Fee on certain tobacco products ruled unconstitutional

The Third Court of Appeals in Travis County recently affirmed a lower court ruling that a fee on cigarettes and cigarette tobacco manufactured by certain small producers was an unconstitutional tax. The state is expected to appeal the ruling to the Texas Supreme Court.

The Aug. 15 ruling addressed a law enacted in 2013 that requires a fee on cigarettes and certain tobacco products offered for sale in Texas by producers that did not participate in the 1997 and 1998 comprehensive settlements between states and large tobacco companies. The producers subject to the fee sued the state, arguing that it was effectively a tax that violated a requirement under Tex. Const., Art. 8 that taxation be equal and uniform, among other claims.

The 1998 Comprehensive Settlement Agreement required large tobacco companies to pay the state for damages incurred by tobacco use, such as Medicaid expenditures, and to pay punitive damages for antitrust violations, deceptive advertising, and marketing to children. Under the agreement, the companies agreed to make large annual payments based on market share and were released from past and future claims of harm caused by tobacco use. Small tobacco producers were not involved in the settlement agreement, either because they did not exist in 1998 or were not accused of wrongdoing.

HB 3536 by Otto, enacted in 2013 by the 83rd Legislature, imposes a fee on cigarettes produced by manufacturers that did not participate in the agreement. The fee, which is collected when distributors buy tax stamps, is currently 56.65 cents per pack. The bill does not release the non-settling manufacturers from liability but would apply all fees paid by a manufacturer to any judgment or settlement on a claim brought against the manufacturer.

According to HB 3536, its stated intent was to:

  • recover state health care expenditures attributable to the non-settling manufacturers;
  • prevent non-settling manufacturers from undermining the state’s policy of reducing underage smoking by offering products at prices substantially below those offered by other manufacturers;
  • protect the tobacco settlement agreement and funding, which has been reduced by growth in sales of non-settling manufacturers’ products; and
  • ensure evenhanded treatment of manufacturers.

The state argued that the fee does not violate the equal taxation clause because the Legislature’s decision to place a fee on the products of non-settling manufacturers and not those of settling manufacturers was based on a reasonable distinction between them. The court rejected the assertion that because big tobacco entered into the settlement agreement and small tobacco did not, the entities could be treated differently. The court said the proper test was to examine the kinds of products produced. The court, finding no difference, concluded that the fee unacceptably violates the constitutional requirement that taxation be equal and uniform. The court said HB 3536 was “an apparent attempt to prevent Big Tobacco from losing market share to Small Tobacco” and that “protecting one company’s market share over another’s does not justify the unequal treatment of identical products.”

The fee is still being collected. If the Supreme Court does not accept the state’s appeal or issues a final ruling against the fee, the Comptroller’s Office is expected to return collected fees under guidance from the courts.

by Tom Howe

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