Tobacco: Issues Surrounding a National Tobacco Settlement (Letter Report,
04/15/1998, GAO/RCED-98-110).

In June 1997, the nation's largest tobacco companies and 40 state
attorneys general who had filed suit against the industry agreed on a
settlement that, if implemented, would significantly change the way that
tobacco products are manufactured, marketed, and distributed in the
United States. Under the proposed agreement, the industry would pay
$368.5 billion over 25 years, accept the Food and Drug Administration's
authority to regulate tobacco products, restrict the advertising of its
products, and release internal research papers. In return, the
settlement would resolve the present actions by the 40 state attorneys
general, drop all punitive damages claims for past conduct, and grant
the tobacco industry immunity from future class-action lawsuits. This
report (1) identifies tobacco-related industries and summarizes existing
studies that assess the national and regional economic impacts of the
tobacco industry, (2) examines smoking trends for U.S. and Canadian
youths, (3) estimates the potential effect of a settlement on state
revenues from cigarette excise taxes, and (4) investigates the extent of
interstate and international cigarette smuggling affecting the United
States.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-98-110
     TITLE:  Tobacco: Issues Surrounding a National Tobacco Settlement
      DATE:  04/15/1998
   SUBJECT:  Tobacco industry
	     Labor statistics
	     Smoking
	     Tobacco taxes
	     Economic analysis
	     Smuggling
	     Youth

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GAO/RCED-98-110

Cover
================================================================ COVER

Report to the Honorable
Richard M.  Burr, House of Representatives

April 1998

TOBACCO - ISSUES SURROUNDING A
NATIONAL TOBACCO SETTLEMENT

GAO/RCED-98-110

Tobacco Settlement

(150741)

Abbreviations
=============================================================== ABBREV

  ATF - Bureau of Alcohol, Tobacco, and Firearms
  ERS - Economic Research Service
  FDA - Food and Drug Administration
  FIA - FIA International Research Ltd.
  FTC - Federal Trade Commission
  USDA - U.S.  Department of Agriculture

Letter
=============================================================== LETTER

B-279155

April 15, 1998

The Honorable Richard M.  Burr
House of Representatives

Dear Mr.  Burr:

On June 20, 1997, the nation's largest tobacco companies and 40 state
attorneys general who had filed suit against the industry agreed on a
settlement that, if implemented, would significantly change the way
tobacco products are manufactured, marketed, and distributed in the
United States.  Under the proposed agreement, the industry would pay
about $368.5 billion over a period of 25 years, accept the Food and
Drug Administration's (FDA) authority to regulate tobacco products,
restrict the advertising of its products, and release internal
research documents.  In return, the proposed settlement would resolve
the present actions by the 40 state attorneys general, drop all
punitive damages claims for past conduct, and grant the tobacco
industry immunity from future class-action lawsuits.

As a result of the proposed settlement, you asked us to (1) identify
tobacco-related industries and summarize existing studies that assess
the national and regional economic impacts of the tobacco industry,
(2) examine smoking trends for U.S.  and Canadian youths, (3)
estimate the potential effect of a settlement on state revenues from
cigarette excise taxes, and (4) investigate the extent of interstate
and international cigarette smuggling affecting the United States.
To respond to your request, we analyzed government, industry, and
academic studies that we identified through extensive literature
searches and through discussions with recognized experts in
government, industry, and academia.  In addition, we developed an
economic model to estimate the potential lost revenues from state
excise taxes as a result of an increase in the price of cigarettes.
Further detail on our objectives, scope, and methodology can be found
at the end of this report.

   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

         TOBACCO-RELATED
         EMPLOYMENT
-------------------------------------------------------- Letter :1.0.1

According to recent studies, from 353,000 to 555,000 jobs are
directly related to the tobacco industry nationwide, including jobs
in the tobacco growing, warehousing, manufacturing, wholesaling, and
retailing industries.\1,2 According to these studies, an additional
653,000 to over 2.3 million jobs nationwide are estimated to be
indirectly related to the tobacco industry.  This additional
employment includes jobs associated with the producers that supply
materials and services to the tobacco industry and jobs associated
with the industries that provide goods and services to the employees
of the tobacco industry and its suppliers.  Two of the studies
estimated that declining tobacco consumption--that would occur, for
example, as a result of an increase in the price of a pack of
cigarettes--would likely result in job losses in the tobacco growing
and manufacturing industries.\3 However, it must be recognized that
the money previously spent on tobacco products would not simply
disappear from the nation's economy; rather, it would be reallocated
to other goods and services.\4 These studies indicate that this
reallocation could have little effect on national employment,
although the Southeast Tobacco Region could experience job losses.

--------------------
\1 These studies are (1) Kenneth E.  Warner; George A.  Fulton; Peter
Nicolas; and Donald R.  Grimes, "Employment Implications of Declining
Tobacco Product Sales for the Regional Economies of the United
States," Journal of the American Medical Association, Vol.  275, No.
16 (Apr.  24, 1996), pp.  1241-46 (Warner); (2) Excerpts from the
Tobacco Merchants Association's study, "Tobacco's Contribution to the
National Economy," released September 17, 1996; (3) Fred Gale, U.S.
Department of Agriculture (USDA)/Economic Research Service (ERS),
"Tobacco Dollars and Jobs," Tobacco Situation and Outlook Report,
USDA/ERS, TBS-239 (Sept.  1997), pp.  37-43; and (4) "The U.S.
Tobacco Industry in 1994:  Its Economic Impact in the States," The
American Economics Group, Inc.  (Mar.  1996).  This study was
sponsored by the Tobacco Institute.

\2 At least one third of these jobs involve the retail sale of
tobacco products.

\3 However, U.S.  Department of Agriculture (USDA) data indicate that
tobacco production has been increasing, despite declines in domestic
consumption, because tobacco exports have increased.

\4 USDA officials pointed out that both their study and the Warner
study assume that money reallocated from the tobacco sector is spent
entirely on domestic goods and services.  However, a portion of this
reallocation could be spent on imports.

         SMOKING AMONG YOUTHS
-------------------------------------------------------- Letter :1.0.2

Survey data show that in 1977, 29 percent of U.S.  12th-graders
smoked daily.\5 After falling to a low of 17 percent in 1992, this
smoking rate increased to 25 percent by 1997, erasing more than half
of the reduction in smoking achieved during the preceding 15 years.
Studies indicate that the real price of cigarettes (i.e., adjusted
for inflation) is a significant factor affecting youths who smoke.\6
Consistent with this finding, the recent upswing in the smoking rate
of youths coincides with a modest decline in the real price of
cigarettes.  Although data on the smoking behavior of Canadian youths
are incomplete, available data suggest a relationship between the
prevalence of smoking and cigarette prices that is consistent with
the relationship found among U.S.  youths.

--------------------
\5 "Monitoring the Future," University of Michigan's long-term survey
of 12th-graders, 1977 through 1997.

\6 The studies we reviewed are (1) "Price, Tobacco Control Policies
and Youth Smoking," National Bureau of Economic Research Working
Paper #5740 (1996); (2) "Economic and Other Factors in Youth
Smoking," final report, National Science Foundation (1983); (3) "The
Effects of Government Regulations on Teenage Smoking," Journal of Law
and Economics, Vol.  24, (1981), pp.  545-69; and (4) "The Impact of
Cigarette Excise Taxes on Smoking Among Children and Adults:  Summary
Report of a National Cancer Institute Expert Panel," National Cancer
Institute (1993).

         STATE EXCISE TAXES
-------------------------------------------------------- Letter :1.0.3

National tobacco settlement legislation would likely result in a
decline in state revenues from cigarette excise taxes.  A settlement
would probably contain a provision to increase the real price of
cigarettes and would have the reduction of smoking as its goal.  As
prices increase, total cigarette consumption will fall.  Our analysis
indicates that the states' revenue losses from cigarette excise taxes
corresponding to these consumption declines could, taken together,
range from about $673 million to $3 billion, assuming current tax
rates.\7 However, these excise tax losses would average less than 1
percent of the states' total tax revenues.

--------------------
\7 Other factors are already affecting states' revenues from
cigarette excise taxes, such as overall declines in consumption for
reasons other than price (e.g., increasing concerns over the health
consequences of smoking) and interstate and international cigarette
smuggling.

