketplace and deters technological development by removing the economic incentive to produce less harmful tobacco products.

With the dollar sums under discussion being so large, recovery of costs will carry significant political as well as economic import. It is also true that a political overprint is placed on this file by the actions of 40 American states and several U.S. cities in suing the American tobacco industry for the recovery of tobacco-attributable medicare and medicaid costs. Canadian politicians are surely aware that multi- billion dollar settlements and altered industry practices have been attained in the U.S., and that the relative stakes in Canada are dramatically higher for the provinces due to Canada’s entirely publicly-funded health care system. Many Canadians are wondering why cost recovery is being ardently pursued in the United States but not in Canada.

With these economic and political realities, the salient question is not whether to shift the economic burden created by tobacco products to the cigarette companies, but by what mechanism.

COST RECOVERY OPTIONS

This work reviews five options for cost recovery: (i) public litigation; (ii) joint public/private litigation; (iii) license fees; (iv) taxes; and (v) negotiation. Most of the focus is placed on public litigation and license fees, for these are more novel and less well understood than taxation or negotiation. Of course, nothing prevents a combination of several of these approaches either in concert or sequentially. And that is exactly what has been occurring in the United States recently, with litigation prompting a negotiated solution.

While cost recovery is a major public objective, this paper assumes it should not be the sole objective driving any choice amongst these options. The potential attainment of several ancillary objectives is factored into the evaluation of the various cost recovery vehicles presented.

Cost recovery will be politically-charged irrespective of the vehicle chosen. Significant public resources and political capital will probably be expended. Media attention will be focussed on the initiative because of its importance and because of attempts by the cigarette companies to thwart the effort. Together this provides the incentive and the opportunity to advance public health objectives vis-à-vis tobacco on several fronts.

Ancillary objectives, beyond just acquiring satisfactory sums from the industry, which may be advanced include: (i) a rigorous quantification of the type and magnitude of the social and economic damages tobacco industry products cause; (ii) obtaining industry information; (iii) increased public education; (iv) denormalization of the tobacco industry; (v) alteration of tobacco industry behaviour; (vi) reduction of tobacco consumption; and (vii) reduction of tobacco- caused morbidity and mortality.

1. PUBLIC LITIGATION

(a) The American Experience

Public tobacco litigation is a frequent vehicle in the United States to facilitate the recovery of tobacco-attributable public health care costs. Beginning in Mississippi in 1994, a wave of medicare lawsuits swept across the U.S. seeking recovery of medicare costs and equitable relief in the form of mandated changes in business practices.(2) As of early March 1998, the trial dates of four state lawsuits had arrived, with the first three cases settled out of court early in the proceedings(3) and the Minnesota case proceeding to trial.(4) Public litigation also prompted a proposed national settlement in the United States.(5)

The American litigation has chiefly served as a lever to encourage a negotiated solution. It has not yet proven to be a full cost recovery vehicle by itself. Not one case has been litigated to conclusion. The reasons are plain for both sides. Tort liability hanging over cigarette companies seriously depresses their share values. A negotiated solution, even one requiring an outlay of hundreds of billions of dollars on the part of the companies, removes much of the uncertainty and would permit share values to rise significantly. On the state side, the reasons are probably two-fold. Success in litigation is never assured, and even successful litigation, given the inevitable appeals, will take the better part of a decade. Financial imperatives and risk assessment will lead many states to accept some negotiated resolutions on the basis of the financial interest, particularly if the agreement includes changed marketing. A second reason is practical politics. Elected officials, both the state governors and the attorney-generals, will fear political repercussions of losing the lawsuit. Even if the state ultimately prevails on appeal, that may come too late in the election cycle to redeem a politican who is seen to have bet the farm and lost.

The Mississippi, Florida and Texas state settlements have resulted in very significant settlements, including non-monetary provisions related to industry behaviour of beyond the likely equitable relief that might be granted in a trial decision. Many different legal theories have been advanced in the various suits as the basis for the claim, including: negligence, unjust enrichment, strict liability, breach of express or implied warranty, fraud, conspiracy, racketeering, restraint of trade, and deceptive trade practices. However, the cases fall into two broad categories: (i) those using existing tort law and rules of evidence; and (ii) those predicated upon legislation changing the law in preparation for the lawsuit.

