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JEFFERSON CITY • In Missouri, Little Tobacco is king.

Smokers can buy a pack of “value brand” cigarettes like Edgefield or Decade for $2.50. A pack of Pall Malls, the low-price brand made by industry giant R.J. Reynolds, generally will cost at least 60 cents more.

You can thank the Missouri Legislature for the cheaper options.

For the last 12 years, legislators have refused the state attorney general’s request to pass a law to neutralize a pricing advantage that small tobacco manufacturers enjoy. Missouri is the only state that has not passed such a law.

The issue is drawing heightened attention this year because of an arbitration panel’s decision. Under that decision, Missouri will forfeit $69 million of the roughly $130 million that the state had expected to receive this year from the national tobacco settlement.

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In fact, the state could lose tens of millions in tobacco money each year for at least seven years. Given that financial wallop, Attorney General Chris Koster is once again urging that the pricing advantage be addressed.

Lobbyists for small tobacco manufacturers are working the Capitol’s hallways to fend off the proposal. They say they’re not to blame for the arbitration award and it would be unfair to make them shoulder the large cigarette makers’ liabilities.

Legislators involved in the fight say they doubt they can overcome the political muscle of Little Tobacco.

“The small-tobacco people keep telling folks that this is a tax increase, and that it’s big business picking on small business, none of which is true,” said Rep. Chris Kelly, D-Columbia. “What is factually accurate is, we will lose at least $70 million a year until we fix it.”

TOBACCO SETTLEMENT

The debate has been raging for more than 15 years.

In 1998, Missouri was among 46 states that settled a case with major cigarette makers, including the parent companies of R.J. Reynolds and Philip Morris.

To cover the damage their products caused to smokers’ health, the companies agreed to make payments to the states based on their annual nationwide cigarette sales. They also agreed to quit targeting young people with cigarette advertising.

Missouri Gov. Jay Nixon, who was then the state’s attorney general, signed off on the deal. As part of the settlement, the Legislature passed what was called a “model statute.” It required smaller tobacco companies that were not bound by the settlement to pay into an escrow fund.

One goal was to cover any future damage claims. Another was to keep the companies that were not participating in the settlement from selling highly discounted cigarettes and thus, gaining market share.

The money was supposed to stay in the escrow fund for 25 years unless needed to pay a judgment. If a state failed to require the payments from the “nonparticipating companies” and Big Tobacco lost a set amount of its market share, a state would forfeit part of its tobacco settlement money.

Sure enough, the large companies suffered a loss in market share — an auditor put the loss nationwide at 8 percent from 1997 to 2003.

Three former federal judges, acting as an arbitration panel, decided last fall that Missouri had not “diligently enforced” the law requiring escrow payments to be made by the smaller companies.

Of the 432 million off-brand or nonparticipating manufacturer cigarettes sold in Missouri in 2002, companies made the escrow payment on only 102 million in 2003, the arbitrators said.

Missouri’s 24 percent collection rate was the lowest among the 15 states in the arbitration case.

The arbitrators said that then-Attorney General Nixon had neglected to file lawsuits against the smaller tobacco companies to force them to pay into the escrow fund and the state Department of Revenue had failed to audit them to see if their sales were underreported.

Bottom line: Missouri will lose $69.2 million that had already been budgeted to help pay for Medicaid, early childhood education and other services. Nixon has asked legislators to plug the budget hole with state general revenue.

CLOSING A ‘LOOPHOLE’

So what does Koster want legislators to do to stop the bleeding? Here’s where it gets really complicated.

When the escrow fund was set up, drafters assumed the small cigarette makers would sell their products nationally. But small companies discovered that, under the formula, if they concentrated their sales in a few states, they could get nearly all their escrow money back.

Nearly 25 percent of the cigarette sales in Missouri are made by the smaller companies that are not bound by the tobacco settlement, according to tax data in a recent fiscal note prepared by state Auditor Tom Schweich. That compares to 6 to 8 percent of sales nationally.

