The Impact of the 1998 Tobacco Settlement on the North Carolina Economy

Transcription

1 The Impact of the 1998 Tobacco Settlement on the North Carolina Economy Technical Report No. 104 Prepared by the N.C. Rural Economic Development Center in partnership with the N.C. State University College of Agriculture and Life Sciences Principal Investigators Chris Beacham, N.C. Rural Economic Development Center Dr. A. Blake Brown, NCSU Department of Agricultural and Resource Economics Dr. Michael L. Walden, NCSU Department of Agricultural and Resource Economics August 2000 ural R The Center 4021 Carya Drive, Raleigh, NC (919) FAX (919)

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3 EXECUTIVE SUMMARY This document presents an analysis of the economic impacts of the 1998 Tobacco Settlement on the economy of North Carolina. The analysis provides estimates of the impacts within regions of the state and within various sectors based on declines in tobacco farming and processing and cigarette manufacturing. The analysis was prepared by a partnership of the North Carolina Rural Economic Development Center and the NCSU College of Agriculture and Life Sciences, with oversite by the Tobacco Advisory Committee. The advisory committee is made up of leading agricultural, manufacturing, governmental and socioeconomic specialists and was formed to help the Rural Center examine the changes occurring in the tobacco industry from the tobacco settlement, federal/local actions affecting the tobacco industry, and international market changes. The Rural Center gratefully acknowledges the extraordinary assistance and significant time commitment made by all members (listed in the Appendix). Specifically the advisory committee helped define the format (models) for analysis of economic changes in the state s tobacco industry and the set of scenarios used in this analysis of impacts. They also carefully reviewed the analysis and estimates of impacts described here. We estimate that the 1998 Tobacco Settlement will lead to the following economic impacts over the next 3-5 years: A decline in cigarette production of 9% to 17%. A further decline in tobacco production of 5% to 10%. A reduction in tobacco quota owner income of 1% to 2.4%. Lost output of $2.2 to $4.0 billion annually (0.6% to 1.1% of state total). Between 14,500 to 26,700 permanently lost jobs (0.3% to 0.6% of state total). Between $403 and $743 million in lost earnings annually (0.3% to 0.6% of state total). Three conclusions can be drawn from the results. First, the tobacco economy (farming, processing and manufacturing) will be seriously affected. Second, communities, both rural and urban, where tobacco is a significant portion of the economic structure will see substantial declines in income and employment from the settlement. Third, the overall economy of North Carolina will not be dramatically affected by the decline because of its strength and size. The report is structured as follows. Section 1 provides background on tobacco in North Carolina helpful in understanding the impact analysis. It first describes the importance of tobacco to the state and the Federal system under which tobacco is grown. THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 1

4 Direct employment and income from tobacco farming, tobacco processing, and cigarette manufacturing are described. The section ends by describing the political and legal realities that will affect the future of tobacco in North Carolina. Section 2 provides estimates of the direct impacts of the settlement. We project a cigarette consumption decline due to the increased price of cigarettes and then use the consumption decline to estimate the overall decline in tobacco leaf production, processing and cigarette manufacturing. The estimates are based on two scenarios of political and economic changes that may occur. Section 3 takes the direct impacts of Section 2 and uses an economic input-output model to estimate the full range of economic impacts direct, indirect and induced. Estimates are provided for output, value-added, employment, and employment compensation. The model allocates the impacts to seven economic regions within the state and describes the impacts to particular economic sectors. Several caveats bear stating. This report looks North Carolina of the decline in tobacco production and processing and cigarette manufacturing. We do not estimate the positive impact of the inflow of dollars to the state from the settlement nor do we examine the positive impacts (economic, health and social) from a decline in tobacco consumption. In addition, the report examines only the negative impacts of the settlement and, in one scenario, an additional settlement with the Federal government. It does not attempt to estimate additional declines that may occur because of declines in tobacco exports, increases in imports, the threat of additional individual and class action lawsuits or changes to the tobacco allotment program. Lastly the analysis does not reflect the combined impacts many rural economies are feeling due to a combination of recent events. The decline in tobacco is occurring simultaneously with historic price lows in other agricultural commodities and declines in traditional manufacturing like textiles and apparel with attendant loss of jobs and income. The analysis was also completed before the great floods following Hurricane Floyd. only at the gross negative economic impacts to 2 THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