While most U.S. states are using pre-existing law in advancing their cases, Florida passed the Third Party Liability Act to permit, among other things, the introduction of epidemiological evidence to prove causation, the allocation of responsibility on the basis of market share, the creation of a new cause of action by way of statute, and the removal of otherwise arguable affirmative defences (usually involving the conduct of the tort victim, including comparative negligence, assumption of risk etc.). The constitutionality of the Florida law was challenged, principally as an alleged violation of the “due process” protections granted under the Florida constitution. In 1996 the central elements of the law were upheld by the Supreme Court of Florida.

The American public litigation has aptly demonstrated several things. First, the industry will vigorously oppose the litigation with legal motion after motion attempting to delay or limit the proceeding as much as possible.

Second, despite their overwhelming past success in the courts, the industry fears public litigation. This probably is an acknowledgment that the industry appreciates that its past litigation successes (usually with ill individuals as plaintiff) owe more to out spending the plaintiff rather than the backing of persuasive law.

Third, in terms of the process, the pre-trial procedure of legal discovery, and most probably documentary discovery, is what the cigarette companies are most desperate to avoid. The tobacco company “shredding parties” imagined to have taken place in the 1980s after the Cippollone case were not, at least in the eyes of the industry, as successful as the cigarette companies might have hoped.(6)

Fourth, the industry values stability more highly than retaining the status quo. A significantly altered nicotine marketplace, one the tobacco industry will acquiesce to, is within sight.

Fifth, the tobacco industry is not monolithic. Some companies, particularly those seeing their market share dwindle under the status quo, will cut separate deals in order to gain an advantage over their competitors.

And sixth, litigation in one jurisdiction can prompt an overall resolution of outstanding health care costs, primarily driven by the industry’s desire to get it all over, to not have to continue to have significant liability depressing share values, and to not have to continue to fear discovery in some future court case.

(b) Transferability of Public Litigation to Canada

(i) The General Concept

Litigation, whether public or private, fits well with American culture as a tool for the development of social policy. The United States is an extremely litigious society, with the courts long assuming a prominent role in political decision making and social policy formation. Historically, the same has not been true of Canada, although it must be noted that the differences between Canada and the U.S. is this regard are diminishing in the post-Charter era. The reasons for the differences between Canada and the United States are both social and legal. Five are provided.

Unlike the U.S. where taxation as a social policy tool is always difficult, historically Canadians have accepted government intervention, including taxation, as a politically palatable vehicle. This provides Canadian provinces with a choice broadly unavailable to American states.

Second, unlike the U.S. where the tobacco lobby has for decades blocked significant legislation, the Canadian tobacco industry has not yet demonstrated a lock on the political process. The reasons are apparent and two-fold. Tobacco growing and tobacco manufacturing are very localized in Canada. Few constituencies and no governments in Canada are likely to ever succeed or fail based on the pro-tobacco vote. As well, without the big money factor that permeates through American politics where tobacco companies are the largest contributors to political campaigns, Canadian politicians will not find themselves beholden to the interests of very major tobacco company contributors.

Third, American civil procedure provides fewer deterrents to litigation than does Canadian civil procedure. In the U.S. each side pays their own legal bills win or lose. In Canada, by comparison, the loser pays the legal bills of the winner. So suing the tobacco industry and losing in Canada is a much more expensive process than suing and losing in the United States.

Fourth, damage awards in Canada are much, much lower than in the United States.

Fifth, embarking on prolonged litigation will inevitably lead the Canadian tobacco industry to argue, as they have successfully done in the past, that new developments on the legislative front, or active enforcement of existing legislation should be halted because “the issue is before the courts.” In the U.S., where few meaningful legislative initiatives were coming forward, this argument would have little practical effect due to serious pre-existing political impediments to legislation. However, in Canada where there is hope and, indeed, the expectation of significant developments legislatively, this argument could be problematic.

An important argument in favour of public litigation is how that legal process would feed into the ancillary objectives identified above. Again, the American experience has demonstrated the public education and industry denormalization value of a hotly contested lawsuit between two comparably- financed titans. The authenticity of the trial and basic human curiosity likely means that a well reported trial would educate more people than a planned public education campaign. And, of course, public education campaigns could also be run in tandem, building upon and feeding off the information and the interest the trial would generate.

In general, then, public litigation in Canada is a less desirable option in Canada than in the United States. The costs are higher, the likely benefits lower, and there are more viable options available for Canadian politicians than their U.S. counterparts. Still, as a vehicle to prod a negotiated solution rather than a direct cost recovery vehicle itself, public litigation in Canada retains many of the benefits it enjoys in the U.S. Equally important, litigation would greatly assist the various ancillary objectives identified.