         CIGARETTE SMUGGLING
-------------------------------------------------------- Letter :1.0.4

Cigarette smuggling from low- to high-tax states, or interstate
smuggling, may be increasing.  A recent estimate indicates that
interstate smuggling activity may be costing the states,
collectively, hundreds of millions of dollars in annual tax
revenues.\8

International smuggling also occurs as a means to avoid both state
and federal taxes.  According to the Canadian government, sharp
increases in Canadian federal and provincial cigarette taxes in the
late 1980s and early 1990s led to large-scale international smuggling
between the United States and Canada.  Violence increased, merchants
suffered, and in 1 year alone, Canada and its provinces lost over $2
billion (in Canadian dollars) in tax revenues.  Although the extent
of U.S.-Mexican international cigarette smuggling is currently
unknown, evidence exists that such activity is occurring, according
to officials from the state of California, the Bureau of Alcohol,
Tobacco, and Firearms (ATF), and the Mexican Embassy.

--------------------
\8 See A Tax Study:  Cigarette Consumption in Washington State,
Washington State Department of Health (Jan.  1997).  This study
statistically determines how demographic factors, such as income and
religious preferences, and state tax-rate differentials affect taxed
sales of cigarettes by state.  The estimated relationships are used
to simulate actual consumption.  The quantities of cigarettes
smuggled into a state are then estimated by subtracting estimated
taxed sales in a state from simulated actual consumption.

   BACKGROUND
------------------------------------------------------------ Letter :2

On June 20, 1997, the nation's largest tobacco companies\9 and
attorneys general representing 40 states proposed a national
settlement that, if implemented, would significantly change the way
tobacco products are manufactured, marketed, and distributed in the
United States.\10 The tobacco industry agreed to pay about $368.5
billion (in 1997 dollars) over a period of 25 years--subject to
consumption or volume adjustment.\11 Annual payments would range from
$8.5 billion to $15 billion.  Among other things, these payments
would be used to fund an extensive federal enforcement program,
including a state-administered retail licensing system to stop minors
from obtaining tobacco products; an annual national
counter-advertising and tobacco-control campaign; a nationwide
smoking cessation program; and expenditures for states' health
benefits programs.  The proposed settlement would also impose
substantial surcharges on the tobacco industry if underage tobacco
use does not decline by at least 30 percent in 5 years, 50 percent in
7 years, and 60 percent in 10 years.  In addition, the settlement

  -- clarifies FDA's authority to regulate tobacco
     products--including regulating the level of nicotine in
     cigarettes--under the Food, Drug, and Cosmetic Act and requires
     the tobacco industry to pay for FDA's oversight of the industry;

  -- bans all outdoor tobacco advertising and the use of cartoon
     characters and human figures, such as the Marlboro Man, in
     tobacco advertising;

  -- requires manufacturers to disclose internal research relating to
     the health effects of their products;

  -- establishes a minimum federal standard to restrict smoking in
     public places, with enforcement funding coming from the
     industry's payments;

  -- settles all punitive damages claims against the tobacco industry
     and places limits on future class-action suits against the
     industry;

  -- provides for the annual payments to be reflected in the prices
     that manufacturers charge for tobacco products; and

  -- treats all payments as ordinary and necessary business expenses,
     which makes them tax-deductible.

Many of the elements of this proposed national tobacco settlement
were included in a bill introduced by the Chairman, Senate Committee
on Commerce, Science, and Transportation, on November 7, 1997.  Over
the past several months, other Members of Congress have presented
their own alternative settlement proposals.  Comparing the provisions
of all these various proposals is beyond the scope of this report,
but we note that a common goal of many of the proposals we reviewed
is to reduce smoking by youth, in part through a large increase in
the price of a pack of cigarettes--ranging from 62 cents to about
$2.00 per pack.

On September 17, 1997, the President announced five key goals that he
believes should be included in any national tobacco settlement
legislation:  (1) reducing smoking by teens, through, among other
things, a combination of industry payments and penalties;\12 (2)
granting FDA full authority to regulate the manufacturing, marketing,
and sale of tobacco products; (3) changing the way the tobacco
industry does business, such as through restricting the marketing and
promoting of tobacco to children, and requiring the industry to
disclose scientific and health-related research; (4) addressing other
related public health goals, such as promoting smoking cessation,
researching the health consequences of smoking, and further
restricting smoking in the workplace and in public areas; and (5)
minimizing the impact of a national settlement on tobacco farmers and
their communities.

While the Congress has been deliberating the issue of a tobacco
settlement, individual state lawsuits continue to move through the
legal process, and to date, three have been settled, resulting in
settlements totaling at least $28.8 billion.\13 If there is a
national tobacco settlement, some terms of these individual state
settlements may be superseded.

--------------------
\9 The U.S.  domestic tobacco market is dominated by five cigarette
manufacturers--Philip Morris, Inc.; R.J.  Reynolds Tobacco Co.; Loews
Corp.'s Lorillard Tobacco Co.; B.A.T.  Industries Ltd.'s Brown and
Williamson Tobacco Corp.; and Brooke Group Ltd.'s Liggett Group Inc.
Combined, these manufacturers produce over 99 percent of the
cigarettes sold in the United States.

\10 On Mar.  15, 1996, and Mar.  20, 1997, the smallest of these five
cigarette companies, Liggett, and its parent company, Brooke Group
Ltd., settled with each of the 22 states that had filed suit against
them.

\11 The agreement also states that additional annual payments will
continue in perpetuity.

\12 Cigarette prices would be increased by up to $1.50 per pack over
10 years in order for the industry to make the payments.  The tobacco
companies would be held accountable for meeting targets for reducing
the number of teens who smoke, would be penalized when the targets
are missed, and would fund a public education and counter-advertising
campaign.

\13 On July 2, 1997, Mississippi settled its suit against Philip
Morris, Inc.; R.J.  Reynolds Tobacco Co.; Brown and Williamson
Tobacco Corp.; and Lorillard Tobacco Co.  These four tobacco
companies agreed to pay Mississippi at least $3.3 billion over 25
years, with annual payments of at least $135 million continuing
thereafter.  On August 25, 1997, Florida settled its suit against
Philip Morris, Inc.; R.J.  Reynolds Tobacco Co.; Brown and Williamson
Tobacco Corp.; Lorillard Tobacco Co.; and United States Tobacco Co.
These five tobacco companies agreed to pay Florida at least $11
billion over 25 years, with annual payments of at least $440 million
continuing thereafter.  On January 16, 1998, Texas settled its suit
against Philip Morris, Inc.; R.J.  Reynolds Tobacco Co.; Brown and
Williamson Tobacco Corp.; Lorillard Tobacco Co.; and United States
Tobacco Co.  These five tobacco companies agreed to pay Texas at
least $14.5 billion over 25 years, with annual payments of at least
$580 million continuing thereafter.

   REDUCING TOBACCO CONSUMPTION
   UNLIKELY TO INCREASE NATION'S
   UNEMPLOYMENT RATE
------------------------------------------------------------ Letter :3

From 353,000 to 555,000 U.S.  jobs are directly related to the
growing, warehousing, manufacturing, wholesaling, and retailing of
tobacco products, according to the studies we reviewed that examined
the national and regional economic impacts of the tobacco
industry.\14 These studies do not specifically address the potential
economic impacts of either a national tobacco settlement or the
absence of a national settlement.\15 However, two studies--Warner's
and USDA's--examined the potential net impact on U.S.  employment if
tobacco consumption were to decline, which is likely in the event of
a national settlement.  These two studies concluded that overall, the
negative impact on U.S.  employment would be offset by ex-smokers'
spending the money they previously spent on tobacco products on
other, potentially more labor-intensive goods and services.  However,
the new jobs related to these other goods and services might be
lower-paying, on average, than the tobacco-related jobs they
replaced.  The Southeast Tobacco Region,\16 where tobacco production
is most heavily concentrated, would likely experience job losses.

--------------------
\14 These studies are (1) Kenneth E.  Warner; George A.  Fulton;
Peter Nicolas; and Donald R.  Grimes, "Employment Implications of
Declining Tobacco Product Sales for the Regional Economies of the
United States," Journal of the American Medical Association, Vol.
275, No.  16 (Apr.  24, 1996), pp.  1241-46 (Warner); (2) Excerpts
from the Tobacco Merchants Association's study, "Tobacco's
Contribution to the National Economy," released September 17, 1996;
(3) Fred Gale, USDA/ERS, "Tobacco Dollars and Jobs," Tobacco
Situation and Outlook Report, USDA/ERS, TBS-239 (Sept.  1997), pp.
37-43; and (4) "The U.S.  Tobacco Industry in 1994:  Its Economic
Impact in the States," The American Economics Group, Inc.  (Mar.
1996).  This study was sponsored by the Tobacco Institute.

\15 In addition, some of the relationships and data utilized in these
studies may have changed.  For example, data that address the
relationships among the industries included in the studies are based
on 1992 or earlier benchmark data, which were the latest available
data at the time the studies were done.

