The Tobacco Deal


Jeremy Bulow

Graduate School of Business, Stanford University


Paul Klemperer

Nuffield College, Oxford University


August 1998



We analyse the major economic issues raised by the 1997 Tobacco Resolution and the ensuing proposed legislation that were intended to settle tobacco litigation in the United States. By settling litigation largely in return for tax increases, the Resolution was a superb example of a "win-win" deal. The taxes would cost the companies about $1 billion per year, but yield the government about $13 billion per year, and allow the lawyers to claim fees based on hundreds of billions in "damages". Only consumers, in whose name many of the lawsuits were filed, lost out.

Though the strategy seems brilliant for the parties involved, the execution was less intelligent. We show that alternative taxes would be considerably superior to those proposed, and explain problems with the damage payments required from the firms, and the legal protections offered to them.

We argue that the legislation was not particularly focused on youth smoking, despite the rhetoric. However, contrary to conventional wisdom, youth smokers are not especially valuable to the companies, so marketing restrictions are a sensible part of any deal.

The individual state settlements, if allowed to stand, open up unprecedented opportunities for collusion throughout the economy. The fees proposed for the lawyers (around $15 billion) and the equally remarkable proposed payoff for Liggett (perhaps $400 million annually, for a company with a prior market value of about $100 million) also set terrible examples.

We conclude with some views about how public policy might do better.