In a 2012 letter to legislators, Koster said the law allowed the small tobacco companies to “game the system.” Missouri returns about $80 million in escrow payments each year “and stands alone in its coddling” of the small producers, he wrote.

Like Nixon before him, Koster asked legislators to close that loophole by repealing a section of law that allows the escrow returns. All states except Missouri have done so.

Small cigarette manufacturers and retailers have fought that move vigorously, and each year they win.

They say they weren’t in existence when the master settlement was signed, and thus bear none of the blame for marketing cigarettes to children. They also say they get no benefit from the settlement, such as immunity from lawsuits.

“It’s shifting the market from the small guys to the big guys,” said Andy Arnold, who has lobbied against the change on behalf of Fenton-based tobacco distributors Hub Inc. and LPC Inc., and U-Gas Inc., a tobacco retailer.

“Our big issue is, why should we be penalized for Philip Morris’ and R.J. Reynolds’ lies in the past? That’s kind of the kicker for us. It’s a fairness issue.”

Changing the escrow fund “is not some sort of silver bullet,” added Ron Leone, executive director of the Missouri Petroleum Marketers & Convenience Store Association. The other five states that lost the arbitration case have closed the so-called escrow fund loophole. But they still lost.

A POTENT LOBBY

In addition to Arnold and Leone, the Little Tobacco lobbying and legal team includes Chuck Hatfield, an attorney who used to work for Nixon in the attorney general’s office.

Hatfield, who represents Cheyenne International LLC of Grover, N.C., said Missouri doesn’t need to pass the bill that Koster suggests. The state already passed everything that is needed under the settlement, he said.

“The statute that Missouri passed is exactly the statute that Big Tobacco told them to pass. That was the deal. What this is, at the end of the day, is, it’s Big Tobacco trying to gain market share. Cheyenne doesn’t think they should have to pay to settle a lawsuit that they weren’t a part of,” Hatfield said.

Missouri did pass a partial fix to the enforcement problems, in 2010. Before then, the state had to chase manufacturers down and try to serve legal papers in places such as Nepal, Brazil and the Philippines. Now, the firms are required to have registered agents in Missouri, which makes it easier to enforce collection efforts.

It took eight years for Missouri to adopt that change. Missouri was the last state to pass it.

In another sign of the potency of the tobacco lobby, Missouri’s 17-cents-per-pack tax is the lowest cigarette tax in the nation.

Three times since 2002 Missouri voters have defeated increases. Leone has headed the opponents’ campaigns.

“All tobacco bills boil down to market share and money, and either using the Legislature or the vote of the people to pick winners and losers in the free market,” Leone said.

If Missouri’s escrow fund provisions are changed as they have been in other states, the price of the smaller companies’ cigarettes would go up at least $6.04 per carton at the manufacturer’s level, he said. That would be passed on to consumers, eliminating the pricing advantage the off-brands now enjoy.

Few legislators are familiar with the tobacco settlement’s intricacies.

At a recent House Budget Committee hearing on the need to replace $69 million in lost tobacco settlement funds, no member asked a single question.

Given the complexity of the issue, committee Chairman Rick Stream, R-Kirkwood, plans a work session on it.

“Frankly, I don’t believe many of them even know what this is about,” Stream said. “It’s going to cost us money for the next eight to 15 years. It’s one of those difficult issues. I’m not sure we’ll get it resolved.”

He is sponsoring a bill that would make the smaller manufacturers pay as much per cigarette as the large companies do.

“There apparently isn’t any middle ground,” Stream said. “Either you do it or you don’t.”

Lobbyist Harry Gallagher, who represents R.J. Reynolds Tobacco Co.’s parent company, Reynolds American Inc., didn’t sound optimistic that this would be the year that the proposal would pass.

The smaller companies are “supposed to pay into an escrow account, which they do but then they get it right back,” he said. “It’s a loophole, and we’ve been unable to do anything about it.”

Stream’s bill is HB1242.

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