5 SECTION 1 Tobacco in the North Carolina Economy 1. Introduction This report examines the impact of the 1998 Tobacco Settlement on the North Carolina economy. This section provides the background on tobacco in North Carolina that is helpful in understanding the impact analysis. It first describes the importance of tobacco to the state and the Federal system under which tobacco is grown. Direct employment and income from tobacco farming, tobacco processing, and cigarette manufacturing is described. Finally, Section 1 describes the political and legal scene that will affect the future of tobacco in North Carolina Tobacco Settlement In November 1998 the states attorneys general and the cigarette industry signed a $206 billion Master Settlement Agreement compensating the states for Medicaid costs attributed to smoking. The settlement gives the cigarette industry limited protection from certain types of additional lawsuits. Still, legal actions including individual and class action lawsuits continue to be filed, additional excise tax increases are possible, and the future of the tobacco program which regulates production and marketing of tobacco remains uncertain. The cigarette industry will make annual payments to the states averaging $8 billion per year over the next 25 years. Payments will continue in perpetuity but may decline if cigarette consumption declines. North Carolina is expected to receive $4.6 billion during the 25-year period. The first payment was received in December 1999 and a second payment was made in April In addition to the national settlement, a Consent Decree was signed between N.C. Attorney General Mike Easley and the cigarette manufacturers describing the distribution of settlement funds within the state. This fund is known as Phase I. The agreement sets aside half of North Carolina s share of the settlement for a fund to help tobacco-affected areas. A non-profit organization, the Golden L.E.A.F. Foundation, was created to administer this portion of the settlement. The General Assembly subsequently approved a bill to place 25 percent in a fund for tobacco farmers, quota holders and persons engaged in tobacco-related businesses and the remaining 25 percent in a health fund. There is a second agreement known as Phase II. Phase II comes out of the $5.15 billion private agreement between cigarette companies and tobacco farmers, allotment holders and political leadership of the tobacco growing states. North Carolina, as the largest producer of tobacco in the country, gets nearly $2.0 billion to be paid in installments over the next 12 years. Phase II provides direct payments to farmers and allotment holders as determined by a board of trustees. There was $145 million available for 1999, and the first payments were made in December 1999 with half of the payment going to tobacco farmers and half to quota holders. Growers and allotment holders split 68.5 cents per pound of quota lost from 1998 to 1999 from the 1999 payment. As noted above, the positive impacts from Phase II dollars are not included in our analysis. 3. Tobacco Farming in North Carolina Tobacco has a long history of production and processing in North Carolina and other southeastern states. Since 1938, it has been grown under a Federal agricultural program that guarantees minimum leaf prices and promotes price stability at the cost of limiting the supply of leaf. Farmers must own or rent tobacco quota in order to sell tobacco. A national total for the quota is set each year by the U.S. Department of Agriculture which determines the approximate level of tobacco that will be grown that year. The program is run as a "no-net-cost" program to taxpayers and is paid for out of assessments to leaf farmers and buyers. Tobacco is one of the few commodities remaining in New Deal-era farm programs. There are a THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 3

6 number of reasons for the continuing success of this program including the "no-net-cost" feature. More importantly, while other supply restriction programs failed, often due to the existence of close substitutes in the world market, US tobacco growers have been able to retain world-pricing power due to a persistent quality differential between US and foreign tobaccos. Unlike some other commodities, this quality differential has allowed the tobacco program to operate effectively for most of its life without import restrictions. This system has worked to keep tobacco profitable and support a substantial number of small farms far beyond what would be expected without the program. Under the program tobacco remains the leading crop in North Carolina, representing $1.0 billion in annual sales (14 percent of total farm sales and 31 percent of total crop sales in 1998). As an agricultural commodity it trails only hogs and poultry as generators of farm sales. From the standpoint of net income (income after the cost of production is removed) it is even more important due to farm efficiency, the high quality of U.S. tobacco and the Federal tobacco program. No other commodity approaches the combination of price stability and net return for North Carolina farmers. As Dr. Blake Brown, who developed the analysis detailed in Section 2, notes in another publication, "US flue-cured tobacco remains the most stable and most profitable crop for the vast majority of farmers in the five state flue-cured producing region. If a farmer owns his quota, his return to quota per acre can range from $700 to over $1,100. Also, because tobacco is a management intensive crop, the per acre return to management and risk is much higher than most field crops." 1 Comparing tobacco to other crops he notes, "Some specialty crops have the potential to earn as high a net return as tobacco, but the markets are usually limited and their production involves substantial production and price risk. The high net return earned on tobacco is one of the main reasons that North Carolina is ranked second in the United States in terms of net farm income." As noted above the tobacco program supports price levels and stability, but it does so by restricting the amount of tobacco that a farmer can grow. Farmers must own or rent tobacco quota in order to grow and sell tobacco. After an 1 Implications of Elimination of the U.S. Flue-Cured Tobacco Program, September 18, Testimony to U.S. Senate. 1,200,000,000 Figure 1 North Carolina Tobacco Production * 1,000,000, million pounds in 1955 Pounds 800,000, ,000, million pounds in ,000, ,000,000 Projected 372 million pounds in * Projected production for THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