\16 The Warner study defines the Southeast Tobacco Region as the six
major tobacco-producing states:  Georgia, Kentucky, North Carolina,
South Carolina, Tennessee, and Virginia.  This definition is used in
this report to allow comparisons to be made.

      A VARIETY OF U.S.  JOBS
      ASSOCIATED WITH THE TOBACCO
      INDUSTRY
---------------------------------------------------------- Letter :3.1

The studies that we reviewed divided estimates of total
tobacco-related employment into three categories--the core sector,
supplier sector, and expenditure-induced sector.  (See table 1.) The
estimates for total core-sector employment (or direct employment)
range from 353,000 to 555,000.\17 These jobs include, for example,
ones associated with the growing, warehousing, manufacturing,
wholesaling, and retailing of tobacco products.  The estimates of
total supplier-sector employment--indirect tobacco-related jobs
associated with the producers of farm chemicals, paper, cellophane,
and others that supply materials and services to the tobacco core
sector--range from about 149,000 to about 213,000 employees.  In
addition, the income earned by tobacco growers, manufacturers,
suppliers, and others is spent on a variety of consumer goods and
services that generate additional revenue for a wide range of
industries throughout the U.S.  economy.  The estimates of employment
associated with this expenditure-induced sector range from about
504,000 to about 2.3 million jobs.\18 The combined estimates of
tobacco-related employment associated with the supplier and
expenditure-induced sectors range from about 653,000 to over 2.3
million jobs.  Overall, according to the studies we reviewed,
tobacco-related employment totals from about 1.2 million to 3.1
million jobs nationwide.  (For more detailed information on
tobacco-related employment by industry, see app.  I, tables I.1, I.2,
and I.3.)

                                Table 1

                Estimated Number of Jobs Associated With
                     Tobacco Nationwide, by Sector

                           Studies' estimates of the number of jobs
                                  associated with tobacco\a
                        ----------------------------------------------
                                                   Tobacco
                           Tobacco               Merchants
                        Institute,     Warner,  Associatio
Type of sector                1994        1993     n, 1995  USDA, 1995
----------------------  ----------  ----------  ----------  ----------
Core sector                449,426     353,000          \b     555,000
Supplier sector            212,976          \c          \b     149,000
Total, core and            662,402          \c     730,000     704,000
 supplier sector
Expenditure-induced      1,150,110          \c   2,330,000     504,000
 sector
======================================================================
Total                    1,812,512   1,786,938   3,060,000   1,208,000
----------------------------------------------------------------------
\a The number of jobs estimated is not strictly comparable across
studies because different methods, models, and assumptions were used
to generate the estimates.

\b Combined total of 730,000 provided for core and supplier sectors.

\c Supplier and expenditure-induced sector totals were not reported
separately.

Source:  GAO's analysis of Tobacco Institute's, Warner's, Tobacco
Merchants Association's, and USDA's data.

--------------------
\17 From about 155,000 to over 250,000 of the jobs estimated to be
directly related to tobacco are jobs associated with the retail sale
of tobacco products.  According to USDA officials, persons employed
in the retail sale of tobacco products may also sell other goods and
services.

\18 According to USDA officials, the number of jobs associated with
the expenditure-induced sector are the most difficult to estimate
with certainty; therefore, these estimates are the least reliable.

      DECLINES IN CIGARETTE
      CONSUMPTION COULD CAUSE JOB
      LOSSES IN THE SOUTHEAST BUT
      HAVE LITTLE IMPACT
      NATIONWIDE
---------------------------------------------------------- Letter :3.2

The estimates shown in table 1 indicate the total number of jobs (or
gross impact) associated with the production and sales of U.S.
tobacco products.  However, if tobacco consumption were to fall,
according to Warner's and USDA's studies,\19 the money previously
spent on tobacco products would be spent on other consumer goods and
services, and, therefore, employment in other sectors would rise,
offsetting part or all of the employment decline in the tobacco
industry.\20

Warner estimated the impact of decreasing tobacco consumption under
two scenarios.  (See table 2.) The first scenario assumes that all
domestic spending on tobacco stops immediately (which is unlikely in
the absence of an outright tobacco ban), while the second scenario
assumes that annual domestic spending on tobacco decreases at twice
the current rate, or at about 4 percent.\21 This study also assumes
that money previously spent on tobacco products would be reallocated
to all goods and services in the U.S.  economy in the same
proportions as these goods and services currently contribute to the
gross domestic product.  As table 2 shows, under the first scenario,
the U.S.  economy would gain 133,000 jobs nationwide over a 7-year
period and about 20,000 jobs under the second scenario.  Job losses
in the retail and wholesale trade, farm, manufacturing, and
government sectors would be more than made up by job gains in the
services and other private industry sectors.  Warner explained the
reason for this net gain by suggesting that most of the industries
that produce the products that would replace tobacco are more labor
intensive than the tobacco industry.\22 However, because 91 percent
of tobacco farming and manufacturing jobs are located in the
Southeast Tobacco Region, this region could suffer net job losses in
all sectors of the economy.  These total losses are likely to be less
than 1 percent of the region's total employment.\23 (For more
detailed information see app.  I, tables I.4 and I.5.)

                                Table 2

                  Estimated Net Impact on National and
                Southeast Tobacco Region's Employment if
                the Money Previously Spent on Tobacco Is
                Spent on Other Goods and Services in the
                             United States

                                  Number of jobs gained or (lost)
                              ----------------------------------------
                                              Employment    Employment
                                            in Southeast            in
                                  National       Tobacco    nontobacco
Scenario analyzed               employment        Region       regions
----------------------------  ------------  ------------  ------------
Domestic spending on tobacco       133,000     (222,248)       355,248
 is stopped immediately
Domestic spending on tobacco        19,719      (36,584)        56,303
 decreases at twice the
 current rate of decline\a
----------------------------------------------------------------------
Notes:  Warner examined the net economic impact in 2000 of either
eliminating or reducing tobacco spending beginning in 1993.  Warner
defined the Southeast Tobacco Region as the six major
tobacco-producing states:  Georgia, Kentucky, North Carolina, South
Carolina, Tennessee, and Virginia.

\a The Bureau of Labor Statistics estimated the current rate of
annual decline to be 2.06 percent through the year 2000.

Source:  Warner.

In 1995, USDA also estimated the net impact of immediately ending
domestic tobacco consumption.  Under a scenario that USDA examined,
the money currently spent on tobacco products would be reallocated to
snack food and beverage products, and the U.S.  economy would gain
156,000 jobs nationwide--a result similar to that of Warner's
scenario described above.  USDA's study concluded that jobs in
tobacco farming and tobacco manufacturing would be reduced
considerably.  However, the industries that produce the products that
would replace tobacco are more labor-intensive, although, on average,
lower paying, and thereby would more than offset the job losses
resulting from reductions in tobacco consumption.  The study also
concluded that the general result does not change--that is, an
overall gain in jobs nationwide--regardless of how tobacco
expenditures are assumed to be reallocated.\24 Although numerical
results were not presented specifically for the Southeast Tobacco
Region, USDA noted that Kentucky, North Carolina, Tennessee, and
Virginia would lose tobacco farming and manufacturing jobs.

--------------------
\19 Declines in domestic consumption will result in production
declines, unless export growth makes up the difference.  USDA data
indicate that, in recent years, domestic cigarette consumption has
been falling while cigarette exports and total cigarette production
have been rising.

\20 USDA officials pointed out that both their study and Warner's
assume that money reallocated from the tobacco sector is spent
entirely on domestic, rather than imported, goods and services.  In
addition, USDA officials noted that total tobacco production includes
leaf and other non-cigarette tobacco products.  Depending upon how
tobacco price support and quota programs are treated in a settlement,
the production of these other tobacco products could change.

\21 The Bureau of Labor Statistics estimated the current rate of
annual decline to be 2.06 percent through the year 2000.

\22 This study assumes that there are unemployed workers in the
economy who can fill these jobs.

\23 According to the 1994 Statistical Abstract of the United States,
the Southeast Tobacco Region--Georgia, Kentucky, North Carolina,
South Carolina, Tennessee, and Virginia--employed approximately 15.6
million in 1993 (the year studied by Warner).

\24 This study, like Warner's, assumes that there are unemployed
workers in the economy who can fill these jobs.

   TRENDS INDICATE PRICES MAY
   INFLUENCE SMOKING AMONG YOUTHS
------------------------------------------------------------ Letter :4

According to a 1997 University of Michigan survey, in 1977, about 29
percent of 12th-graders smoked daily.\25 This level decreased to
about 17 percent by 1992 and then rose to about 25 percent in 1997.
The recent increase in smoking probably occurred because the upward
trend in real cigarette prices ceased.  The most recent estimates
indicate that an increase in the price of cigarettes leads to a drop
in the smoking rate for youths.\26

The data available on smoking behavior for Canadian youths indicate a
trend that is consistent with that shown for the United States.

