People sometimes convert an anticipated payment stream into cash by issuing bonds. Rocker David Bowie pioneered the practice of floating bonds financed by anticipated royalty streams; he received $55 million in exchange for his discography. Accident victims call J.G. Wentworth, the pseudo-opera singers on TV, to convert settlements into liquidity. Now, there are many good reasons to exchange future payments for cash today – uncertainty of the reliability of the payments, fear of surprise inflation surges, unexpected one time bills. A bad reason is to finance a lavish lifestyle. Floating a bond might fund the expenses for a while, but the money will run out, leaving nothing. Such is the case of states borrowing against their tobacco settlements.
In 1998, a group of Attorneys General from 46 states colluded to extract $206 billion from the tobacco industry, ostensibly to fund tobacco related Medicaid costs. A small portion of the settlement was earmarked for an education campaign to reduce tobacco consumption. None of the money went to these purposes. The State money went to fund general budget items unrelated to health, and the education campaign became an annoying series of TV commercials calling tobacco companies liars and murderers – a topic unrelated to the challenges of quitting smoking.
As governments are wont to do, they incorporated the tobacco money into their budgets, spent the payments and more. One by one, the most of the states found themselves in a budget pinch and balanced their budgets with a one-time tobacco bond sale. Last year Minnesota mortgaged its tobacco payments for $700 million. Two years ago, Illinois plugged its budget gap with a $1.5 billion tobacco bond. One time tricks do not solve long run spending problems, though, and Illinois later raised its income tax by over 60%.
Worse still, many of the state’s tobacco bonds are general obligations of their treasuries, so if the tobacco payments fall short, the states are on the hook. Of course that is exactly what is happening. The settlement payments are based on tobacco consumption, which is declining. Kids who want to look tough and women who prefer cancer to obesity still smoke, but many other people are quitting or not even taking up the habit. In several states, the settlement payments are becoming insufficient to fund the bond payments.
Despite the imprudence, Alabama just floated $93 million in new tobacco bonds. The Wall Street Journal reports that Alabama has avoided some of the risks and excesses of other states’ tobacco bonds, however they have mortgaged their future to prop-up irresponsible spending today. Separately, Jefferson County, Alabama (Birmingham) just filed the US’s largest municipal bankruptcy ever. If high finance catastrophes cannot stop politicians from borrowing to spend recklessly, perhaps nothing can.
Like underfunded pensions, tobacco bonds are an example of states’ sneaky borrowing against future revenue to fund wasteful spending today. In most states, running a state budget deficit is illegal, but the politician’s instinct to spend is too strong, so they find a way to borrow.
So, who needs people to smoke? The states that have borrowed against the smokers’ habit would be ruined if everybody quit. Irresponsible, perverse, and probably immoral, yet irresistible to politicians who are paid to spend like there is no tomorrow. The states need spending controls to solve their budget problems, not tobacco bonds to enable them.
