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Constitutional Analysis of the "Look-back" Provisions of the McCain Committee Bill By Richard A. Daynard I. Description of the look-back provisions. There are two "look-back" provisions in the McCain bill. A. The first such provision, section 202, establishes a "penalty" for failure by the industry to meet stated annual percentage reduction goals for underage tobacco use, with the proceeds to be used by government agencies "to reduce further the use of tobacco products by persons under the age of 18 years." Sec. 202(d). The penalty is "a joint, several, and strict obligation" of all cigarette manufacturers (or, separately, against all smokeless tobacco products manufacturers). Sec. 202(c). The penalty is allocated among the manufacturers "based on actual federal excise tax payments," sec. 202(d)(1). However, companies with less than 1% market share are exempt from paying any portion of the penalty so long as their market share among underage users is less than their total market share. Sec. 202(d)(2). The goals for reducing underage tobacco use are set out in sec. 201. In the case of cigarettes they range from 15% in the third year after enactment to 60% in the tenth year and thereafter. In the case of smokeless tobacco, the goals range from 12.5% to 45% over the same period. The baseline in the case of cigarettes is a defined weighted average of adolescent smoking rates from 1986 to 1996. Sec. 204(3)(A). In the case of smokeless tobacco the baseline is drawn from studies done in 1995 and 1996. Sec. 204(3)(B). The question of whether the industry has failed to meet the goal is to be determined either by a survey methodology set forth in the bill, or by a modification of that methodology adopted by the Secretary of Health and Human Services after a 5 U.S.C. sec. 553 notice and comment rulemaking procedure. Sec. 202(a). The cigarette industry's penalty under sec. 202 is determined by multiplying the non-attainment percentage (required reduction in underage sales, minus actual reduction in underage sales) by $80 million for the first five percent, by $160 million for the second five percent, and by $240 million for the next 10%. If the non-attainment percentage exceeds 20%, the penalty is fixed at $3.5 billion. In the March 29, 1998 Committee draft exceeding 20% would also have triggered the loss by the industry of the benefit of the $6.5 billion liability cap for the year in question. This sanction was apparently eliminated by an amendment accepted at the April 1 mark-up, and does not appear in the final May 1 version of the bill. Sec. 202(b). The smokeless tobacco industry's penalties are set at 10% of those levels. Again, the draft provision removing the liability cap if the 20% non-attainment percentage is exceeded disappeared in the final version. The word "strict" in sec. 202(c) is not defined, but is probably intended to convey that the penalty is being assessed without regard to the fault of either individual manufacturers or of the industry as a whole. Nonetheless, the bill provides that "any penalty paid by a tobacco product manufacturer under this section shall not be deductible as an ordinary and necessary business expense or otherwise...." Sec. 202(f). While fault is not relevant in determining the penalty owed the government, any liable manufacturer may recover "contribution or reimbursement" from another manufacturer if it proves "by a preponderance of the evidence that the defendant manufacturer, through its acts or omissions, was responsible for a disproportionate share of the non-attainment penalty as compared to the responsibility of the plaintiff manufacturer." Sec. 202(g)(2). In such an action, the "manufacturer shall be held responsible for any act or omission of its attorneys, advertising agencies, or other agents that contributed to that manufacturer's responsibility for the penalty...." Sec. 202(g)(3). B. The second "look-back" provision in the McCain bill, section 203, is very different. This section authorizes the Secretary to bring an action against the manufacturer of any brand of cigarettes or smokeless tobacco if in any year the non-attainment percentage for that brand exceeds 20%. The methodology for determining the non-attainment percentage is similar to that required by sec. 202, except that it is brand-specific and uses a base year (1999) that is likely to be more favorable to the manufacturers. Sec. 203(a)(2). The sec. 203 action is to be brought in a three-judge U.S. District Court for the District of Columbia. If the court determines by a preponderance of the evidence that the manufacturer "(1) has failed to comply substantially with the provisions of the Act regarding underage tobacco use, of any rules or regulations promulgated thereunder, or of any other applicable Federal, state, or local law, rules, or regulations; (2) has taken any material action to undermine the achievement of the required percentage reduction for the tobacco product in question; or (3) has failed to comply with all recommendations of the Tobacco Agreement Accountability Panel established under section 801", then the manufacturer loses the benefit of the annual liability cap. Sec. 203(c) and (d). The decision is reviewable only by the