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Is it a tobacco fee? Is it a tax? It's up to the judges to decide

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The legal fight over whether smokers in Minnesota need to continue paying a 75-cent per pack fee is just beginning. A judge ruled against the fee, but that ruling is being appealed. (MPR Photo/Bianca Vazquez-Toness)
When the state settled its landmark lawsuit against tobacco companies in 1998, it appeared Minnesota's legal battles with the industry were over. Nevertheless, seven years later, the state and tobacco companies are back in court. This time, cigarette makers say the state is reneging on the terms of its settlement by hiking cigarette prices by 75 cents a pack.

At stake is $400 million in revenue each biennium. The state attorney general argues the case presents a constitutional showdown. Other experts say, however, it is just a dispute over the original agreement.

St. Paul, Minn. — Seven years ago, then-Attorney General Skip Humphrey announced to the public that the state of Minnesota had brought the tobacco industry to its knees.

"They have surrendered, and they have surrendered on our terms," Humphrey said at the time.

Those settlement terms are now at the heart of a legal battle between the state and tobacco companies. When the state settled, it released the industry from future claims over smoking-related health care costs.

In return, the tobacco companies agreed to make two separate kinds of payments -- about $1 billion over five years, and annual payments based on national cigarette sales.

The Minnesota Finance Department says the tobacco companies have made annual payments of about $172 million per year. Their last payment, which came in two weeks ago, totaled $179 million. Since the settlement, tobacco companies have paid the state $2.25 billion.

Much of that money had gone into three anti-smoking endowments, including one designed to prevent children from starting to smoke. During the 2003 state budget crisis, however, the Legislature liquidated the endowments to balance the budget.

At the time, Gov. Pawlenty said he had no choice, but said the state would still be getting annual payments from the tobacco companies.

Then last May, the state Legislature passed what the governor described as a "health impact fee" of 75 cents on each pack of cigarettes sold in Minnesota.

"I believe this is a user fee. Some people are going to say it's a tax. I'm going to say it's a compromise, and a solution to move Minnesota forward," Pawlenty said at the time.

The state cannot prevent itself from raising taxes, but the state can only charge a fee once.
- Fred Morrison, constitutional law professor at the U of M

The governor said the revenue from the fee would help offset health costs due to smoking. These are the same costs earmarked in the 1998 settlement.

After the Legislature approved the health impact fee, tobacco companies accused the state of double-dipping. They said they had already paid, and the companies asked a court to force the state to comply with the agreement.

Ramsey County Judge Michael Fetsch agreed, and struck down the fee. The state has appealed Fetsch's order to Minnesota's Supreme Court.

While the dispute has raised issues financially and politically, the attorney general says it's also raised lofty questions of constitutional law. In particular, did the state's branches of government trample on each other's turf?

Donna Byrne, a tax law professor at William Mitchell College of Law, says the answer to that question rests in the label of the price hike itself.

"Kind of looks like a fee; kind of looks more general, like a tax; and it looks like you could probably argue it either way," Byrne says.

The attorney general argues it is a tax. Mike Hatch, a DFLer who announced he is running for governor, says the only reason Gov. Pawlenty, a Republican, called it a fee was to skirt Pawlenty's "no new taxes" pledge.

The question is whether then-Attorney General Skip Humphrey, as part of the executive branch, had the power to sign away in the settlement the Legislature's ability to tax the tobacco companies further.

Professor Fred Morrison, who teaches constitutional law at the University of Minnesota, says the answer is no.

"The state cannot prevent itself from raising taxes, but the state can only charge a fee once," Morrison says.

Morrison does not see the case raising any major constitutional law issues. He says if the increase is a fee, it is a basic settlement case and the state cannot renege on its earlier promise.

"That's a pretty standard piece of law, that once you've settled a lawsuit, you can't say, 'Oh gee, I'd like a few million more,'" Morrison says.

One of the state's lawyers who worked on Minnesota's tobacco case says it was never their intention to prevent the Legislature from taking future action against the companies. Former Deputy Attorney General Tom Pursell says the settlement agreement released the tobacco companies from legal claims only.

"We were settling a lawsuit. We were not settling anything to do with the state's future to regulate, or to tax, or to impose fees on the tobacco companies. And we were well aware of the principle that you can't bind the Legislature in actions such as that," Pursell says.

In his ruling, Judge Fetsch said the price hike was a fee. He defined it as a fee, in part, because the Legislature passed a tax bill that same day and the health impact fee was contained in a separate bill.

In addition, Fetsch said the settlement language was clear -- the state released the companies from "liabilities of any nature, whatsoever," including those of a "statutory nature."

Former state Revenue Commissioner John James agrees with Fetsch's definition of the increase as a fee. James is currently treasurer for Peter Hutchinson, who is running for governor as an independent. James says there is even a larger issue at stake -- truth in taxation.

James says the court would do the public a disservice if it finds the cigarette price hike is a tax, even though the Legislature said it was a fee. James says if it finds it is a tax, it will be easier for the Legislature to hide taxes under the guise of fees.

"We've entered an age where there's a lot of pressure on not taxing. That translates into finding other ways to get money, and that translates into fees, and so we're going to see more and more of this," James says.

For their part, the tobacco companies argue that calling the 75-cent hike a fee or a tax is meaningless. What is important, they contend, is its purpose -- raising money to offset smoking-related health care costs. They say they agreed to pay billions in the settlement, and the state should live up to its side of the bargain.

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