7 unusually high quota for the crop year 1997, the quota has fallen by 35 percent over the last two years and a further decline in 2000 of 18.5 percent has been announced (flue-cured), even given production reductions due to flooding of farms. The burley quota plunged by 47 percent. North Carolina grows mostly flue-cured tobacco with a smaller amount of burley tobacco being grown in the mountain west. Overall North Carolina accounts for more than a third of the tobacco grown in the United States and more than half of the flue-cured tobacco. During the 1990s, state tobacco production has averaged about 600 million pounds annually with a high of 731 millions pounds in The 1999 crop year is likely to be the smallest crop on record given the 450 million pound quota and production reductions due to flooding from Hurricane Floyd (Figure 1). The decline in 2000 quota will bring production down to about half the 1997 level. Production occurs in 82 counties within the state with concentrations in the east, north Piedmont and mountain west (Figure 2). Pitt, Johnston, Robeson, Columbus, Wilson, and Nash are leading flue-cured producers. Madison, Buncombe, Yancey and Haywood are the leading areas for western burley tobacco production. Tobacco farms tend to be much bigger in the east than in the Piedmont or the mountain west. As a result, the distribution of farms varies significantly from production (Figure 3). While production has declined there has been an even greater decline in the number of tobacco farmers. Since 1964 the number of tobacco farmers has fallen from more than 87,000 to about 12,000, a decline of 86 percent. The average tobacco farm has increased in size from 5 to 27 acres (Figure 4). Still, tobacco farms remain much smaller on average than other farms. An average North Carolina non-tobacco farm is nine times larger (236 versus 27 acres) than a tobacco farm, largely due to the impacts of the tobacco program. Without the tobacco program the location of tobacco production and the size of farms would change dramatically. Tobacco provides significant income to another group within North Carolina, namely those individuals who own the quota rights to grow tobacco. While most of the 12,000 tobacco farmers own some quota, most also rent out quota from owners of quota who no longer farm tobacco. These rents vary from place to place and from year to year. Quota in North Carolina is tied to the county to which it as originally given. For example, a quota in Pitt County cannot be Figure 2 Tobacco Production in 1997 and Manufacturing Plants in 1998 Tobacco Growing Counties No tobacco Up to 2 million pounds 2 to 10 million pounds 10 to 20 million pounds Above 20 million pounds Sources: 1997 Census of Agriculture, U.S. Dept. of Commerce; and 1999 NC Manufacturers Directory Location of manufacturing plants in SIC 21, including stemming and drying and cigarette production. Plants employ over 17,000 full and part time employees. THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 5

8 Figure 3 Tobacco Farms by County 1997 Number of Tobacco Farms by County transferred to Robeson. Quota in the eastern counties is typically rented for $0.35 to $0.45 per pound with lower quota rental rates in the Piedmont and mountain west. With tobacco production levels averaging 600 million pounds during the 90s, it can be seen that quota income in North Carolina is substantial. Little research is available on characteristics of quota holders. The Phase II board has certified 91,808 quota holders for payments. A Rural Center analysis of 1997 records indicates that most quota holders (93 percent) held less than 25,000 pounds of quota and only 445 hold more than 100,000 pounds. More than 95 percent live in North Carolina, though quota holders are found in most states and many foreign countries. Quota holders vary from wealthy farmers and businessmen to those who rely on quota rental payments for retirement income. Figure 4 100, ,000 Number of Tobacco Farms and Average Tobacco Farm Size Number of Farms 70,000 60,000 50,000 40,000 30,000 Farms Average Farm Average Farm Size (acres) 20, , THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

9 4. Tobacco Manufacturing in North Carolina The relationship between tobacco and other economic sectors in North Carolina has long been strong. Tobacco has moved from North Carolina farms to North Carolina auctions to North Carolina stemming and drying operations finally ending up at North Carolina cigarette manufacturers. This vertical relationship increases the overall importance of tobacco to the state s economy. As a result tobacco accounts for between 5 and 6 percent of North Carolina s gross state product. Tobacco product manufacturing is a $14.8 billion industry (1997 Annual Survey of Manufacturers) employing 15,400 (CES Employment data, average for 1998) with a payroll over $500 million. Most of the employment and wages are from urban cigarette plants (two RJR facilities in Forsyth County and a Philip Morris plant in Cabarrus County outside of Charlotte). Nevertheless, there is significant though partially seasonal employment in stemming and drying operations (also classified as manufacturing) that are mostly located in smaller plants in rural areas of North Carolina. Table 1 lists the tobaccorelated plants in the 1999 North Carolina Manufacturers Directory along with their employment and sales classification. As can be seen, many facilities are located in counties with significant leaf production. 5. Legal and Political Issues There are a number of other remaining issues surrounding tobacco besides those addressed by the 1998 Tobacco Settlement. These issues all have the potential to fundamentally change the role and importance of tobacco within the state. While this document focuses on the settlement, interested observers should be aware of these additional emerging issues. When this analysis was begun we assumed that the Tobacco Settlement might not be the end of governmental lawsuits. Specifically our analysis includes a scenario for a Federal lawsuit and settlement similar to that reached with the states attorneys general. Since the analysis was completed the Clinton administration and U.S. Attorney General Janet Reno filed a federal lawsuit on September 21, 1999, asking for unspecified damages from the cigarette manufacturers. Table 1 Tobacco Processing and Cigarette Manufacturing Plants, 1999 Company County City SIC Employment Sales (1,000,000s of $s) Philip Morris Cabarrus Concord ,372 GT 500 Liggett Group Durham Durham GT 500 Brown & Williamson Forsyth Winston-Salem RJ Reynolds Forsyth Tobaccoville ,100 GT 500 RJ Reynolds Forsyth Winston-Salem ,000 GT 500 General Processors Granville Oxford Lorillard Tobacco Guilford Greensboro ,000 GT 500 Edwards Leaf Tobacco Johnston Smithfield Dimon Intl Lenoir Kinston Thorpe-Greenville Tobacco Nash Rocky Mount Dimon Intl Pitt Farmville Taylor Company Robeson Lumberton Taylor Company Vance Henderson Export Leaf Tobacco Wilson Wilson Standard Commercial Tobacco Wilson Wilson Tobacco Processors Inc Wilson Wilson THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 7