Supreme Court through a writ or certiorari. The Tobacco Agreement Accountability Panel, mentioned in sec. 203, is to "consist of the Surgeon General, the Director of the Center for Disease Control or the Director's delegate, and the Director of the Health and Human Services Office of Minority Health." The Panel is charged to receive and evaluate annual plans by tobacco manufacturing companies for meeting the underage use reduction targets, and to "recommend, where necessary, additional measures individual tobacco companies should undertake to meet those targets." A manufacturer which loses its liability cap under sec. 203 can get it back only if the Secretary determines in a future year that the non-attainment percentage for the brand in question is less than 20%, or if the manufacturer demonstrates to a similar three-judge court at least two years after the initial judgment that it is now in compliance with the relevant legal rules, that it has done nothing further to undermine the achievement of the percentage reduction goals, and that it "has pursued substantial additional measures reasonably calculated to attain the required percentage reduction for the tobacco product in question." Sec. 203(g). A companion provision to sec. 203 is sec. 801(d), which allows the Commissioner of Food and Drugs, even prior to the first "look-back," to seek a judicial determination under sec. 203 that the actions or inactions or a particular manufacturer create a "clear and present danger" that the underage use goals will not be met. If the three-judge federal district court so finds, it may suspend that company's liability cap. The "clear and present danger" standard, which had been developed in the First Amendment context for determining when political speech can be suppressed, is extremely difficult to meet. II. Constitutional Analysis Section 202 could easily have been drafted as a tax provision, rather than as a penalty provision. In the exercise of its plenary power over interstate commerce, Congress can tax any activity at any rate in wishes. "Sin taxes" have long been justified as deterring undesirable conduct. Underage smoking is certainly undesirable, excise taxes on tobacco products are generally believed to deter underage smoking, and setting tax rates specifically to deter this behavior is certainly unobjectionable. Nor is there any conceivable objection to Congress saying, "We think the tax rates we are currently setting, and other programs we are putting in place, will drop underage smoking to acceptable levels; but if these deterrents turn out not to be adequate, we will raise the taxes by additional specified increments." The next question is whether Congress' calling the specified future payments "penalties" rather than "taxes", assessing them upon manufacturers (by market share) rather than upon the retail product, and making them non-tax-deductible, changes this result. The references to "penalties" in this section should not be decisive, since these assessments do not turn on any misbehavior by the manufacturers, and indeed may not be entirely within the manufacturers' control. The mechanism of assessing manufacturers rather than taxing consumers directly is also not very meaningful in context, since the June 20 agreement relied upon market-share-based manufacturer assessments throughout the agreement (not just in look-backs) to raise the price of tobacco products, and thereby discourage underage consumption. The denial of tax deductibility for these "penalties" does, however, suggest that the bill's drafters had something more than a hidden tax increase in mind. But even if the industry is to be "penalized" for failing to reduce underage tobacco consumption sufficiently, the question remains, so what? As a matter of substantive due process, there is no constitutional requirement for a "good faith" defense in civil penalty cases. While the tobacco industry is not solely responsible for teenagers desiring their products, it is largely responsible for this demand; and while it probably could not extinguish this demand entirely through creative counter-advertising, it could doubtless go a long way towards doing so. It would therefore be rational for Congress to place the financial responsibility on the industry for seeing that the underage percentage reduction goals are met. Assuming that these penalties are sufficiently severe, they would likely evoke efforts by the industry (either collectively or on the part of the largest player or players) that would substantially contribute to the compelling public interest in reducing underage smoking. And, on the other hand, there is simply no way for Congress to know in advance precisely how much the industry could accomplish by way of reducing underage smoking, other than to provide the incentives and watch what happens! Nor would this be a bill of attainder. Congress is not seeking to punish the industry for what it has done in the past, but for what it does or fails to accomplish in the future. It is clear that Congress does not even have a covert purpose of punishing past misbehavior through the "look-back" provisions, since it can exact any measure of such punishment it wishes in a far more certain and immediate fashion by assessing fees and taxes for