$1 billion annual boost: Big Tobacco breathing easier

• The federal government forced tobacco companies to make payments to farmers.
• Annual payments averaged $960 million from 2005 through 2014.
• The Tobacco Transition Payment Program helped tobacco farmers cope with sudden deregulation.
• Big Tobacco raised the cost of cigarette packs by about 5 cents to fund the payments.

The tobacco industry is breathing easier after the end of a federal assessment that forced cigarette manufacturers, cigar companies and smokeless tobacco producers to make 10 years of payments to farmers, averaging nearly $1 billion annually.

The expiration of the Tobacco Transition Payment Program has bolstered the bottom line of Big Tobacco after years of tax increases and declines in smoking,

The annual savings equal about 2.4% of the U.S. tobacco industry’s annual revenue — or about 9.9% of its profit — based on industry figures provided by research firm IBISWorld.

For 10 years, the government forced tobacco manufacturers such as Altria Group, Reynolds American and Lorillard to make quarterly payments totaling about $9.6 billion to help farmers cope with the sudden deregulation of tobacco farming in 2005. The U.S. Department of Agriculture passed those payments along to tobacco growers to help them deal with the resulting drop in the crop's price.

Though the end of the mandated payments on Sept. 30, 2014, went largely unnoticed among industry watchdogs, it was long visible on the horizon for Big Tobacco.

“They’ve been anticipating this since the deal was done 10 years ago,” said Blake Brown, an agricultural economist and professor at North Carolina State University. “There was a real cost to manufacturers for this.”

That cost has been snuffed out.

The USDA declined to release an itemized list of payments made by the Big Tobacco companies to deregulate tobacco farming, citing tax privacy law. The department deferred comment on the issue to outside experts.

A USA TODAY review of U.S. Securities and Exchange Commission filings, earnings call transcripts, government data and analyst reports reveals the depths of the benefits for the nation’s top tobacco companies following the assessment’s expiration:

•Altria Group: The largest U.S. maker of cigarettes, whose Philip Morris USA unit makes the Marlboro brand, is the biggest winner. The company no longer has to make payments that cost it $1.1 billion in the final three years of the tax equivalent, according to Securities and Exchange Commission filings. That included $300 million in 2014, when only three-quarters of payments were due.

•Reynolds American: The second largest U.S. cigarette manufacturer, maker of the Camel brand, paid about $583 million in the final three years of the assessment, including $161 million in 2014, according to corporate filings. Reynolds American Chief Financial Officer Andrew Gilchrist recently told investors the policy change “played a significant role” in boosting the company’s finances.

•Lorillard: The third largest manufacturer — which Reynolds American acquired in June — paid about $330 million over the final three years of the tax while it was  an independent company, according to a public filing. That included $92 million in 2014.

Representatives for Altria Group and Reynolds American declined USA TODAY's requests for comment.

Smaller companies that make cigars, tobacco chew and other tobacco products are also enjoying a bump from the tax equivalent’s expiration, although Altria and Reynolds are the biggest beneficiaries. After the Lorillard deal, those two companies collectively control 94% of the cigarette market in America, according to research firm IBISWorld.

DEREGULATION

President George W. Bush established the system of buyouts when he signed a bill in late 2004 implementing the assessment on tobacco companies.

The plan deregulated the tobacco farming industry, putting an end to a complex Great Depression-era system in which the government kept crop prices artificially high in part by limiting the amount each farmer could grow.

Farmers received the buyout payments from Big Tobacco to help them deal with the sudden elimination of federal quotas and price controls. They were compensated based on the total pounds of tobacco they were allowed to grow under the previous system.

Almost 52% of the nation’s tobacco farmers stopped growing tobacco within a year of deregulation, according to research firm IBISWorld.

Farmers used the payouts to retire, bolster their finances, spend on personal activities or invest in other parts of their business. Many tobacco farmers had other crops to rely on for income.

Some simply cashed in because they held the federal rights to farm tobacco, even if they had already stopped growing the crop because of stiff competition.

The U.S. government didn’t keep a dime from the assessments, serving only as an enforcer by collecting the installments and directing the money to farmers. That’s why it wasn’t technically a tax.

NCSU agricultural economist Brown said manufacturers passed the extra assessment along to smokers in the form of higher prices — an estimated 5 cents per pack.

That’s not much considering that the federal cigarette tax sextupled from 1990 to 2014 while average state cigarette taxes quintupled, according to the World Health Organization.

But about 13.2 billion cigarette packs were sold in the USA in 2014, according to the Centers for Disease Control and Prevention, so 5 cents per pack adds up quickly.

“Ultimately, most of the cost was transferred to consumers,” Brown said.

TIMELY CUSHION

Now that the assessment is gone, tobacco companies will reap the benefits of higher cigarette prices implemented to fund deregulation.

Marty Barrington, CEO of Altria Group, hinted this year that the largest U.S. tobacco manufacturer would use the cash to bolster its online strategy and improve its position in the e-cigarette market, among other things.

“There's lots of places for us to invest in our businesses,” he said when asked about the savings Jan. 30, according to a transcript of the call by Seeking Alpha. “Our goal is to keep our brand franchises strong and relevant, and there's lots of tools to do that.”

The savings come as Big Tobacco has bolstered its balance sheet despite challenging market conditions.

From 2009 to 2014, industry revenue fell 1% to $39.9 billion, according to IBISWorld, as the percentage of Americans who smoke fell from 21% to 18%. Cigarette makers have navigated the changing landscape by cutting jobs, consolidating manufacturing operations and voluntarily raising prices.

Consequently, profit margins for U.S. tobacco makers increased from 18.5% in 2009 to 24.2% in 2014, according to IBISWorld. The industry collected about $9.7 billion in profit in 2014, the research firm estimated.

Margins will get another boost now that the industry does not have to make payments that averaged $960 million a year.

“I don’t think profits are really hurting for these manufacturers overall,” said Will McKitterick, a senior analyst for research firm IBISWorld who left the firm in August.

Follow USA TODAY reporter Nathan Bomey on Twitter @NathanBomey.