Tobacco.org

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Senate Majority Leader Lott's decision to join forces with Senator McCain, and the White House's announcement that they are negotiating with McCain on a scaled-down version of McCain's bill, sharply increases odds that the Senate will pass a tobacco bill next week that has as its core a $1.10/pack tax hike over 5 years, an $8.0 billion liability cap, and sweeping new advertising and regulatory restrictions. With Clinton-McCain-Lott together, efforts to substitute a "skinny" drug/tobacco bill are likely to fail.

Lott's plan is to get the tobacco issue off of the Senate floor as soon as possible, and then rewrite the modified McCain bill in a House-Senate conference during the August recess in a way that the White House, conservatives, and the industry can live with. We still expect the House to approve a much narrower tobacco bill -- at its core a $.60 -$.75/pack excise tax over five years.

The bait with which Lott expects to bring the industry back are two essential liability protections:an unconditionalliability cap not dependent on attainment of lookback provisions, and an express provision that liability be limited to domestic tobacco operations to protect the parents' assets in the event of tobacco bankruptcy. These would permit spinoffs of non-tobacco assets..

There remains an outside chance that "pro-tobacco" forces led by Assistant Majority Leader Nickles can get 41 votes together to filibuster the Senate tobacco legsilation next week as a way to delay the Senatevote until mid-June until after they have had a chance to introduce their own "skinny" anti-drug/tobacco bill. McCain's intent to water down his bill and express White House endorsement before Monday would likely seal the fate of the pro-tobaccofaction, permitting passage of McCain II.

Investors should not underestimate the role of the plaintiffs' bar in this proecess -- who continue to negotiate on the industry's behalf with both Mccaina nd the White house. These lawyeres will only get paid if there is a deal to the industry's liking. Senate Majority Leader Lott's decision to support McCain's bill is consistent with the plaintiff bar's decision to back McCain's bill, since a skinny Nickles drug/tobacco bill would offer no liability protections, and hence, result, not result in a big payday for the lawyers.

Investors are likely to remain uncomfortable with the approach taken by Lott to leave the fate of tobacco legislation in the hands of perhaps a dozen players from the House and Senate and the White House in what be referred to as a brokered deal. In conference, attendees are chosen by the Senate and House leadership in proprotion to overall House and Senate seats, and usually involve members from committes that asserted jurisdiction. The White House will bless the brokered deal to get is share of the money

Yesterday's largely meaningless Senate Finance vote to convert the non-volume adjusted $1.10/pack base payments in McCain's bill to a volume-adjusted excise tax increases of $1.50 over three years, if adopted by the full Senate, would be a net negative during the first three years, but a net positive thereafter, and is essentially a wash overall. The Comitteeaslo voted to: *Convert the $3.5 billion lookback penalty to a penalty excise tax which would be volume adjusted but not tax-deductible. *Struck the International fee provisions (estimated impact $1.5 billion per year), but not the marketing provisions *Rejected the idea to use tobacco money to fund health care tax cuts, voting instead to split up the money on the Senate floor. *Removed both the favorable small company tax treatment (paid up to 75% less), and Liggett's special exemption

Favorably for UST, the smokeless tax increase would be proportionate to the cigarette tax increase. UST's excise tax increase over three years would be $.17/can (current $.027/can), in proportion to cigarette tax increase ($1.50 vs. current $.24/pack).

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