--------------------
\25 "Monitoring the Future," University of Michigan's long-term
survey of 12th-graders, 1977 through 1997.  Each year, approximately
16,000 completed interviews are obtained from a nationally
representative sample of high school seniors.

\26 See "Price, Tobacco Control Policies and Youth Smoking," National
Bureau of Economic Research Working Paper #5740 (1996).

      U.S.  YOUTHS' PURCHASE OF
      CIGARETTES IS SENSITIVE TO
      PRICE
---------------------------------------------------------- Letter :4.1

Studies indicate that increases in the real price of a pack of
cigarettes contribute to decreases in the percentage of U.S.  youths
who smoke daily.  According to the University of Michigan survey,
from 1977 through 1992, the percentage of U.S.  12th-graders smoking
daily generally declined from about 29 percent in 1977 to about 17
percent in 1992.  (See fig.  1.) However, since 1992, the smoking
rate has risen significantly, to about 25 percent in 1997.  After
initially decreasing from about $1.44 per pack of cigarettes in 1977
to about $1.23 per pack in 1981, the real price of a pack of
cigarettes (in 1997 U.S.  dollars) rose steadily, to a high of about
$2.10 in 1992, before falling to about $1.95 in 1997.  These two
trends show an inverse relationship between the real price of a pack
of cigarettes and the smoking rate for youths.  The most recent
estimates indicate that this inverse relationship remains strong,
even when antismoking regulations and restrictions on youths' access
are included in the analysis.  According to these estimates, a real
price increase of 10 percent will cause a 4- to 9-percent decrease in
the percentage of youths who smoke.

   Figure 1:  Percentage of U.S.
   12th-Graders Smoking Daily in
   Relationship to the Price of a
   Pack of Cigarettes, 1977
   Through 1997

   (See figure in printed
   edition.)

Note:  The data on smoking by youths presented here are the only
long-term annual data available and are widely accepted as
methodologically sound.

Sources:  University of Michigan, DRI/McGraw-Hill, and the Tobacco
Institute.

      DATA ON SMOKING BY CANADIAN
      YOUTHS ARE INCOMPLETE
---------------------------------------------------------- Letter :4.2

Data describing the smoking behavior of youths in Canada are
incomplete.  (See fig.  II.1 in app.  II for available data.) The
data that are available, which we obtained from Canada's National
Clearinghouse on Tobacco and Health, suggest that the percentage of
Canadians aged 15 to 19 who smoke daily fell sharply, from about 42
percent in 1977 to about 16 percent in 1991.  Since then, however,
the data suggest that smoking by youths is on the rise--reaching the
rate of about 20 percent in 1994.  From the data available, it is
impossible to conclude with any certainty the reason for the higher
1994 rate.  However, we believe two likely factors are (1) a possible
reaction to the federal and provincial cigarette tax decreases
enacted earlier that year, which suggests a relationship between
smoking by youths and the price of cigarettes consistent with that
observed for U.S.  youths, and (2) Canadian youths' increasing access
to contraband cigarettes.

   A TOBACCO SETTLEMENT WOULD
   LIKELY REDUCE STATES' TAX
   REVENUES
------------------------------------------------------------ Letter :5

National tobacco settlement legislation would likely result in a
decline in state revenues from cigarette excise taxes.  A settlement
would probably contain a provision to increase the real price of
cigarettes, with the goal of reducing the smoking rate.  Already,
several legislative proposals would increase real cigarette prices.
According to our analysis, if such price increases were to take
effect, they alone could cause cigarette consumption to fall
substantially.  As a result, states, collectively, could lose
billions of dollars annually in associated revenues from cigarette
excise taxes;\27 however, individual states, on average, would lose
less than 1 percent of their total tax revenues.\28

--------------------
\27 This analysis assumes state rates for cigarette excise taxes stay
constant.

\28 Other factors that already affect states' cigarette excise tax
revenues include declines in consumption resulting from reasons other
than price (e.g., increasing concerns over the health consequences of
smoking) and interstate and international cigarette smuggling.  This
analysis does not include any federal collections from a nationwide
settlement that may be allocated to the states.

      INCREASES IN THE PRICE OF
      CIGARETTES COULD
      SIGNIFICANTLY REDUCE
      CONSUMPTION
---------------------------------------------------------- Letter :5.1

Several current tobacco settlement proposals contain provisions to
increase the price of cigarettes.  It has been estimated that the
original $368.5 billion settlement proposal between the tobacco
industry and 40 state attorneys general is likely to be passed on to
consumers, resulting in a price increase of about 62 cents per pack.
The President's plan calls for an increase of up to a $1.50 per pack
over a 10-year period.  Table 3 presents a range of estimated changes
in consumption that could result from these price increases.  A price
increase of $2.00 per pack is included in table 3 to illustrate a
reasonable upper bound on the likely impact on consumption, because
one tobacco bill we reviewed, although not a comprehensive settlement
proposal, proposed a price increase higher than the one proposed by
the President.\29 As table 3 shows, an increase of 62 cents per pack
in the real price of cigarettes could result in a 9- to 16-percent
decline in cigarette consumption, depending on how consumers react to
these increases.  The President's $1.50 per pack increase could
result in an even greater decline in cigarette consumption--from
about 19 to 33 percent.  Overall, table 3 shows that the price
increases included in current proposals could reduce consumption from
about 9 to 40 percent.

                                Table 3

                    Estimates of Declining Cigarette
                 Consumption Resulting From Changes in
                    The Real Price of Cigarettes for
                 Selected Assumed Price/Quantity Trade-
                             off Responses

                                    Percent change in consumption
                                --------------------------------------
                                       Lower bound         Upper bound
Price increase per pack                   estimate            estimate
------------------------------  ------------------  ------------------
Original settlement:
 $0.62                                           9                  16
President's plan:
 $1.50                                          19                  33
Current upper bound:
 $2.00                                          24                  40
----------------------------------------------------------------------
Note:  Studies indicate price elasticities of demand for cigarette
consumption ranging from -3.5 to -6 percent, which we present here to
serve as lower and upper bounds, respectively, on the potential
impact on consumption of increased cigarette prices.  In other words,
a 10-percent increase in the price of cigarettes has been estimated
to result in a decline in consumption of between 3.5 (lower bound)
and 6 (upper bound) percent.  If the real price of a pack of
cigarettes were to increase by $0.62, which represents about a
30-percent increase in price, consumption is estimated to decline by
9 (lower bound) to 16 (upper bound) percent.  In computing the
percentage changes in consumption, we used a constant elasticity
demand function in our economic model.  It should be noted that these
estimates of price elasticities are based on historical cigarette
price increases that are much smaller and at lower levels than the
price increases expected in a tobacco settlement.  As a result, any
forecast of consumption changes based on these elasticities is
uncertain.

Source:  GAO's analysis.  Elasticity bounds based on "The Impact of
Cigarette Excise Taxes on Smoking Among Children and Adults:  Summary
Report of a National Cancer Institute Expert Panel," National Cancer
Institute (Bethesda, MD, 1993); and "Smoke and Mirrors:
Understanding the New Scheme for Cigarette Regulation," W.  Kip
Viscusi, The Brookings Review (Winter 1998).

--------------------
\29 S.  1343, the Public Health and Education Resource Act,
introduced by Senator Frank Lautenberg on October 29, 1997, provides
for increasing the federal excise tax on cigarettes by $1.89 per pack
by 2002.

      CIGARETTE EXCISE TAX LOSSES
      COULD COST STATES AN AVERAGE
      OF LESS THAN 1 PERCENT OF
      TOTAL TAX REVENUES
---------------------------------------------------------- Letter :5.2

Nationwide, the increase in the real price of cigarettes resulting
from various tobacco settlement proposals could end up costing the
states from about $673 million to $3 billion annually in lost
revenues from cigarette excise taxes.  (See table III.1 in app.  III.
Table III.1 provides a range of the estimated lost revenues from
cigarette excise taxes for each state.) The states that stand to lose
the most tax revenues are those with large populations of smokers
and/or the highest state rates for cigarette excise taxes.  For
example, Michigan, which has one of the highest rates, could lose
from about $50 million to $220 million in annual tax revenues.  On
the other hand, Ohio, which has approximately the same population of
smokers as Michigan, or more, would stand to lose from $26 million to
$117 million because of its much lower tax rate.  Overall, all but
one state would lose less than 2 percent of their total tax revenues
from all sources (see app.  III, table III.1); on average, states
would lose less than 1 percent of their total tax revenues.