the year immediately following the enactment of the bill. Section 202 also does not trigger any procedural due process problems. While the government is indeed proposing to deprive industry members of their property if the industry as a whole fails to meet certain standards, it is not proposing to do so on grounds specific to individual companies. Section 202's penalties are to be based on rates of underage use of tobacco products generally, not on the use of particular brands. Generic actions based upon "legislative facts" do not trigger due process hearing rights. See Bi-Metallic Investment Co. v. State Bd. Of Equalization, 239 U.S. 441 (1915); Heckler v. Campbell, 461 U.S. 458 (1983). Since allocation of penalties among manufacturers is determined by actual excise tax payments, a matter of public record, even this individualized determination would not trigger any hearing right. A manufacturer with less that 1% market share would, however, have a right to contest in some appropriate manner a determination by the Secretary of Health and Human Services that it was not entitled to an exemption because its market share among underage users was not less than its overall market share. Section 203, on the other hand, clearly raises procedural due process issues. But, having raised them, it resolves them in the most traditional way possible. No company will be subject to the specified penalty (abrogation of its liability cap) unless and until it is found to have misbehaved by a three-judge federal district court. While it is not clear whether the statute contemplates the court taking evidence as to the accuracy of the survey which "found" the triggering event (to wit, defendant's brand missed the underage percentage reduction goal by more than 20%), the court would certainly do so if it thought it necessary to preserve the constitutional validity of the statute. In any event, survey evidence is an exception to the hearsay rule, so the dispute about the survey results would be limited to issues of methodology and execution. III. Conclusions As a constitutional matter, neither the industry-wide (sec. 202) nor the company-specific (sec. 203) look-back provisions requires the consent of the industry or its members. It is an entirely separate question as to whether either provision, or both together, will achieve their objective of substantially reducing underage smoking. The maximum annual penalty for the entire cigarette industry under section 202 is $3.5 billion. Since this would not be tax deductible, the industry, which has a 35% marginal tax rate, would require $5.38 billion of additional revenue to come out even. Assuming that a total of 15 - 20 billion packs of cigarettes are sold in the year in which the penalty is being assessed (down from about 24 billion packs today), this penalty could be recouped with a 27 to 36 cent per pack increase. The price elasticity of overall demand for cigarettes is generally accepted to be -.42; the price elasticity of demand by teenagers is generally believed to be around -.1. Since the McCain bill as a whole is expected to raise cigarette prices to above $3.50 per pack, such an increase would amount at most to about 10% of the pack price, which would result in a 4% drop in overall sales, and hence profits. In contrast to the March 29 draft, which promised to hold the industry's attention by threatening the elimination of liability caps for missing the target by 20% or more, this potential 4% profit drop would have a negligible deterrent effect on industry behavior. The drop in consumption among youth could be expected to be somewhat larger, in the order of about 10%, but still not large enough to guarantee that the stated goals for reducing underage smoking will be achieved. Section 203 is somewhat more promising, since it does threaten to eliminate part of the liability protection (caps, but not parental immunity) offered by the bill. But this section is more useful for deterring egregious misbehavior by tobacco companies (e.g. the Joe Camel campaign, and perhaps the "heroin chic" models which replaced it) than it is for encouraging efforts by them to "demarket" cigarettes to young people. While section 202 penalties are mandatory, actions under section 203 are discretionary with the Secretary. Furthermore, all three triggers for Secretarial action under section 203 require evidence of actual corporate misbehavior. While one of them, failure to comply with a recommendation of the Tobacco Agreement Accountability Panel, could conceivably involve the failure to demarket a cigarette favored by teenagers, it is unlikely that such a recommendation could be phrased in a way that forces the manufacturer to make the "right" creative decisions, rather than permitting it to "go through the motions" by running humdrum and ineffective "counter-advertisements". The residual effects of past industry misbehavior, in terms of near-record level cigarette consumption by teenagers, may persist through the next decade. The March 29 version of the bill, which provided a substantial market incentive for the industry to find ways to demarket its products to teenagers and pre-teens, dealt with the problem. The current version does not.
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