(ii) The Florida Approach

To date, British Columbia alone of the Canadian provinces has followed the public litigation path of the U.S. states. And with the passage of the Tobacco Damages Recovery Act, B.C. has adopted the approach of Florida. The province should expect that, like Florida, the constitutionality of its law will be challenged, and Canadian tobacco executives have implied this in letters to the B.C. health minister. A constitutional challenge based in part on “principles of fundamental justice” under section 7 of the Canadian Charter of Rights and Freedoms is expected.(7) That challenge, assuming it is eventually appealed to the Supreme Court of Canada, could inject about 10 years delay to B.C.’s recovery of tobacco-related health care costs via litigation.

However, B.C. probably anticipates that like Mississippi, Florida and Texas, the litigation threat will bring the industry to a negotiated resolution. For that to happen B.C. doesn’t necessarily need to ultimately prevail at the Supreme Court, a positive decision on the province’s side at some lower court may be sufficient. And if the province is correct on that point, the legislation, despite the constitutional argument is raises, may prove to have been a wise choice.

2. JOINT PUBLIC/PRIVATE LITIGATION

The British Columbia Tobacco Damages Recovery Act sets out the authority for the province to join any private tort case against the tobacco industry for the recovery of the province’s loss with respect to the plaintiff. Usually this will occur by adding the province as a plaintiff seeking recovery of the health care costs associated with treating the private plaintiff’s tobacco-caused illness. In essence, it creates a mixed public/private case against the industry.

Canadian tort litigation against the tobacco industry to date has been of the single, private plaintiff variety. If this continues, this “add on” approach of B.C. will prove to be negligible as a cost recovery vehicle, even if these sort of suits eventually begin to be successful. The number of plaintiffs simply will be far too small.

However, two important benefits do accrue to the province via this approach, and these make this measure desirable if not as the complete cost recovery vehicle, but at least as a worthwhile secondary strategy.

First, this approach sets the province up to potentially recover significant sums if a large private class action proceeds. Class actions, like public litigation itself, will often bring with it a more equitable pairing of financial resources. The province’s likelihood of significant recovery is increased both by increasing the likelihood of success and by increasing the number of plaintiffs. Second, this approach permits the province to participate as a plaintiff, including in the discovery process, in any private tort action. Though the individual case itself may not be of great import, the discovery process could greatly assist the planning of either some subsequent public litigation or additional legislation. By participating the province can ensure that the legal representation serves its interests rather than just hoping for competent counsel for the private plaintiff and waiting for some benefit to fall into its lap.

With the province participating as a plaintiff, not only will there be greater likelihood of competent counsel but the case will garner much greater media attention. With increased media attention many of the ancillary objectives outlined earlier will be more easily attainable. Without government participation many standard tort actions will appear to be doomed due to an inequity of resources. The media will tend to file an initial story then ignore the case. The public education value of the trial will be much diminished. However, with the province participating the newsworthiness will naturally increase because new angles are at play and the participants are more equal. But, in addition to that, the province will bring not only its lawyers but also its public relations people contributing to the resultant public education and industry denormalization resulting from the trial.

3. LICENSE FEES 

Cost recovery could occur by imposing upon the cigarette companies a licensing fee as the cost of marketing their products in the province. For example, the yearly license fee for each tobacco company could be set equal to the annual health care costs that company’s tobacco products foist on society. Those costs would be tied to market share, either presently or on a weighted basis through, say, the last 30 years.(8) Since legally and illegally sold cigarettes have the same adverse effects on the human body and the provincial health care budget, the relevant market share for calculating the license fee should include both the legitimate and contraband market. Calculating the contraband market, and divisions within that market is not inordinately difficult.

Though the tobacco industry would undoubtedly raise a legal challenge to a licensing system, this is not as problematic as the required court case in a litigation- based approach. During any challenge the companies would still be required to pay their license fees, even if only into an escrow account, while the legal challenge proceeds. So unlike the American litigation approach which likely could produce a final damage award in, say, year seven, a license system could have the tobacco companies paying in year one.

Very importantly, if government recovery of tobacco’s costs was upfront — that is, primarily through license fees rather than taxes — smuggling would not circumvent the collection of these revenues. Because the companies would pay their assigned license fee whether the products were legally sold or contraband, they would have no incentive, as they have had in the past, to facilitate smuggling by exporting cigarettes to non-existent markets and having these cigarettes smuggled back into Canada. Further, because tobacco companies would be paying a license fee that reflected the volume of contraband sales, they would be keen to see that fee reflected in the selling price of all cigarettes, including contraband. We would then see Canadian tobacco companies trying to stamp out tobacco smuggling.