10 In sections 2 and 3 we assume that a federal lawsuit will lead to an ultimate settlement of $150 billion. An additional lawsuit has perhaps even more farreaching implications. On October 20, 1999, an appeals court ruling in the "Engler case" paved the way for a multi-billion dollar award for punitive damages against cigarette manufacturers in a class-action lawsuit filed by Florida smokers. The civil jury that found against the cigarette companies in the suit has now awarded $140 billion dollars in damages. While the case is likely to be in appeals for several years, an award of this size could lead to bankruptcy by some cigarette firms or another large settlement to avoid such an award. Either possibility would increase cigarette prices and increase the negative impacts to the industry described in sections 2 and 3. Lastly, international lawsuits and Federal Drug Administration regulation threaten cigarette producers and could increase prices or further regulate tobacco use. Tobacco farmers have two additional worries. The first is the potential for direct contracting between cigarette firms and farmers as proposed by Philip Morris in April Such a system could have several impacts. It might replace the historic wholesale auction system that is used to sell tobacco. Farmers also fear it might give cigarette makers too much market power and force changes to or end the federal quota system. Philip Morris ultimately backed away from the proposal but it is likely to be raised again in the future. It should be noted that some farmers see contracting as a potentially positive development. Lastly, the floods caused by Hurricane Floyd have affected everyone in eastern North Carolina including tobacco farmers. The North Carolina Department of Agriculture estimates that Floyd affected nearly 81,000 acres of tobacco (about one quarter of the state s acreage) causing $95 million of losses (NCDA, October 29, 1999). This represents more than 10 percent of the 1999 crop. The crop loss becomes more significant when it is added to the loss of quota over the past two growing seasons, the destruction of other crops and livestock due to the hurricane, the damage of farm structures and the overall low prices for farm commodities. It is fair to say that North Carolina farmers have been battered from all sides. 8 THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

11 SECTION 2 Direct Impacts of the Tobacco Settlement 1. Introduction This section examines the direct impacts of the 1998 Tobacco Settlement on North Carolina tobacco production and revenue, quota income and production of cigarettes. The analysis is based on simplifying assumptions that provide broad estimates of the impacts. We start with two settlement scenarios with a lower and upper bound estimate for each scenario. The limitations of the analysis should be well understood. The study examines long-run impacts and does not pretend to account for year-to-year fluctuations that can result from, for example, weather, international conditions or short-term adjustments in leaf inventories. In addition, we examine only the impacts of the 1998 Settlement and a potential Federal settlement along with currently scheduled increases in cigarette excise taxes. No assumptions were made with regard to other lawsuits or legal actions. Lastly, the current tobacco program that limits leaf supply in order to maintain prices is assumed to remain in place without change. Much of the analysis that follows is necessarily technical. Efforts have been made to allow the non-specialist to understand and follow the analysis. The original technical paper, written by Dr. Blake Brown, on which this section is based is available upon request from the Rural Center. 2. Settlement Costs and Excise Tax Increases Two settlement scenarios are assumed in the analysis. First, the 1998 Tobacco Settlement is considered. Under this scenario U.S. cigarette manufacturers pay $200 billion over 25 years or an average of $8 billion per year. (While the total payments are purported to be $206 billion, many projections place the total closer to $200 billion). In the second scenario, cigarette manufacturers are assumed to settle the lawsuit with the federal government for $150 billion over 25 years in addition to the projected $200 billion payment to the states. Thus in scenario 2, the projected average annual payment by U.S. cigarette manufacturers is $14 billion. This scenario could also provide a proxy for the impacts from settlement of other lawsuits such as the Engler case if there is no federal settlement. In addition to settlement costs, the federal excise tax on cigarettes rose $0.05 per pack in 2000 and will rise $0.10 per pack in 2001, giving a final federal excise tax of $0.39 per pack. State excise taxes are assumed to increase an average of $0.05 per pack between 1998 and Cigarette Price Increases 1997 is used as a base year for cigarette prices and consumption. This is because reaction by cigarette manufacturers to settlement proposals would have been expected to begin in The average retail price of a pack of cigarettes in 1997 was $2.05 and U.S. cigarette consumption was 24 billion packs. Prices and price changes are in 1998 real dollars giving a 1997 equivalent base price of $2.08 per pack. The settlement payments are assumed to be long-term in nature. Cigarette companies are assumed to consider the costs of the settlement in decisions of whether or not to continue operation in the future. Because of the long-run nature of the costs, the fact that the payments are made on an annual basis, and that firms may exit or enter the industry, the annual lump-sum payments are assumed to increase (shift up) long-run costs. (The actual cost of producing each additional cigarette not including fixed costs short-run marginal costs is not affected because of the lump-sum nature of the payments.) The cigarette industry is assumed to be oligopolistic in nature (meaning there are only a few firms and these firms have some market control) so that only part of the increased taxes or costs due to the settlement are passed through in the form of higher cigarette prices. We estimate that about 70 percent of an increase in costs is passed through in the form of higher prices. THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 9

