Furges’ checks are part of the biggest windfall that Virginia has ever stumbled across. The state’s total share of the so-called Phase One of the Master Settlement Agreement (MSA) is estimated at $4.2 billion over 25 years. It’s like manna falling from heaven — without the taxman showing up. At the same time, it is a two-headed monster that could prove to be either a bonanza or a boondoggle. The money could revitalize the tobacco belt areas of Southside and Southwest Virginia, which are the most economically depressed parts of the state. Or it could end up padding the bank accounts of rich tobacco quota holders, some of whom live out of state in New York, Chicago and Las Vegas. In its first year, the program has been a little of both.

The state plans to allocate 40 percent, or an estimated $1.7 billion, to its General Fund to spend as it pleases. Gov. Jim Gilmore wants to use it to plug budget shortfalls and finance the controversial repeal of the car tax. Another 10 percent, about $17 million a year, will be spent on convincing people not to smoke. The other 50 percent, totaling up to $2.1 billion, will be dispersed by a powerful governmental body created by the General Assembly in 1999 called the Virginia Tobacco Indemnification and Community Revitalization Commission. It is governed by 31 members drawn largely from the flue-cured and burley tobacco country of Southside and Southwest Virginia.

Commission members regard the tobacco settlement money as a once-in-a-lifetime opportunity to bankroll the tobacco belt’s computer science centers at local schools and install broadband telecommunications infrastructure, so the region can leapfrog into the 21st-century knowledge economy. In one of its first projects, the commission also is lending money for research to create a new market for tobacco by transforming the plants into botanical pharmaceutical factories (see Page 12). In the same breath, however, commissioners talk about using the money to upgrade sewer service to attract new industries. A key challenge will be to resist the temptation to treat the fund as a piggybank for local politicians doing business as usual.

The mid-1999 legislation reserving half the proceeds of the 1998 master settlement for "indemnification" of tobacco growers and their communities represents a coup for Sen. Charles R. Hawkins, R-Chatham, the main architect of the bill and now the commission’s chairman. Of the 46 states participating in the 1998 master settlement, Virginia appears to be dedicating the largest share of its take to making tobacco growers whole. Although states are free to spend the settlement money as they wish, the spirit of the settlement was to fund health research, especially for lung cancer, underwrite anti-smoking campaigns and, in the case of the 14 tobacco states, wean tobacco-dependent regions from cultivation of the weed (see Page 10).

In Virginia, tobacco quota holders and growers need only mail in application cards and documents proving they either own quotas or grow tobacco in order to receive payments to spend any way they wish. "Virginia is one state of all the tobacco states that actually has a real helpful program where the tobacco money’s being flowed back to the tobacco farmers. These other states haven’t backed the tobacco farmer like Virginia has," says Oliver Coleman "Buddy" Mayhew, a Pittsylvania County farmer who owns or leases 70 acres of leaf and is on the board of the political group, Concerned Friends for Tobacco.

Hawkins makes a strong case that tobacco-producing counties desperately need help since the region’s other key industries, such as apparel, textiles, furniture and coal mining, are sloughing off jobs by the thousands. But the commission’s early actions raise questions about its priorities. In 2000, it spent 80 percent of the money available in the first year, $58 million, for no-strings cash payments to 25,150 tobacco quota holders and growers like Robert Furges and only 20 percent on economic development. This largesse will allow tobacco cultivators to double dip on a massive scale: Virginia tobacco growers and quota holders are due an additional $337 million over the next 12 years from Phase Two of the tobacco settlement, a separate pot of money. Indeed the commission’s policy, if unchanged, could amount to triple dipping. The commission is basing its pay out on an assumption that quota cutbacks harmed Virginia leaf growers to the tune of $1.2 billion. But the commission’s own expert now says a better figure would be $500 million.

Photo courtesy Richmond Times-Dispatch

Why the urgency? When the commission was founded in 1999, cuts in tobacco quotas were hammering Virginia’s farmers. Flue-cured tobacco quotas were on their way down by 44 percent and burley tobacco quotas were off by 53 percent. "The total asset loss in quota and economic losses for active tobacco producers in Virginia is estimated to be $1.2 billion," stated the bill creating the commission. No one has questioned that estimate since then. But based on that number, commission members felt they had a mandate to get aid to farmers quickly.

There was a presumption that tobacco growers and quota holders were suffering tremendous losses. "There were a lot of bankruptcies," says Sen. Hawkins, who chairs the commission after having helped create it. "Family farms are dependent on debt structure, and if you sell off road front or cut trees to pay off debt, it’s gone forever." However, Hawkins could cite no specific instances of bankruptcies directly attributable to quota cuts, nor could tobacco grower Mayhew.

