States tackle deep discount cigarettes: cheap cigarettes have undercut the major tobacco companies and their ability to make payments to states under the master tobacco settlement agreement.

• Author: Gordon, Dianna

Because they're cheaper--$12.99 to $13.50 per carton, compared with Marlboros at $22.99 or Camels at $24-deep discount cigarette brands have cornered an estimated 10 percent to 15 percent of the U.S. market.

This is not good news for states relying on tobacco settlement money from the major manufacturers. The settlement allows cigarette companies to reduce payments if they lose market share.

Payments to states fell to 85 percent of the projected total in 2001 and to 81 percent in 2002, partially due to the encroachment of these "fourth tier" and "taste-a-like" brands.

Off brands such as Cowboy, Santelmos, Lobos, Durants and Marathons undercut the prices of major brands, such as Winston or Marlboro. This was partially because their manufacturers didn't participate in the lawsuits filed to recoup taxpayer money spent treating tobacco-related illnesses. When those settlements were reached, major brand prices increased 40 cents a pack or $4 a carton. Cigarette makers who didn't participate immediately gained a substantial price advantage.

But the tobacco settlements do require off-brand manufacturers to pay into escrow accounts in each state where their products are sold. The escrow payments offset some of the price advantage and establish funds that can be used to cover settlement costs should someone sue them in the future.

Many makers, however, have exploited a number of loopholes to avoid payments or remove escrow contributions soon after deposit. One method of setting the per pack contribution to a state escrow fund is based on previous year's sales. Some manufacturers have dodged this by changing the names of their brands every year, says Wade Hope, an attorney with the Alabama Department of Revenue. The National Association of Attorneys General estimates that states lost $450 million from the $5.2 billion payment for April 2003.

Policymakers are taking steps to make sure manufacturers of discount cigarettes follow the law.

Thirty-five states have set up directories of cigarette brands approved for sale. Only cigarettes whose manufacturers are legally making settlement payments or putting money into an escrow account are listed. Brands skirting the requirements are considered contraband, cannot be sold and can be confiscated.

Eighteen states have passed laws designed to increase the cost of the off-brand cigarettes and close loopholes in escrow account requirements. Alabama, for one, has added...