12 Based on the assumptions about market power, the cost of the settlement(s), and increases in excise taxes settlement, scenario 1 yields a longrun price increase of about $0.37 per pack (adjusting for inflation in 1998 dollars). In nominal dollars this implies that cigarette prices would be about $2.68 per pack in Scenario 2 yields a long-run price increase of about $0.55 per pack (in 1998 dollars). In nominal dollars this implies that cigarette prices would be about $2.87 per pack in Effect of Cigarette Price Increases on Cigarette Consumption Numerous economic studies have examined the impact of changes in the price of cigarettes on cigarette consumption (in economics terms the long-run elasticity of demand). Reasonable upper and lower bound estimates for the long-run elasticity of demand for U.S. cigarette consumption with respect to retail cigarette price are 0.75 and To explain what this means, an elasticity of 0.45 implies that a 10 percent increase in price leads to a 4.5 percent decline in the number of cigarettes bought. This study uses these boundary estimates (elasticities of 0.75 to 0.45) to estimate the impacts on demand from each settlement scenario (the change in price of cigarettes due to the settlement). There are therefore four estimates of the impact on cigarette demand, the upper and lower boundaries for the settlement scenario 1 and upper and lower boundaries for settlement scenario 2. In addition to the price effects of the settlement(s), the effect of more stringent smoking regulations is also included. While difficult to gauge, a reasonable guess may be that restrictions on smoking (e.g. restrictions on where individuals are allowed to smoke) will be approximately twice as restrictive in 2001 as they were in the mid-1990s. The model incorporates a measure of the effect of smoking restrictions on cigarette consumption. The impacts of each scenario on U.S. cigarette consumption are given in tables 2 and 3. The impacts are long-run in nature. In other words the levels given in the tables are what might reasonably be expected 4 to 5 years after the price increases occurred (i.e. after an adjustment period) and in the absence of other factors affecting the variables. 5. Effects on U.S. Cigarette Production Exports of cigarettes from the United States reached 32 percent of U.S. cigarette production in However, cigarette exports are now in decline and fell to 8 billion packs in 1999, down from nearly 11 billion packs in 1997 (Tobacco Situation and Outlook, April, 2000). This decline is not due to the current or proposed settlements in the United States and is not reflected in tables 2 and 3. The decline is due to maturing foreign markets and the global economic slow-down. The decline in U.S. cigarette production in tables 2 and 3 reflects only the effect of increased cigarette prices in the United States as a result of settlement costs. Cigarette exports are held constant in the tables. In other words, the decline in U.S. cigarette production reflected in the tables is the expected effect if the only change occurring in the industry was the tobacco settlement(s). 6. Effects on U.S. Tobacco Production and Revenues In 1997 North Carolina produced 718 million pounds of flue-cured tobacco and 13 million pounds of burley tobacco. In 1998 North Carolina production fell to 553 million pounds of flue-cured and 12 million pounds of burley. Only the impacts on U.S. flue-cured tobacco are examined since burley amounts to less than 3 percent of North Carolina tobacco production and the effects of tobacco settlement(s) on U.S. burley tobacco are similar to the effects on flue-cured tobacco. For the period , total use of U.S. flue-cured tobacco for cigarette manufacturing averaged 881 million pounds per year. Of this total, 526 million pounds were used on average by U.S. cigarette manufacturers for manufacture of cigarettes for U.S. consumption and cigarettes for export. Unmanufactured (leaf) exports to foreign cigarette manufacturers averaged 355 million 10 THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

