Tobacco Farmers, Markets, & Industry: Buyout Impacts

1. Tobacco Farmers, Markets, & Industry: Buyout Impacts Kelly Tiller Agricultural Policy Analysis Center The University of Tennessee ERS & Farm FoundationTobacco Buyout Impacts Workshop Washington, D.C. September 20, 2005 Agricultural Policy Analysis Center - University of Tennessee - 310 Morgan Hall - Knoxville, TN 37996-4519 www.agpolicy.org - phone: (865) 974-7407 - fax: (865) 974-7298

2. A P A C Impacts Addressed • Impacts on manufacturers • Impacts on/of Phase II • Impacts on state/regional economies • Post-buyout contract evolution • Other impacts and observations

3. A P A C Impacts on Manufacturers • Tobacco manufacturer and importer assessments(-$10b) • Domestic leaf cost savings (+$3.1b to $6.5b) • Imported leaf cost savings (+?) • Savings for domestic leaf purchases for use in international manufacturing operations (+?) • Phase II payment savings (+$2.1b) • Responsiveness to future market changes (+?) • Net financial burden: 1.3¢ to 2.7¢ per pack

4. A P A C Assessments • Assessments authorized up to $10.14 billion FY2005 through FY2014 • Based on share of sales volume for 6 major tobacco product classes • 158 product manufacturers and 666 product importers • Required to submit data regularly to enable CCC to determine respective quarterly shares of product classes • CCC to send quarterly assessment notices the 1st of March, June, September, and December • Assessments due in 30 days

5. A P A C Assessments

6. A P A C Market Responsiveness • Absent the federal tobacco program, U.S. tobacco industry can exert more control over the tobacco production sector • Mere existence of former program influenced the incentive structure surrounding contracting • Growers now have a much stronger incentive to quickly adjust production, curing, and market prep practices to meet customer demands • Highly beneficial in the event of future FDA authority

7. A P A C Measuring Mfgr Impacts • Event study methodology • Predicated upon the efficient markets hypothesis • All available information is impounded in current stock prices • The value of a firm changes as the result of unexpected events that cause investors to revise estimates of future cash flows and/or risk • Calculate a measure of “normal” returns • Calculate “actual” returns around event dates • Estimate abnormal returns, the difference between actual and normal returns

8. A P A C Companies Included

9. A P A C Event Dates • June 14, 2004 • Buyout added to H.R.4520, vote in House W&M Committee • No FDA, funded by part of tobacco excise tax (public $) • July 15, 2004 • JOBS bill passed Senate vote with a buyout intact • Included FDA, funded by tobacco manufacturers • October 6, 2004 • H.R. 4520 reported out of conference committee WITH the buyout • October 22, 2004 • President signs JOBS bill, prior to election • December 23, 2004 • Judge rules in favor of cigarette manufacturers on 2004 Phase II payment question

10. A P A C Cumulative Abnormal Returns

11. A P A C Phase II Payments • Because the buyout funded by manufacturer and importer assessments, future Phase II payments will be terminated • Total Phase II payments expected to be about $2.13 billion 2005-2010 • Not specifically addressed in the buyout, triggered by an offset condition in the Phase II agreement • Legally untested, but many believed that taxpayer (Treasury) funding of a buyout would not trigger the legal Phase II offset language

12. A P A C Phase II Legal Issues • Shortly after buyout passed, participants withheld Q4 payments ($106 m) and requested refund of Q1-Q3 payments for 2004 ($318 m) • Major legal question was the start of the buyout • Decision issued by NC federal business court December 23 • 2003 Phase II payments were essentially the “last” Phase II obligations • Decision appealed to NC Supreme Court • Decision issued August 19 reversing lower court • Ordered participants to make 2004 Phase II payments

13. A P A C Phase II Impacts • Widespread lack of anticipation that 2004 Phase II payments may not be forthcoming • Phase II payments tied to cash flow • Misperception about basis for Phase II payments • Influencing quota owners and growers to choose discounted lump sum over 10 annual payments • Perception of risk of early termination and significant payment delays • Promoted grower distrust of manufacturers • In reality, Phase II and buyout are apples and oranges

14. A P A C Buyout Payments by State

15. A P A C Buyout Payments by Kind

16. A P A C Community Economic Impacts • Input-Output analysis using the IMPLAN model • State level analysis for 11 states • Congressional district level analysis for NC, KY, TN • Estimate regional impacts and statewide impacts • Sum over regions does not equal state impacts • Estimate impacts (2003 vs. 2005) due to • Infusion of buyout payments (with tax consequences) • Changes (reduction) in acreage • Changes in yields and prices • Phase II payments

17. A P A C IMPLAN Impacts • Direct Impacts • Impacts that result from changes in the tobacco sector’s economic activity • Indirect Impacts • Impacts that result from changes in inter-industry purchases • Induced Impacts • Impacts that result from changes in household income and spending

18. A P A C IMPLAN Impacts, cont’d • Total Industry Output Impacts • The annual dollar value of the goods and services that the tobacco production sector produces • Employment Impacts • The number of total wage and salary employees (full-time, part-time, self-employed) • Total Value Added Impacts • The dollar value of wages and salaries, including benefits, self-employment income, interest, rents, profits, taxes

19. A P A C IMPLAN Scenarios

20. A P A C Post-Buyout Contract Evolution • Since 1999, most contracts offered generally marketing contracts with some production guidelines • Grower still bears most production risk, reduces price risk • Post-buyout incentives to move toward production contracts • Contractor has significantly more control over the production process • Changes in contract length: (+) and (-) • Shorter term contracts • May reduce long-term purchase commitments • Gain flexibility in meeting market changes and demands • Longer term contracts • Ensure longer-term leaf supply security • With sufficient competition, ensure quality and stability in supplies

21. A P A C Other Impacts • Impacts on locations and staffing of USDA Service Centers in tobacco states • Impacts of §1031 like kind exchanges on land sales and land values • Financial decision for contract holders are very individualized • Many at or above retirement age, many without internet access • Lack of information among tax preparers and financial planners in many rural areas

22. A P A C www.TobaccoBuyoutInfo.com www.agpolicy.org/tobquota.html