   CIGARETTE PRICES AFFECT EXTENT
   OF SMUGGLING ACTIVITY
------------------------------------------------------------ Letter :6

Smuggling cigarettes from low- to high-tax states, or interstate
smuggling, which was prominent in the 1970s, may now be a reemerging
problem.\30 The opportunity for individuals to profit from interstate
smuggling exists because of the wide disparity in excise taxes across
the states.  Currently, the states' cigarette excise taxes range from
2.5 cents per pack in Virginia to $1.00 per pack in Alaska.  (See
fig.  2.) According to the Department of the Treasury's Bureau of
Alcohol, Tobacco, and Firearms (ATF), cigarettes are currently being
smuggled across state borders to avoid the payment of state excise
taxes.  This activity can violate federal and/or state laws.\31 A
January 1997 study by the Washington State Department of Health
estimated the extent of interstate smuggling activity in terms of
packs per capita by state--which we converted to the associated loss
(or gain) of state tax revenue.  (See app.  IV, table IV.1.)\32
According to our analysis of these data, some states are losing up to
about $100 million annually in potential tax revenues.\33 As
expected, the Washington State study indicated that substantial
smuggling occurs from states with low tax rates to states with high
tax rates.  For example, Washington and Michigan, states with among
the highest tax rates, had estimated annual losses in tax revenues of
$51 million and $105 million, respectively.  On the other hand,
exporting states--such as Kentucky, North Carolina, and Virginia--did
not show revenue losses; however, at most, they showed only modest
revenue gains because their tax rates are so low that extra sales to
buyers in the high-tax states do not generate significant tax
revenues.

   Figure 2:  State Cigarette Tax
   Rates, in Cents, per Pack of 20
   Cigarettes, as of January 1,
   1998

   (See figure in printed
   edition.)

Source:  The Tobacco Institute.

Recent experience demonstrates that international smuggling can occur
when differences in cigarette tax rates are substantial.  For
example, international smuggling has occurred recently between Canada
and the United States.  From 1984 through 1993, the average real
price of a pack of cigarettes in Canada--in 1994 Canadian
dollars--increased from $2.64 in 1984 to $5.65 in 1993, as a result
of sharp increases in Canadian federal and provincial cigarette
taxes.  According to a 1994 study for the National Coalition Against
Crime and Tobacco Contraband, because of these price increases,
Canadians found lower-priced alternatives on the black market.\34
Organized criminal groups purchased Canadian cigarettes that had been
exported tax-free to the United States and smuggled them back into
Canada.  The Canadian government estimated that, in 1993, contraband
cigarettes made up over 60 percent of the Quï¿½bec market and from 15
to 40 percent of the market in other parts of the country.  Violence
increased, merchants suffered, and in 1 year alone, Canada and its
provinces lost over $2 billion (in Canadian dollars) in tax revenues.
The Canadian Prime Minister believed that Canadian tobacco
manufacturers were aware that tobacco exports to the United States
had been reentering Canada illegally and that these manufacturers
benefited directly from this illegal trade.  Canada responded in 1994
by sharply reducing federal and provincial cigarette taxes and
increasing its enforcement efforts, among other steps.  Since then,
international cigarette smuggling has declined considerably.
Available evidence also shows that international smuggling is
currently occurring between the United States and Mexico; however,
the extent of this activity is not known.  (For more information on
international cigarette smuggling, see app.  V.)

--------------------
\30 The profitability of interstate smuggling depends on the real
(inflation-adjusted) value of differences in states' tax rates.  By
the early 1980s, inflation had eroded the relatively large
differentials existing in the 1960s and 1970s, resulting in
relatively little smuggling activity.  The mid-1980s, however, marked
a new round of tax-rate increases, which returned the real
differentials to mid-1970s levels.  According to the Bureau of
Alcohol, Tobacco, and Firearms, interstate smuggling activity has
been increasing in recent years.

\31 All forms of tax avoidance--both large and small--are considered
"smuggling," even though some actions, such as local cross-border
purchases in small quantities, may not be illegal.  It is unlawful
for any person to ship, transport, receive, sell, distribute, or
purchase 60,000 cigarettes or more that bear no evidence of state tax
payment in the state in which the cigarettes are found, if such state
requires a stamp to demonstrate payment of taxes (18 U.S.C.  2342).
States may also have stricter laws related to cigarette smuggling.
For example, in Maryland, it is generally illegal for a consumer to
bring more than two packs of cigarettes on which Maryland taxes have
not been paid into the state.

\32 See A Tax Study:  Cigarette Consumption in Washington State,
Washington State Department of Health (Jan.  1997).  This study
statistically determines how demographic factors--such as income,
race, and religious background--and state tax-rate differentials
affect the taxed sales of cigarettes by state.  The estimated
relationships are used to simulate actual consumption.  The
quantities of cigarettes smuggled into a state are then estimated by
subtracting estimated taxed sales in a state from simulated actual
consumption.

\33 For some states, revenue from state sales taxes, in addition to
cigarette excise taxes, may also decline because of cross-border
purchases and contraband sales.  For this reason and others, the
Washington State study results should be viewed as providing ballpark
estimates of revenues lost.  In addition, estimates of lost revenues
may be (1) overstated because they do not account for the fact that
smokers would buy fewer cigarettes if they were unable to avoid the
state cigarette tax (and therefore pay more for their cigarettes on
average) or (2) understated because they do not account for federal
and state tax revenues avoided because of international smuggling.

\34 The National Coalition Against Crime and Tobacco Contraband is a
U.S.  coalition composed primarily of retailers, wholesalers, and
tobacco manufacturers.  The coalition's report on smuggling entitled
Cigarette Smuggling in the United States (Aug.  15, 1994) was
prepared by Lindquist Avey Macdonald Baskerville, Inc.

   AGENCY COMMENTS
------------------------------------------------------------ Letter :7

We provided a draft of this report to USDA for review and comment.
We met with officials from the Economic Research Service, including
two agricultural economists; Foreign Agricultural Service, including
a senior tobacco economist; and Farm Service Agency, including the
Deputy Administrator for Farm Programs.  USDA generally agreed with
the accuracy of the report and provided clarifications on the
economic impact of the tobacco industry.  USDA noted that employment
in the tobacco industry is most accurately characterized by counting
only employment in the growing, processing, manufacturing, and
wholesaling of tobacco products.  Because the studies we reviewed
generally included a broader definition of jobs directly related to
tobacco by including the retail industry, we used this broader
definition throughout our report.  In addition, USDA commented that
it is important to note that while cigarette consumption has been
declining, production and exports have been increasing.  We included
language in our final report to make this point clear.  We also
incorporated other suggested clarifications where appropriate.

   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8

We searched the literature to identify studies that assessed the
national and regional economic impacts of the tobacco industry and
talked to officials at USDA, the tobacco industry, and academia.  We
obtained data on smoking trends for U.S.  youths from the University
of Michigan's "Monitoring the Future" survey; obtained information on
cigarette prices from the Tobacco Institute, which we converted to
1997 dollars; and searched the economic literature for estimates of
the price/quantity elasticities for cigarette purchases by youths.
We obtained all available data on the smoking rate for Canadian
youths from Canada's National Clearinghouse on Tobacco and Health,
which Statistics Canada reviewed for accuracy.  The National
Clearinghouse also provided us with the latest available information
on the price of Canadian cigarettes.  We obtained estimates of price
elasticities for U.S.  domestic cigarette consumption by reviewing
the economics literature and used a methodology similar to the
Federal Trade Commission's to estimate the impact of price increases
on cigarette consumption.\35

The Tobacco Institute provided us with the states' rates for
cigarette excise taxes and data on the states' revenues from these
excise taxes, which we used to calculate estimates of the impact of
declining cigarette consumption on states' revenues from cigarette
excise taxes.  We obtained data on total state revenues (from all
sources) from the Statistical Abstract of the United States, 1997.
For information on interstate smuggling in the United States and
U.S.-Canadian international smuggling, we talked to officials from
ATF; USDA; Canada's Office of the Auditor General; FIA International
Research, Ltd.; and Empire Pacific Group; and we obtained a study
that estimated the extent of interstate cigarette smuggling from the
Washington State Department of Health.  To obtain information on
U.S.-Mexican smuggling, we interviewed officials from the California
Board of Equalization; California Alcoholic Beverage Control;
Glendale, California Police Department; ATF; the U.S.  Customs
Service; U.S.  Border Patrol; FIA; Empire Pacific Group; and the
Mexican Embassy, and we visited the border ports of San Ysidro,
California; and Otay Mesa, California; and the border checkpoint at
San Clemente, California.  We conducted our review from July 1997
through February 1998 in accordance with generally accepted
government auditing standards.