13 pounds per year of this total. These averages are used as bases for computing changes due to the tobacco settlement(s). An average price of $1.75 is used for U.S. flue-cured tobacco. The price is unaffected by the settlement(s) because the U.S. tobacco program maintains the average price at this level. Only the quota (quantity) is affected by the settlement(s). Unmanufactured exports are unaffected by the tobacco settlement(s). In other words, the decline in U.S. tobacco sales and revenues reflected in the results is the expected effect if the only change occurring in the industry was the tobacco settlement(s). In reality exports have declined through 1999 when they were at the lowest level of the decade. This is due to the global economic slowdown, a large crop of good quality in Brazil, and a decrease in the value of the Brazilian currency of over 60 percent relative to the dollar since (Brazilian tobacco is a close competitor with U.S. tobacco in the world market.) U.S. exports of flue-cured tobacco fell from 390 million pounds in 1997 to near 300 million pounds in 1998 and likely declined further in We used what is called a displacement equilibrium model to examine the farm level effects of higher cigarette prices and increased smoking restrictions. The model is used to separately analyze the economic effects of an increase in the price of cigarettes and an increase in smoking restrictions (both due to the tobacco settlement scenarios discussed in Section 2.2 above) on tobacco revenues and quantity sold under the current tobacco program. Results of the model simulations for each scenario for domestic and total annual use of U.S. flue-cured tobacco, total revenues from U.S. fluecured tobacco, and total quota income from U.S. flue-cured tobacco are shown in Table 2. It is important to keep in mind that the tables do not reflect declines in total use, revenues or quota income as a result of declining cigarette or leaf exports. 7. Direct Impacts on North Carolina Farm income (gross farm receipts) from tobacco in North Carolina as reported by the North Carolina Department of Agriculture was $943 million in 1994, $1.048 billion in 1995, $1.021 billion in 1996, and $1.193 billion in 1997, or an average of $1.051 billion for the four-year period. The 1996 IMPLAN estimate (the economic input-output model used to estimate the impacts in Section 3) of value of output for tobacco production in North Carolina is $1.04 billion and $513 million for the value-added contribution of tobacco production. The 1996 IMPLAN estimates are used as bases for determination of the total impacts from a decline in tobacco production. The simulation results indicate scenario 1 (price increase of $0.37 per pack of cigarettes) will result in a 5.3 to 7.6 percent decline in farm revenues from U.S. flue-cured tobacco. Using the 1996 North Carolina farm income from tobacco as a base, the results imply that annual gross farm receipts in North Carolina will decline by between $54.1 and $77.6 million for scenario 1. The value added contribution at the farm level declines between $27 and $39 million. These declines are due solely to the current settlement between the states and cigarette manufacturers, an approximate doubling of smoking restrictions since the mid-90s, and 20 cents of increases in cigarette excise taxes. It does not include the impact of declining cigarette or leaf exports. For scenario 2 (price increase of $0.55 per pack of cigarettes), farm revenues from U.S. flue-cured tobacco are expected to decline between 6.4 and 10 percent. This implies the effect of a federal lawsuit settlement as outlined in scenario 2 plus the current settlement, increases in smoking restrictions, and increases in excise taxes would lead to a decline in annual gross farm receipts in North Carolina of between $65.3 and $102.1 million. Under scenario 2 the value added contribution at the farm level declines between $33 and $51 million. THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 11

14 To put these potential changes due to the tobacco settlement(s) in perspective, the 1999 U.S. flue-cured tobacco quota declined to 666 million pounds in 1999 (the average production for used as a base for the study was 881 million pounds). North Carolina has about 2/3 of the U.S. flue-cured tobacco quota or about 444 million pounds for This implies gross farm receipts in North Carolina of about $777 million in In addition to the long-run effects of the tobacco settlement(s) examined in this study, this large decline is due to adjustments of manufacturer inventories as a result of anticipated lower future demand for cigarettes and depressed cigarette and leaf exports. The impacts of inventory adjustments are short-run in nature. Leaf exports could recover with a recovery of the world economy and a strengthening of the Brazilian currency. Cigarette exports may recover partially. However, much of the decline in cigarette exports may be permanent in nature since as U.S. brand cigarettes become established in a country, a natural progression is for some of the production of those cigarettes to move to that country. Estimates of the value added to the North Carolina economy by cigarette manufacturing and stemming and redrying differ depending on the source. According to the Annual Survey of Manufacturers (U.S. Bureau of Census), the value-added contribution in North Carolina of cigarette manufacturing and stemming and redrying combined was $9.42 billion in 1994, $10.07 billion in 1995, and $10.66 billion in The Annual Survey of Manufacturers does not report separate estimates for cigarette manufacturing and stemming and redrying for 1994 and But for 1995 the estimate for the value added by stemming and redrying is $384 million and $9.656 billion for cigarette manufacturing. Estimates of the value-added contribution in North Carolina from IMPLAN are $8.12 billion for 1994, $7.18 billion for 1995, and $6.78 billion for The Bureau of Economic Analysis is yet another source for these estimates. Economy-wide impacts given in the study are based on the IMPLAN estimates. These estimates should be scaled up if the 1996 Annual Survey of Manufacturer estimates are used as base estimates. The direct impact of scenarios 1 and 2 on income from cigarettes can be calculated by multiplying the percentage change in U.S. cigarette production from Table 2 by the appropriate income or employment measure of cigarette manufacturing in North Carolina. The direct impact on stemming and redrying in North Carolina can be obtained by multiplying the percentage change in total use of U.S. flue-cured tobacco from Table 2 by the appropriate income or employment measure of stemming and redrying. For example, using the 1995 Annual Survey of Manufacturers estimates indicates a decline in the value-added contribution of cigarette manufacturing of between $860 million and $1.2 billion for scenario 1 and between $1.03 billion and $1.62 billion for scenario 2. For stemming and redrying the decline in value added contribution would be between $20 and $29 million for scenario 1 and between $25 and $38 million for scenario 2. Using the IMPLAN value added contributions for 1996, the estimated decline for cigarette manufacturing is between $590 and $835 million for scenario 1 and between $709 million and $1.11 billion for scenario 2. For stemming and redrying the estimated decline in value added is between $8 and $11 million for scenario 1 and between $9 and $15 million for scenario 2. Shifts of production within the United States may change the way North Carolina is affected by the tobacco settlement. For example, the study implicitly assumes that cigarette manufacturing in Kentucky is affected in the same proportion as cigarette manufacturing in North Carolina. In reality, Philip Morris has decided to close a cigarette manufacturing facility in Kentucky and will likely maintain capacity at 12 THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

