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OCR Page 1 of 6807/10/97 THU 19:27 FAX 202 6222633
002
Real Net Revenue From Tobacco Settlement
Attached are preliminary estimates of the net revenue from the tobacco settlement. They include
revenue effects at federal, state and local levels. One set of calculations assumes that the
payments are reflected in the price of all tobacco products, while the other assumes that the
payments are reflected only in the price of cigarettes. These estimates are in real terms, measured
in 1996 dollars.
We find that, considering all tobacco products, the real net revenue from the tobacco settlement is
likely to be about $189 billion in total, if summed over the first 25 years of the agreement. We
obtain essentially the same estimate in our cigarette only calculation.
Two reasons explain why our $189 billion net revenue estimate is substantially lower than the
$368.5 billion figure cited in the report. First, the $368.5 billion figure in the report ignores the
sales adjustment feature of the settlement. As sales fall, whether as a result of the long-term
secular trend which has historically characterized the tobacco market, or as a result of the features
of this agreement, the size of the payment falls proportionately. Adjusting for the fall in sales
reduces the net revenue estimate by about 19%, to $298 billion.
Second, the $368.5 billion figure does not adjust for the reduction in revenue from existing excise,
income, and employment taxes. Considering federal income and employment taxes, and federal,
state and local excise taxes, this adjustment can reduce net revenue by an additional $109 billion,
or by 32% of the $368.5 billion cited in the report. In total, then, we estimate that the actual
increase in net government receipts will be about $189 billion, or 51%, of the $368.5 billion
payment cited in the report.
The $368.5 billion figure also is misleading because it is a simple sum of (real inflation adjusted)
payments which flow in over time. Proper measurement of the value of the payment flow would
discount to reflect the (real) time value of money. As shown in the table, discounting the payment
stream by a 3.7% real discount rate will reduce its sum from $189 billion to $123 billion, or by
about 18% of the original $368.5 billion dollar figure cited in the report. A higher (lower)
discount rate would lower (raise) the discounted present value of the payment stream, relative to
our $123 billion figure.
Our modeling focuses on the basics of the payment plan outlined in the agreement. We do not
include the effects of the special penalty imposed if profits increase, nor do we model the look-
back provisions that impose a penalty if sales to minors fail to fall to specified target levels. By
way of justification, we note that is seems unlikely that domestic profits will increase as a result of
this agreement, so neglecting the profits tax seems reasonable in this preliminary estimate. For
two reasons, the look-back also seems unlikely to have a major revenue effect. First, it seems
likely that the agreement will be effective in significantly reducing under-age smoking, and so any
penalty would likely be much lower than the $2 billion annual maximum. Second, any assessed
penalty can be reduced by 75% as along as the manufactures can show that they made a "good-
faith" effort to comply with the agreement.
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