Actually, the $1.2 billion figure has little basis in fact. The number represents potential losses to tobacco farmers if all quotas were lost, says Stan Duffer, a regional market manager for the Virginia Department of Agriculture in Danville, who was involved in compiling it. The drafters of the indemnification legislation estimated Virginia’s average total quota between 1995 to 1998 to be 100 million pounds. They multiplied that number by $12 per pound, an estimate of the value of each pound of tobacco, including labor, investments and the tobacco itself. Where does that $12 come from? Duffer can’t say for sure. "I don’t know if there was ever a particular piece of paper [used to support the figure]," he says. "It was sort of a derived figure." He says the $12 per pound figure came from studies by universities and had been used by Congress. "Anyone can debate the value of it," he says. Duffer says a more realistic figure for lost value would be $500 million. And even that’s a guess.

Complicating the commission’s task is the difficulty of predicting the future direction of U.S. tobacco markets, even though production is fixed by the federal government. Founded in 1938, a program run by the U.S. Department of Agriculture was designed to address the woes of tobacco farmers during the Depression. At the time, tobacco farmers typically worked on small, relatively inefficient plots of land. Many destitute farmers faced the prospect of selling their land to big cigarette makers who could consolidate cultivation and grow the crop more efficiently. To avoid throwing thousands of farmers onto the welfare roles, USDA set up a quota system which, by restricting supply, propped up the price and kept the farmers in business.

A sign off U.S. 360 in the tobacco belt. Photo by Peter Galuszka

The stopgap program took on a life of its own. Thanks to government manipulation of tobacco markets, the crop ended up paying more — much more — than any other that could be cultivated in the soil of the South. Just a few years ago, for instance, a grower who harvested 100 acres of tobacco could gross $750,000, far more than what 100 acres of wheat, corn, cotton or soybeans would pay. Indeed, tobacco is Virginia’s largest cash crop — generating revenues of about $198 million — and its most profitable.

Not all the profits go to farmers, however. The 1938 program allowed quota holders to lease their acreage to someone else who would actually farm it. In effect, the quota became a form of property divorced from actual labor. Few of the original quota holders are still left; most have bequeathed their quotas to relatives who, in turn, have leased them out. According to U.S. Department of Agriculture documents obtained by Virginia Business, of 9,953 flue-cured tobacco quota holders, some 1,246 or 12.5 percent, live out of state. All are eligible for payments. For instance, a review of tobacco quota holders in Brunswick County shows that some 506 out of 1,779 — more than 28 percent — live out of Virginia in such places as Philadelphia, Baltimore, North Miami Beach and Las Vegas. On Halifax County’s list, one quota holder’s address was listed as being near Chicago’s posh Gold Coast filled with skyscraper apartment buildings overlooking Lake Michigan.

The fact that Virginia’s payouts are designed for all quota holders and growers, even rich ones, has caught the eye of tobacco-settlement critics. "Our position," says Eric Lindblom, manager for policy research at the campaign for Tobacco-Free Kids in Washington, "is that if you are giving money to farmers, it would be constructive to target funds to those who really need assistance. Some of these people are very well off." A similar controversy arose in North Carolina where a newspaper reported that nearly 10 percent of quota holders live out of state. "This has hurt from a publicity standpoint in North Carolina where you have doctors and lawyers buying farms or inheriting quotas," concedes grower Mayhew. "This is one of the inequities of the thing. But don’t throw the baby out with the bath water."

Another complication for administering the settlement is the uncertain future of the quota system. Even though tobacco growers jealously protect them, quotas may be living on borrowed time. As Americans shun smoking for health reasons and markets shift overseas for cigarettes, tobacco companies, led by Philip Morris, are dabbling with buying directly from farmers on a contract basis rather than at auction. Quota-based pay-out programs such as Virginia’s would no longer have a framework upon which to base their payments. "The [quota] program has been under pressure for a long time," says Gary Bullen, a tobacco economics specialist at the Department of Agriculture and Resources Economics of North Carolina State University in Raleigh. "If the quota system goes out, then the quota itself has no value."

The lottery-like largesse that Virginia is lavishing upon tobacco quota holders is especially ironic given that tobacco-producing counties also have seen massive layoffs of factory workers in textiles, apparel and other low-tech manufacturing sectors. Over the past five years, some 4,000 apparel workers have lost their jobs as trade restrictions have been eased and trade pacts, notably the North American Free Trade Agreement, have encouraged apparel companies to move their operations outside the U.S. And in far Southwest Virginia, the coal industry has shed another 10,000 jobs over the past two decades as coal seams play out.

Union officials and anti-smoking groups are quick to point to such inequities. "It’s ridiculous," says Carol Sheerer, an organizer from the Union of Needletrades, Industrial and Textile Employees who covers Southside factories from her base in Eden, N.C. Local legislators in the Danville and Martinsville area did try, with limited success, to bring relief to apparel workers through special legislation.

The fact that the settlement arrangements favor tobacco interests enrages anti-smoking groups. "That’s why we opposed the settlement," says John Banzhaf of the anti-tobacco group Action on Smoking and Health based in Washington. "A very small portion of the money would be spent on anti-smoking activity. That’s being proven true. It would be better spent on roads or schools than spending on grower allotment holders." Banzhaf, a law professor at George Washington University, says there was no similar outpouring of sympathy and checks when defense workers faced cutbacks.