--------------------
\35 See "Competition and the Financial Impact of the Proposed Tobacco
Industry Settlement," Federal Trade Commission (Sept.  1997).

---------------------------------------------------------- Letter :8.1

Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days from the date of this
letter.  At that time we will send copies to the Senate Committee on
Agriculture, Nutrition, and Forestry; Senate Committee on Commerce,
Science, and Transportation; House Committee on Agriculture; House
Committee on Commerce; the Secretaries of Agriculture, the Treasury,
and Health and Human Services; the Attorney General; and other
interested parties.  We will also make copies available to others
upon request.

Please contact me at (202) 512-5138 if you or your staff have any
questions.  Major contributors to this report are listed in appendix
VI.

Sincerely yours,

Robert A.  Robinson
Director, Food and
 Agriculture Issues

NATIONAL AND REGIONAL ECONOMIC
IMPACT OF THE TOBACCO INDUSTRY
=========================================================== Appendix I

                               Table I.1

                    Estimated Current Number of Jobs
                 Associated With Tobacco Nationally and
                  in the Southeast Tobacco Region, by
                             Industry, 1994

                                                     Number of jobs in
                                         Number of       the Southeast
Tobacco employment category        jobs nationally      Tobacco Region
------------------------------  ------------------  ------------------
======================================================================
Total, core sector                         449,426             221,222
Tobacco growing                            142,059             130,521
Tobacco warehousing/
 distribution                               10,510               9,342
Tobacco manufacturing                       42,260              37,627
Tobacco wholesaling                         98,866              16,304
Tobacco retailing                          155,731              27,428
======================================================================
Total, supplier sector\a                   212,976              85,809
Total, expenditure-induced
 sector                                  1,150,110             386,109
Agriculture                                 26,703              15,930
Mining and construction                     33,516              11,141
Manufacturing                              185,430              90,652
Wholesale & retail trade                   308,475              77,049
Transportation,
 communications, and
 utilities                                  87,426              30,804
Finance, insurance, &
 real estate                                92,734              29,087
Business & personal
 services                                  383,688             118,165
Government                                  32,138              13,281
======================================================================
Grand total                              1,812,512             693,140
----------------------------------------------------------------------
Note:  Kenneth E.  Warner; George A.  Fulton; Peter Nicolas; and
Donald R.  Grimes, "Employment Implications of Declining Tobacco
Product Sales for the Regional Economies of the United States,"
Journal of the American Medical Association, Vol.  275, No.  16 (Apr.
24, 1996), pp.  1241-46 (Warner).  Warner defined the Southeast
Tobacco region as the six major tobacco-producing states:  Georgia,
Kentucky, North Carolina, South Carolina, Tennessee, and Virginia.
This definition is used here to allow comparisons to be made.

\a See table I.2 for supplemental information on the gross impact of
tobacco on the supplier sector.

Source:  The Tobacco Institute.

                               Table I.2

                  Suppliers to the Tobacco Core Sector

                         (Dollars in millions)

                                           1994 sales to tobacco core-
Major industry                                         sector firms \a
----------------------------------------  ----------------------------
Agricultural products, forestry, and
 fishery services                                               $396.8
Coal mining                                                        9.9
Miscellaneous mining                                               8.3
New and maintenance construction                                 206.2
Food and tobacco                                                 659.9
Textile mill products                                              4.0
Apparel                                                           10.6
Paper and allied products                                      1,210.9
Printing and publishing                                        1,885.5
Chemicals and petroleum                                          383.8
Rubber and leather                                               106.1
Lumber, wood products, and furniture                              40.3
Stone, clay, and glass                                            11.4
Primary metal                                                      2.1
Fabricated metal                                                 189.8
Machinery, except electrical                                      75.2
Electric and electronic equipment                                 26.2
Motor vehicles and equipment                                      18.3
Transportation equipment, except motor
 vehicles                                                          3.7
Instruments and related products                                  12.5
Miscellaneous manufacturing industries                            16.1
Transportation                                                   535.5
Communication                                                    220.8
Electric, gas, water, and sanitation                             418.6
 services
Trade and distribution                                         1,724.2
Finance                                                          340.1
Insurance                                                        114.4
Real estate                                                      886.2
Hotels and amusements                                            112.5
Personal services                                                 77.4
Business services                                              2,894.2
Eating and drinking                                              228.6
Miscellaneous services                                           496.8
======================================================================
Total, all suppliers                                         $13,326.8
----------------------------------------------------------------------
Note:  Although the Tobacco Institute did not break down its estimate
of tobacco-related jobs into various subcategories of the supplier
sector, it did provide this information on 1994 sales to firms in the
tobacco core sector.  These data provide some insight to the relative
contributions to total employment made by each major industry in the
supplier sector.

\a Based on latest data available at the time of the analysis.

Source:  The Tobacco Institute.

                               Table I.3

                The U.S. Tobacco Industry's Contribution
                      to National Employment,1995

                          (Jobs in thousands)

                                  Core and  Expenditure-
                                  supplier       induced    Total, all
Major industry                     sectors        sector       sectors
----------------------------  ------------  ------------  ------------
======================================================================
Total, manufacturing                    90           490           580
Apparel                                  0            30            30
Chemicals                               10            20            30
Electrical machinery                     0            50            50
Fabricated metals                        0            40            40
Food                                     0            40            40
Furniture                                0            20            20
Instruments                              0            20            20
Motor vehicles                           0            30            30
Nonauto transportation                   0            20            20
 equipment
Nonelectrical machinery                  0            50            50
Paper                                   10            20            30
Petroleum                                0            10            10
Primary metals                           0            30            30
Printing                                10            30            40
Rubber and plastics                     10            20            30
Stone                                    0            20            20
Textiles                                 0            20            20
Tobacco                                 40             0            40
Wood                                     0            20            20
Miscellaneous                            0            10            10
======================================================================
Total, nonmanufacturing                460         1,620         2,080
Communications                           0            20            20
Finance, insurance, and real            10           120           130
 estate
Government                               0            10            10
Services                                70           690           760
Transportation                           0            70            70
Utilities                                0            20            20
Wholesale and retail trade             370           690         1,060
Agriculture                            170            40           210
Construction                            10           160           170
Mining                                   0            20            20
======================================================================
Total employment                       730         2,330         3,060
----------------------------------------------------------------------
Note:  Based on latest data available at the time of the analysis.

Source:  Tobacco Merchants Association.

                               Table I.4

                 Estimated Net Impact on Employment by
                  Region of Reducing Domestic Tobacco
                 Spending at Twice the Current Rate of
                Decline and Spending the Money Elsewhere

                                                        Number of jobs
Region                                                gained or (lost)
--------------------------------------------------  ------------------
======================================================================
United States overall                                           19,719
======================================================================
Southeast Tobacco (Ga., Ky., N.C., S.C., Tenn.,               (36,584)
 Va.)
======================================================================
Nontobacco regions                                              56,303
New England (Conn., Mass., Maine, N.H., R.I., Vt.)               2,205
Mideast (Del., Md., N.J., N.Y., Pa.)                             8,991
Great Lakes (Ill., Ind., Mich., Ohio, Wis.)                     13,231
Plains (Iowa, Kans., Minn., Mo., N.D., Nebr.,                    5,835
 S.D.)
Southeast Nontobacco (Ala., Ark., Fla., La.,                     8,251
 Miss., W.V.)
Southwest (Ariz., Okla., N.M., Tex.)                             6,467
Rocky Mountain (Colo., Idaho, Mont., Utah, Wyo.)                 2,343
Far West (Alaska, Calif., Hawaii, Nev., Oreg.,                   8,980
 Wash.)
----------------------------------------------------------------------
Note:  Warner examined the net economic impact in 2000 of reducing
tobacco spending beginning in 1993.

Source:  Warner.

                               Table I.5

                   Estimated Net Impact on Employment
                Nationally and in the Southeast Tobacco
                Region, by Sector, of Reducing Domestic
                 Tobacco Spending at Twice the Current
                 Rate of Decline and Spending the Money
                               Elsewhere

                                                        Number of jobs
                                    Number of jobs    gained (or lost)
                                  gained (or lost)        in Southeast
Sector                                  nationally      Tobacco Region
------------------------------  ------------------  ------------------
Retail trade                               (6,004)             (6,477)
Wholesale trade                            (6,401)             (2,713)
Farm                                       (5,472)             (7,554)
Manufacturing                                (846)             (5,957)
Services                                    27,641             (7,069)
Other private                               10,879             (3,890)
Government                                    (78)             (2,924)
======================================================================
Total                                       19,719            (36,584)
----------------------------------------------------------------------
Note:  Warner examined the net economic impact in 2000 of either
eliminating or reducing tobacco spending beginning in 1993.  Warner
defined the Southeast Tobacco Region as the six major
tobacco-producing states:  Georgia, Kentucky, North Carolina, South
Carolina, Tennessee, and Virginia.