15 their Concord facility in North Carolina. On the other hand, DIMON (a stemmer and redryer) has decided to completely shut down a stemming and redrying facility (processing plant) in Kinston, but will keep open a facility in Danville, Virginia. Like at the farm level, cigarette manufacturing and stemming and redrying are also affected by the decline in cigarette and leaf exports. The effects of declines in cigarette and leaf exports are not reflected in the study. Table 2 Direct Annual Impacts of Tobacco Settlement Related to Increases in the Price Per Pack of Cigarettes and in Smoking Restrictions 1 Scenario 1 Scenario 2 (price increase of $0.37 per pack) (price increase of $0.55 per pack) Scenario Base Levels Lower bound Upper bound Lower bound Upper bound Retail price/pack (98$) $2.08 $2.45(17.9%) $2.45(17.9%) $2.63(26.3%) $2.63(26.3%) Domestic cigarette 24 billion packs 20.7 billion packs 19.4 billion packs 20.1 billion packs 17.9 billion packs consumption (-13.6%) (-19.3 %) (-16.3%) (-25.6%) U.S. cigarette 36.6 billion packs 33.3 billion packs 32.0 billion packs 32.7 billion packs 30.5 billion packs production (-8.9%) (-12.6%) (-10.7%) (-16.8%) Domestic use of U.S. 526 million pounds 479 million pounds 460 million pounds 470 million pounds 438 million pounds flue-cured tobacco (-8.9%) (-12.6%) (-10.7%) (-16.8%) Total use of U.S. 881 million pounds 834 million pounds 815 million pounds 825 million pounds 793 million pounds flue-cured tobacco (-5.3%) (-7.6%) (-6.4%) (-10.0%) U.S. flue-cured $1.54 billion $1.46 billion $1.42 billion $1.44 billion $1.39 billion tobacco revenues (-5.3%) (-7.6%) (-6.4%) (-10.0%) U.S. flue-cured tobacco $352 million $349 million $347 million $348 million $344 million quota income (-1.0%) (-1.7%) (-1.2%) (-2.4%) 1 Percentage changes from base levels are given in parentheses. THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 13

16 SECTION 3 Economy-Wide Impacts of the Tobacco Settlement I. Introduction to Impact Analysis As is apparent to a casual observer of the tobacco and cigarette industries in North Carolina, the economic impacts of these industries do not stop at the property line of the farm or the door of the factory. The direct impacts of these industries sales, income, employment, wages, and taxes lead to additional economic events. The farmer buys fertilizer from the local seed store and pays laborers to harvest the crop. The tobacco stemming and redrying processor deposits funds in the local bank, buys fuel and energy and hires and pays full- and part-time workers. The cigarette manufacturer invests in expensive equipment, purchases specialty paper and pays workers and stockholders. The employees of these farms and firms buy groceries, housing and transportation. As a result, the direct impacts are multiplied when we look at the whole economy. Economists estimate multiplier effects using various models of the economy. The best and most widely accepted economic model to use for this exercise is the input-output or IO model. The IO model describes all the interactions between economic agents who buys what, from whom, and in what quantities. By mapping these interactions, such a model provides a way to estimate the impact of, for example, a $1 decline in an industry on a locality or region. If the IO model estimates that the widget industry in Widgetville has a sales multiplier of 2, then a $1 decrease in widget output (sales) in the region will lead to an additional loss of $1 in output by other firms in the region. Adding the $1 lost in direct sales to the $1 in additional lost sales gives a total of $2 the multiplier. Multiplying the direct impacts by the multipliers provides estimates of the total impacts of economic changes. Multipliers can be estimated for output or sales, value-added, employment and employment compensation. For this report the impacts are measured using the state s economic structure existing in 1996 (the latest year that such data are available). The source of the data and the IO model is IMPLAN (Mig Inc., Stillwater, MN). IMPLAN is well recognized for its economic impact assessment modeling system. The model is based on widely accepted federal data and can describe economic changes down to the county level within a state. II. Background and Explanation of Terminology As described in Section 2, we developed two scenarios of increases in cigarette prices as a result of the tobacco settlement. For each of these scenarios, we developed lower bound and upper bound estimates of direct changes in three tobacco-related economic sectors: cigarette manufacturing stemming and redrying tobacco leaf (farm) production These estimates of direct impacts on the three tobacco-related economic sectors were used as the basis for calculating economy-wide impacts. The economy-wide impacts include the direct impacts plus indirect and induced impacts. Indirect impacts account for economic effects on the suppliers of inputs to the tobacco-related economic sectors. Induced impacts account for changes in consumer spending resulting from both the direct and indirect impacts. 14 THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