Of course, a tobacco company might decide not to market its products in the province, but that is unlikely. The tobacco business is just too lucrative to leave a major market open to one’s competitors. Moreover, the products of any cigarette maker which left the market would be readily identifiable as contraband. Retailers would not openly offer these products for sale, and the company simply would not be able to retain its market share through smaller scale illegal sales out of car trunks.

There remain several downsides to a licensing approach, particularly with respect to the ancillary objectives discussed previously. Most notable is the stamp of approval granted to the industry through a license. Licensing the companies may create additional hurdles for subsequent litigation for the companies will argue that they are now marketing their products under some ‘colour of right.’ And a licensing system alone would not contribute to public education and industry denormalization as much as other cost recovery vehicles. However, prior to the implementation of a licensing system it would be prudent to undertake a Royal Commission or some other public inquiry with powers of subpoena into tobacco and the tobacco industry. Such an inquiry could undertake a comprehensive assessment of tobacco’s costs and, in the process, educate the public and cast much needed light on the inner workings of the cigarette companies and their lobby.

4. TAXES

Tobacco excise taxes have by far been the most frequent means by which Canadian governments have sought to recoup tobacco-related social costs. However, Canada’s tobacco taxes recover only about 1/4 of the total social cost tobacco foists on society. A quadrupling of these taxes without adequate measures to deter smuggling would likely prove unworkable. Though there is room for increased cost recovery via the present tax system, particularly if taxes are moved in concert with nearby jurisdictions in both Canada and the United States, full cost recovery via presently structured excise taxes is neither desirable nor practicable.

While a four-fold excise tax increase would improve cost recovery and vastly reduce Canadian prevalence rates, many ancillary public objectives would remain unaddressed. First, such taxes would amount to recovery of future costs only, neglecting the many billions of dollars tobacco companies have already transferred to taxpayers in the past. Second, because the present form of federal and provincial tobacco taxes target the smoker rather than the tobacco industry, the wrong party would be paying the lion’s share of the bill. Without some finesse in tax structure, cigarette companies would still not have incentives to produce safer products, for to them these costs would remain externalized (albeit to smokers rather than taxpayers generally). Finally, taxes would contribute only marginally to the denormalization of the tobacco industry, do little to advance public education, and would not assist in obtaining inside information about the tobacco industry and its products.

While these objectives would remain largely untouched, governments do have numerous other options to advance these objectives apart from any cost recovery scheme. So if higher taxes, particularly higher taxes aimed at the corporate level were introduced in conjunction with a comprehensive public education campaign and much needed information disclosure laws, taxes could function as one vehicle for the recovery of future tobacco costs. Then, perhaps, litigation could be used to seek to recover past costs and to top up the recovery of future costs.

5. NEGOTIATION

As the Americans have demonstrated, cost recovery irrespective of the initial intervention will usually come down to negotiation. Other approaches may drag the industry to the table but, as with most disputes, a negotiated solution often serves the complex, sometimes self-conflicting interests of both parties better than the uncertainty of a winner take all approach.

While this paper is obviously not the forum for a full discussion of negotiation philosophy, several truths can be highlighted. First, negotiation need only take place over those areas of dispute for which there is no existing resolution, be that a resolution imposed by legislation or a consensual resolution. If the process of encouraging the tobacco industry to seriously negotiate can also resolve or confine certain areas which the province would like to not have on the table, so much the better. And since litigation, inventive taxation or licensing fees all may encourage a newfound fervour for negotiation, any choice as between the various options should also factor in where that approach will leave the province in the likely situation that negotiation will ultimately resolve many of the outstanding issues.

Second, but building on the first point, the negotiator’s strength lies in his knowledge of the other side. Therefore, the bargaining position of the government will be enhanced through greater exposure of internal documents of or relating to Canadian tobacco companies. Three choices exist: (i) be passive and wait for more details to arise from American legal proceedings which, on occasion provide helpful information about the sister companies in Canada; (ii) follow the American route and proceed with litigation through to the discovery phase; or (iii) introduce disclosure laws designed to ferret out the industry’s long-hidden secrets. The latter two proactive approaches are clearly the most advantageous.