Source:  Warner.

SMOKING AMONG CANADIAN YOUTHS
========================================================== Appendix II

   Figure II.1:  Percentage of
   Canadians 15 to 19 Years Old
   Smoking Daily, Selected Years,
   1977 Through 1996, in
   Relationship to Real Price of
   Cigarettes, 1977 Through 1994

   (See figure in printed
   edition.)

Note:  Latest available data.  Data not available for every year
between 1977 and 1996.  Real price estimates shown do not account for
contraband sales and therefore likely overstate actual real prices.

Sources:  Canada's National Clearinghouse on Tobacco and Health and
Statistics Canada.

DECLINING STATE EXCISE TAX
REVENUES RESULTING FROM CIGARETTE
PRICE INCREASES
========================================================= Appendix III

                              Table III.1

                Illustration of the Potential Magnitude
                of Reductions in State Cigarette Excise
                Tax Revenues as a Result of Consumption
                Declines Resulting From Cigarette Price
                          Increases, by State

                                                                 Upper
                                                                bound:
                                         Lower       Upper       state
                                        bound:      bound:   cigarette
                                         state       state  tax losses
                                     cigarette   cigarette        as a
                                    tax losses  tax losses  percentage
                                    associated  associated    of total
                                        with a      with a   state tax
                                    consumptio  consumptio    revenues
                             State   n loss of   n loss of  associated
                         cigarette   9 percent  40 percent      with a
                         tax rate,    (dollars    (dollars  consumptio
                        as of July          in          in   n loss of
State/district             1, 1997   millions)   millions)  40 percent
----------------------  ----------  ----------  ----------  ----------
Alabama                     $0.165          $7         $30         0.6
Alaska                        .290           1           6         0.4
Arizona                       .580          15          66         1.0
Arkansas                      .315           8          35         1.0
California                    .370          57         253         0.4
Colorado                      .200           6          25         0.5
Connecticut                   .500          11          50         0.6
Delaware                      .240           2           9         0.5
District of Columbia
                              .650           2           7          \a
Florida                       .339          41         182         0.9
Georgia                       .120           8          36         0.4
Hawaii                        .600           3          14         0.5
Idaho                         .280           2          10         0.6
Illinois                      .440          38         168         1.0
Indiana                       .155          11          49         0.6
Iowa                          .360           9          39         0.9
Kansas                        .240           5          22         0.5
Kentucky                      .030           2           8         0.1
Louisiana                     .200           8          37         0.8
Maine                         .370           4          19         1.0
Maryland                      .360          12          54         0.7
Massachusetts                 .760          28         123         1.0
Michigan                      .750          50         220         1.2
Minnesota                     .480          17          75         0.8
Mississippi                   .180           5          21         0.5
Missouri                      .170          10          44         0.6
Montana                       .180           1           6         0.5
Nebraska                      .340           4          19         0.8
Nevada                        .350           5          21         0.7
New Hampshire                 .370           7          30         3.6
New Jersey                    .400          22          98         0.7
New Mexico                    .210           2           9         0.3
New York                      .560          59         263         0.8
North Carolina                .050           4          18         0.2
North Dakota                  .440           2           9         0.9
Ohio                          .240          26         117         0.7
Oklahoma                      .230           8          34         0.7
Oregon                        .680          18          78         1.8
Pennsylvania                  .310          32         141         0.8
Rhode Island                  .710           6          25         1.6
South Carolina                .070           3          13         0.3
South Dakota                  .330           2           9         1.2
Tennessee                     .130           7          33         0.5
Texas                         .410          51         228         1.1
Utah                          .515           5          23         0.8
Vermont                       .440           2          10         1.2
Virginia                      .025           2           7         0.1
Washington                    .825          23         103         1.0
West Virginia                 .170           3          14         0.5
Wisconsin                     .440          19          83         0.9
Wyoming                       .120           1           3         0.4
======================================================================
50-state total                  \b        $673      $2,993          \b
======================================================================
50-state average            $0.347          \b          \b         0.7
----------------------------------------------------------------------
Note:  Estimates were calculated using states' revenue data for
fiscal year 1997 (the latest available).  The tax rates as of July 1,
1997, are included here for comparison purposes.  This analysis
assumes state rates for cigarette excess taxes stay constant.  Other
factors that already affect states' cigarette excise tax revenues
include declines in consumption resulting from reasons other than
price (e.g., increasing concerns over the health consequences of
smoking) and interstate and international cigarette smuggling.  This
analysis does not include any federal collections from a nationwide
settlement that may be allocated to the states.

\a Not available.

\b Not applicable.

Source:  GAO's analysis.

ESTIMATES OF MAGNITUDE OF
INTERSTATE CIGARETTE SMUGGLING IN
THE UNITED STATES
========================================================== Appendix IV

                               Table IV.1

                Estimates of Changes in State Cigarette
                   Tax Revenues Because of Interstate
                  Cigarette Smuggling and Cross-Border
                            Sales, by State

                                                       Change in state
                                   State cigarette       cigarette tax
                                tax rate in effect      revenues (1996
                                 from July 1995 to          dollars in
State/district                           July 1996         millions)\a
------------------------------  ------------------  ------------------
Alabama                                     $0.165                ($3)
Alaska                                        .290                 (1)
Arizona                                       .580                (16)
Arkansas                                      .315                 (6)
California                                    .370                (80)
Colorado                                      .200                 (4)
Connecticut                                   .500                (12)
Delaware                                      .240                   4
District of Columbia                          .650                 (7)
Florida                                       .339                (32)
Georgia                                       .120                 (4)
Hawaii                                        .600                 (6)
Idaho                                         .280                   0
Illinois                                      .440                (56)
Indiana                                       .155                   5
Iowa                                          .360                 (6)
Kansas                                        .240                 (4)
Kentucky                                      .030                   5
Louisiana                                     .200                 (4)
Maine                                         .370                 (4)
Maryland                                      .360                (17)
Massachusetts                                 .510                (41)
Michigan                                      .750               (105)
Minnesota                                     .480                (19)
Mississippi                                   .180                 (3)
Missouri                                      .170                 (3)
Montana                                       .180                 (1)
Nebraska                                      .340                 (4)
Nevada                                        .350                 (4)
New Hampshire                                 .250                  18
New Jersey                                    .400                (21)
New Mexico                                    .210                 (1)
New York                                      .560                (93)
North Carolina                                .050                   0
North Dakota                                  .440                 (2)
Ohio                                          .240                 (5)
Oklahoma                                      .230                 (3)
Oregon                                        .380                 (3)
Pennsylvania                                  .310                (20)
Rhode Island                                  .610                 (6)
South Carolina                                .070                 (1)
South Dakota                                  .330                 (1)
Tennessee                                     .130                  12
Texas                                         .410                (57)
Utah                                          .265                 (3)
Vermont                                       .440                   5
Virginia                                      .025                   0
Washington                                    .815                (51)
West Virginia                                 .170                 (1)
Wisconsin                                     .440                (14)
Wyoming                                       .120                   0
======================================================================
50-state total                                  \b              ($674)
======================================================================
50-state average                            $0.327                  \b
----------------------------------------------------------------------
Note:  Table is based on results from Washington State Department of
Health's Study.

\a Changes in tax revenue derived from estimates of nontaxed sales
(packs per capita, 1995) presented in A Tax Study:  Cigarette
Consumption in Washington State, Washington State Department of
Health, Youth Tobacco Prevention Program, 1997.  State cigarette tax
rates from 1995-96, and 1996 state population data were used in our
analysis to be consistent with the time period of the study.

\b Not applicable.

Source:  GAO's analysis of Washington State Department of Health's,
U.S.  Bureau of Labor Statistics', and Tobacco Institute's data.

ADDITIONAL INFORMATION ON
INTERNATIONAL CIGARETTE SMUGGLING
=========================================================== Appendix V

This appendix presents information on cigarette smuggling between the
United States and Canada and between the United States and Mexico.

   CANADA
--------------------------------------------------------- Appendix V:1

According to the Canadian government, Canada increased the price of
cigarettes through federal and provincial excise taxes for several
years, which resulted in a steady decline in the number of Canadians
who smoke.  From 1984 through 1993, federal taxes on a pack of 20
cigarettes increased from 42 cents to $1.93 Canadian.  Provincial
taxes, levied in addition to the federal taxes, increased
significantly as well.  For example, from 1984 through 1993, Quï¿½bec's
cigarette taxes rose from 46 cents to $1.78 per pack, and Ontario's
rose from 63 cents to $1.66 per pack (in Canadian dollars).