17 Four types of economy-wide impacts are measured: changes in output, changes in valueadded, changes in employment, and changes in employee compensation. Definitions of these four measures follow: output: market value of production value-added: market value of production made with inputs in the local economy employment: full and part-time employment employee compensation: payroll and benefit costs of employees Total economy-wide impacts by the four measures are calculated. It is also of interest to understand how various economic sectors are affected. These impacts give a real feel for how the tobacco industry is related to other sectors of the economy, from banking to transportation and trade. Total economy-wide impacts are given for the economy divided into seven sectors: agriculture industrial transportation, communications, public utilities (TCPU) wholesale and retail trade (trade) financial services services government Impacts for the government sector account only for changes in purchases from the government. They do not account for impacts on tax revenues. In addition to which sectors are affected, it is also important to understand where the impacts occur. All of the economic impacts are also calculated for the entire state and for each of the seven "economic development regions" (ERD) of the state, as designated by the North Carolina Department of Commerce (Figure 5). Figure 5 North Carolina s Economic Development Regions Advantage West Carolinas Partnership Piedmont Triad Partnership Research Triangle Regional Partnership Global Transpark Region Northeastern Economic Commission North Carolina's Southeast THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 15

18 There is obviously a great deal of interaction between the three tobacco-related sectors (cigarette manufacturing, stemming and redrying, and leaf production). For example, if cigarette manufacturing output declines, so also will there be declines in stemming and redrying and in leaf production. Thus, the economy-wide impacts of changes in tobacco manufacturing will include changes in stemming and redrying and in leaf production. In the tables that follow, the economy-wide impacts have been separated for the three tobacco-related sectors. That is, the numbers for the economy-wide impacts for changes in cigarette manufacturing don t include the impacts for the corresponding changes in stemming and redrying and in leaf production. The economy-wide impacts are reported separately for each of the three sectors. III. Baseline Economic Values A baseline description of the state s tobacco industry and total economy is necessary to understand the relative impacts of the direct and indirect impacts of the Tobacco Settlement. Table 3 gives 1996 baseline, or total, values for the four economic measures output, valueadded, employment and employment compensation. The information is presented for each of the three tobacco-related sectors. State totals as well as values in each of the seven economic development regions are given (Figures 6, 7 and 8). It should be noted that the baseline values are from IMPLAN. These values may differ from the same measures from other sources. In Table 3 it can be seen that the cigarette manufacturing industry has an annual output of $11.4 billion with most production occurring within plants in the Winston-Salem area (Piedmont Triad). The industry employed 13,693 in 1996 with, again, most in the Piedmont Triad. Stemming and redrying accounts for $1.8 billion in output and 4,091 employees, mostly in eastern counties like Wilson, Nash and Pitt (Global Transpark). Leaf production accounts for over one billion dollars in output and 14,197 employ- Figure 6 Piedmont Triad 72% There is no cigarette production in the other four economic development regions Figure 7 Figure 8 Global Transpark 79% There is no stemming and drying in the other three economic development regions 6% Total cigarette industry output for 1996 was $11.5 billion Global Transpark 31% Northeast Baseline Cigarette Production by Economic Development Region, 1996 Research Triangle 24% Southeast 16% Research Triangle 7% Carolinas Partnership 21% Source: REDC, NCSU and IMPLAN, Mig, Inc Baseline Stemming and Drying Production by Economic Development Region, 1996 Piedmont Triad 19% Total stemming and drying industry output for 1996 was $11.8 billion Tobacco Leaf Production by Economic Development Region, 1996 Southeast Less than 1% Research Triangle 2% Source: REDC, NCSU and IMPLAN, Mig, Inc Advantage West 6% Carolinas Partnership Piedmont Triad 16% 1% Total tobacco leaf output for 1996 was $1.0 billion Source: REDC, NCSU and IMPLAN, Mig, Inc THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement

19 Table 3 Baseline (Total) Values for Economic Measures, 1996 (jobs for employment, $ millions for other measures) Cigarette Manufacturing Employee Output Value-added Employment Compensation Advantage West Carolinas Partnership Piedmont Triad Research Triangle Northeast Global Transpark Southeast State Total Stemming and Redrying Employee Output Value-added Employment Compensation Advantage West Carolinas Partnership Piedmont Triad Research Triangle Northeast Global Transpark Southeast State Total Leaf Production Employee Output Value-added Employment Compensation Advantage West Carolinas Partnership Piedmont Triad Research Triangle Northeast Global Transpark Southeast State Total ees distributed throughout the state. Leading areas, as can be seen in Figure 2, are the east and the Piedmont within the economic development regions of the Global Transpark, Research Triangle, the Piedmont Triad and North Carolina s Southeast. Table 4 presents baseline values for the North Carolina economy as a whole (all industries). These data are useful for judging the relative sizes of the projected economy-wide changes. Figure 9 shows how the size of the ERD economies varies across the state. As would be expected, the ERDs containing the state s largest metropolitan areas, Charlotte, Raleigh-Durham- Chapel Hill and Winston-Salem-Greensboro- High Point, have the largest economies. THE NORTH CAROLINA RURAL ECONOMIC DEVELOPMENT CENTER The 1998 Tobacco Settlement 17