Third, the cigarette companies will not quickly capitulate to the government’s position in any negotiation. With their phalanx of lawyers, they will reserve to themselves the option of delaying the proceedings. And given that all three Canadian tobacco companies form just very minor parts of global tobacco enterprises, ultimate decisions in any important negotiation likely will be made abroad. Moreover, because a Canadian negotiation will have impacts beyond Canada, these decisions likely will reflect the global interests of the companies rather than the narrower interests of their Canadian subsidiaries. One might expect concessions in Canada if those concessions help protect markets elsewhere, because while the North American tobacco market is in decline and there is explosive market growth in the developing world.

CONCLUSIONS

Cost recovery is an important and necessary public choice for reasons of fairness, finance, and public health. In addition to killing 15,000 Ontarians each year, cigarette company products foist onto Ontario taxpayers social and economic losses exceeding $5 billion annually. The direct health care costs alone exceed a billion dollars annually. All taxpayers pay these costs, not just the 30% who smoke. Most unjust of all, the three companies who consciously market addictive, lethal products pay none of these costs.

Nothing will alter the business practices of the cigarette companies more than placing squarely on their shoulders the financial burden their products create. Governments’ consistent failing to do so has lead to market failure on the innovation front. And that has resulted in tens of thousands of needless deaths, both in the past and the coming decades.

As important as cost recovery is, a carefully designed process of recouping costs can also advance desirable ancillary objectives such as public education, tobacco industry denormalization and reduction of morbidity and mortality.

The American approach of public medicare litigation fits well with American social and political realities; less well with Canada’s. In straight cost recovery terms, there are other approaches by which Canadian provinces could obtain the money faster, at lower cost and with greater certainty. However, litigation probably advances the ancillary objectives more than any other option presented in this work. That alone may sway the choice to litigation. Provided the documentary discovery phase of the litigation is likely to produce sufficiently damaging information about the companies — information relevant to the legal case and/or the associated public relations battle — litigation leading to hard nosed negotiation may be the most appropriate vehicle to advance the variety of public objectives.

Joint public/private litigation is the bargain basement cousin of straight-up public litigation. The savings appear minor, particularly when considering the quantum of damages which could be litigated. It probably only makes sense when there is a reasonably viable, significantly large class action pending against the industry.

License fees offer the fastest means of recovering costs. Teamed up with a Royal Commission or some other very public forum to investigate the tobacco industry, many of the ancillary objectives can be attained.

Excise taxes in their present form can never amount to a fully appropriate cost recovery vehicle because they target the smoker rather than the cigarette companies. Restructuring or adding new taxes at the corporate level would help, but this still would leave many ancillary objectives unaddressed. It is probably best to separate the beneficial concept of cost recovery from the equally beneficial concept of economic deterrents to smoking, and approach the former through other vehicles and the latter via tobacco taxes directed at the smoker.

Endnotes

(1) Tobacco Control: A Blueprint to Protect the Health of Canadians, December 1995; and Kaiserman MJ. “The Cost of Smoking in Canada, 1991,” Chronic Diseases, 1997; 18: 13.

(2) None of these American lawsuits have sought to recover non-health related public losses. Non-health losses, as was noted earlier in Canadian government studies, account for about 3/4 of the total tobacco-caused public loss.

(3) The states of Mississippi, Florida and Texas settled for $3.6 billion, $11.3 billion and $15.3 billion (U.S.), respectively.

(4) Additionally, a separate settlement has been reached with a small American tobacco company, Liggett & Myers, covering the then 22 U.S. states proceeding with litigation.

(5) The June 1997 national settlement proposal in the United States requires congressional approval, and as of early March 1998 several bills were before the U.S. congress which are compatible with but not identical to the legislative requirements stipulated in the June proposal.

(6) In the American case of Cipollone the cigarette companies were held jointly responsible with the plaintiff for her tobacco-caused fatal illness. While the industry won on appeal, the case is notable because it shattered the aura of invincibility tobacco companies had earlier garnered through their courtroom successes.

(7) One would anticipate arguments by the tobacco industry such as claiming that the admission of epidemiological evidence against a tobacco company, but not against, say, a pharmaceutical company, is a denial of fundamental justice.

(8) The allocation of responsibility based on market share is an integral part of the Florida Third Party Liability Act and the British Columbia Tobacco Damages Recovery Act which facilitate public tort actions against the tobacco industry as a cost recovery vehicle. This element of the Florida law has been upheld as constitutional by the Florida Supreme Court.