However, during most of this period, cigarettes made in Canada were
exported tax-free to the United States.  According to the 1994 study
for the National Coalition Against Crime and Tobacco Contraband, an
Indian reserve that straddles the U.S.-Canadian border between
Cornwall, Ontario, and Massena, New York, had become the primary
conduit for smuggling these cigarettes back into Canada.  Once in
Canada, the cigarettes were passed through elaborate networks for
distribution to vendors throughout the country.  By evading the
Canadian federal and provincial taxes, smugglers were able to earn
huge profits from contraband cigarettes.  According to the Canadian
government, profits for smuggled cigarettes were an estimated $500
per case,\1 or $500,000 per truckload, in Canadian dollars.\2 The
extent of this smuggling activity is indicated by the more than an
11-fold increase in U.  S.  cigarette imports from Canada from 1990
to 1993.  (See fig.  V.1.) In addition, according to the Canadian
government, in 1993, approximately 2.1 million Canadians consumed an
estimated 90 million to 100 million cartons of contraband cigarettes
with a legal retail value of about $4.5 billion in Canadian dollars.

   Figure V.1:  U.S.  Cigarette
   Imports From Canada, 1984-96

   (See figure in printed
   edition.)

Source:  GAO's analysis of USDA's data.

While citing the effectiveness of past efforts to reduce smoking by
increasing cigarette taxes, Canadian Prime Minister Chrï¿½tien stated
in February 1994 that the widespread availability of relatively
inexpensive contraband cigarettes was negating government controls on
the distribution, sale, and consumption of cigarettes.  According to
the Prime Minister, as the portion of the Canadian market supplied by
smuggled tobacco increased, the average price paid for cigarettes
dropped.  Access to cheap contraband tobacco undermined the
government's health policy objectives of reducing tobacco
consumption, particularly among youths.

In February 1994, Prime Minister Chrï¿½tien addressed the smuggling
problem by proposing, among other actions,

  -- strengthening enforcement at targeted smuggling areas,
     particularly along the U.S.-Canadian border;

  -- reducing the federal cigarette tax by $5 per carton in all
     provinces, effective February 9, 1994, and matching any
     provincial tax reduction over $5, to a maximum federal reduction
     of $10 (in Canadian dollars);

  -- imposing an export tax of $8 per carton (in Canadian dollars) to
     be paid by tobacco manufacturers, with an exemption provided for
     shipments in accordance with each manufacturer's historic level
     of exports;

  -- imposing a 3-year federal surtax on tobacco manufacturers'
     profits to fund a major public education program and other
     health measures;

  -- requiring manufacturers to clearly mark individual cigarettes to
     differentiate cigarettes manufactured for domestic and export
     use; and

  -- further restricting access to cigarettes by minors.

From February 9 through April 15, 1994, federal and provincial taxes
were significantly lowered in the five provinces--including Quï¿½bec
and Ontario--where international smuggling was particularly
troublesome.  For example, combined taxes in Quï¿½bec fell by $2.10 per
pack, and taxes in Ontario fell by $1.92 per pack (in Canadian
dollars).\3

Although taxes in these provinces have increased slightly since, once
the initial tax cuts took effect, the contraband cigarette market
dried up, according to the 1994 study for the National Coalition
Against Crime and Tobacco Contraband.  Consistent with the study's
findings, U.S.  cigarette imports from Canada dropped about 96
percent from 1993 through 1996.  (See fig.  V.1.)

--------------------
\1 A case of Canadian cigarettes contains 50 cartons.

\2 Prime Minister Jean Chrï¿½tien, Government Action Plan on Smuggling,
House of Commons (Feb.  8, 1994).

\3 Based on 20 cigarettes per pack.

   MEXICO
--------------------------------------------------------- Appendix V:2

With respect to international cigarette smuggling that may be
occurring between the United States and Mexico, currently, there is
no consensus among the authorities we interviewed on the extent of
this activity.  An official from California's Board of Equalization,
which, among other things, is responsible for ensuring that state
excise taxes are paid, told us that curtailing U.S.-Mexican smuggling
of cigarettes is a priority for their agency.  The California Board
of Equalization estimates that California loses from $20 million to
$50 million annually in revenues from state cigarette excise taxes
because of tax evasion, most of which it believes is a result of
smuggling between the United States and Mexico.  In addition,
officials from the Bureau of Alcohol, Tobacco, and Firearms (ATF)
told us that such international cigarette smuggling activity is
widespread, and they suspect the main source of the cigarettes is
duty-free shops located along the border.  They stated that instead
of permanently leaving the United States through the export market,
cigarettes are diverted mostly back to the Los Angeles area, where
they are sold on the black market.  Both California Board of
Equalization and ATF officials told us that for the most part, the
tobacco companies and the duty-free shops were not helpful in the
government's attempts to stop the cigarette smuggling occurring
between California and Mexico.  These officials also said that the
tobacco companies profit from the sales of their products whether or
not federal and state taxes have been paid.  An official from the
Mexican Embassy in Washington, D.C., also told us that the Mexican
government has recently become aware of cigarette smuggling occurring
between the United States and Mexico.  Although his government did
not have any data on the extent of this activity, he believes it is
increasing.  He also told us that cigarettes are being brought into
Mexico and then being smuggled back into the United States; however,
he was not sure where the majority of these cigarettes came from.

On the other hand, U.S.  Customs Service officials at the ports of
San Ysidro, California, and Otay Mesa, California, and U.S.  Border
Patrol officials at San Clemente, California, told us that they have
not seen much evidence of cigarette smuggling between the United
States and Mexico.  Although Customs officials told us their number
one priority is preventing the smuggling of narcotics into the
country, this focus does not preclude them from finding other
contraband products during their routine searches of vehicles.
Customs officials at Otay Mesa--a large border port in California for
commercial vehicles entering the United States--told us that their
inspections of commercial vehicles over the last 4 years have yielded
virtually no instances of cigarette smuggling.  At San Ysidro--a
border port through which some 40,000 personal vehicles enter the
United States each day, Customs officials also told us that they have
found very little evidence of cigarette smuggling as a result of
their inspections.  Our discussions with U.S.  Border Patrol
officials in San Clemente yielded similar results.  The Border Patrol
conducts vehicle inspections to search for illegal aliens.  These
inspections could uncover a wide range of contraband goods.  However,
although the officials in San Clemente have discovered contraband
cigarettes as a result of these inspections, to date, they have not
found quantities sufficient to conclude such smuggling activity is
widespread.

Although the extent of U.S.-Mexican cigarette smuggling is unknown, a
1995 case in the Los Angeles area illustrates that this activity is
occurring.  A 1998 study by FIA International Research Ltd.  (FIA), a
Toronto-based investigative research firm, concluded that
international cigarette smuggling is occurring between California and
Mexico involving "For Export Only" cigarettes.  For example, FIA
described a scheme in which a cigarette smuggling operation linked to
Mexico was supplying contraband cigarettes to the Los Angeles and San
Diego areas.\4 Raids conducted in 1995 yielded 13 arrests and the
seizure of seven vehicles and over 4,700 cartons of cigarettes.
Authorities found that Mexican citizens had crossed into California
and purchased cigarettes from duty-free stores and brought them back
into Mexico.  Once these duty-free cigarettes were in Mexico,
smugglers concealed them in personal vehicles and smuggled them back
across the border into California.  Once in California, the
cigarettes were consolidated at storage facilities before being
distributed to the San Diego and Los Angeles areas, where they were
sold in small convenience stores, on street corners, and out of
catering trucks and the trunks of cars.  This case illustrates that
cigarette smugglers are profiting by evading federal, state, and
local taxes through a variety of export- and duty-free-cigarette
diversion schemes.  Currently, the price of a carton of cigarettes in
California is about $10.50 at duty-free stores--as compared with a
retail price of about $20.  If a tobacco settlement increases the
price of cigarettes, this differential could increase further, thus
further increasing the profitability of obtaining these cigarettes
for resale.

--------------------
\4 An official from California's Board of Equalization, who was
heavily involved in the case, corroborated the details of this case
as presented by FIA.

MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix VI

RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION, WASHINGTON,
D.C.

Patricia Gleason, Assistant Director
Stephen Cleary, Evaluator-in-Charge

OFFICE OF THE CHIEF ECONOMIST,
WASHINGTON, D.C.

Scott Smith, Assistant Director
Daniel Coates, Senior Economist
Kirsten Landeryou, Economist
*** End of document ***