Where does the money to growers go? It’s hard to generalize, but in some instances, farmers are reinvesting in their tobacco operations. When the 1997 quota cuts came, his revenue was cut in half, says Donnie Stowe, who grows leaf on 55 to 60 acres in Pittsylvania County. He also raises wheat and soybeans, "but tobacco pays the bills." Help arrived in the mail in the form of checks from the state. "It was a pretty good amount of money," he says, though he declines to say how much. He used the funds to upgrade heat exchangers and other equipment on the heating barns that he uses to cure his leaf. The investment will make his farming more efficient. "We’re lucky in Virginia," he says. "A lot of states didn’t look out for their tobacco growing regions all that good."

Some of the critics’ concerns will be addressed by the tobacco commission’s plan to spend roughly half of its funds on economic development this year, an increase of 30 percentage points. Carthan F. Currin III, director of the tobacco commission, says that hard-bitten communities of the tobacco belt, mainly in Southside and the Southwest, need to use the funds to transform themselves rather than engage in piecemeal projects. "People need to change," he says.

The big question is if the commission can bulk up the tobacco belt’s economic infrastructure in intelligent and coordinated ways rather than treat the funds as pork barrel. The commission didn’t accomplish much in the first year of its work. It paid a modest $7.1 million for economic development while sending tobacco farmers a $58 million bonanza. This year, the scales will tip in favor of economic development, which will receive $39 million of the $63 million in the budget. In Southside, about $23 million will be evenly split between tobacco growers and development projects while the $17 million allocated to the Southwest will tilt marginally towards development. Projects targeted for funding in the near term range from a new lodge for Hungry Mother State Park to a new, $14 million science center at Longwood College in Farmville. In Danville and Pittsylvania County, plans call for a 300-acre "cyber" park to host high-tech industries. It will house an Institute for Advanced Learning and Research that will work on Internet-based projects in a joint venture of Averett College, Danville Community College and Virginia Tech.

To put its bounty to the best use, the commission is working on a comprehensive investment plan for Southside and Southwest. The plan should be finished within six months. For now, however, local officials and residents are grabbing whatever they can with little thought to long-range planning. For example, Pittsyvania County expects to receive $3 million this year in economic development payments. "It’s supposed to be $3 million, but that’s still up in the air," says F.A. Keatts, head of the finance committee of the Pittsylvania County Board of Supervisors. Already, local politicians are squabbling over where the first payment should go. About $1 million is supposed to go to a program involving the Institute and other funds are supposed to help industrial zones by improving sewage systems. Keatts, however, challenged plans to put money into the Danville Community College system, saying he wasn’t sure there was enough to go around. "So far, we haven’t seen any money yet," he says.

Part of the commission’s problem has been the precarious nature of its funding. With no long-term guarantee that settlement payments from the tobacco companies will keep coming, the commission has been unwilling to commit to any long-term projects. The settlement calls for $206 billion to be paid out to 46 states in perpetuity, sort of like an annuity. But there’s no certainty that this will happen. Says John W. Forbes, Virginia’s deputy secretary of finance, who serves on the commission: "the Master Settlement Agreement can be adjusted for 11 different factors. It can go down, for instance, if the tobacco companies see reduced domestic shipments of tobacco, or for inflation rates, or if excise taxes on cigarettes go up." As Americans smoke less and cigarette markets shift overseas, "There could be a downward adjustment on funds."

All of this, says Forbes, "has the affect of putting a great deal of pressure on the agreement." Already, this year’s payment to Virginia is $30 million less than last year’s. What’s more, the governor and the General Assembly have to agree on the disbursement of each year’s payments. The attitude of the legislature towards the settlement could be quite different six years from now. That’s why, says Forbes, "as a commission member, I am extremely hesitant to vote on anything that [has] a longer than one-year value."

One solution being explored by the General Assembly is to follow the example of 13 other states and securitize the settlement. Under the current plan, Virginia would sell $1.6 billion worth of bonds using the promise of the tobacco settlement payments as security. Proceeds from the bonds would be invested in portfolios with holdings in a wide range of industries with the dividends and principal put into a trust fund. The same sum would be equal to $3.1 billion within 20 years at an annual compounded interest rate of 6.75 percent, Forbes says. Forbes expects the bonds to be given a rating of A-plus by the financial market, which is somewhat less than the triple-A rating state bonds now receive. The state would not be liable for the settlement bonds.

By securitizing the commission’s share of the settlement funds, Currin expects to endow a foundation with up to $610 million. That money would, of course, generate an income stream. By spending the income and slowly paying down the principal, the commission expects to be able to spend from a low of $50 million to a high of $156 million annually over 30 years. Doing so will make it easier for the commission to consider funding longer-term and more far-reaching economic development projects. Targeting funds to well-conceived economic development initiatives would help a much broader cross-section of the tobacco-belt communities. And it would advance a goal — economic self-sufficiency of the state’s poorest regions — that all Virginians share. Overpaying tobacco quota holders in an emergency program based on dubious data won’t do much to help the people of the tobacco belt who really need it.

Return to Virginia Business - March 2001