Legislative Analyst's Office Analysis of the 2001-02 Budget Bill

New Tobacco Settlement Fund

Tobacco Settlement Funds Earmarked for Health Programs

The Governor's budget proposes to establish a new fund—the Tobacco Settlement Fund—to be used for specific health programs. In the following pages, we summarize the initiative and discuss our findings and related recommendations.

Background. In November 1998, California and other states reached a settlement agreement on lawsuits brought by the states against the major tobacco companies. It was originally estimated that California would receive about $25 billion over 25 years, with $12.5 billion going to the counties and $12.5 billion to the state. Since that time, however, the estimated amount the state and counties would receive has decreased due to a provision in the settlement agreement that reduces payments in accordance with a decline in tobacco sales. The state's share is now projected to be approximately $10.6 billion, or about $2 billion less than its original estimated share of the settlement agreement (the counties' share has been reduced by a like amount). Figure 1 shows the amounts the state is estimated to receive each year for the entire term of the agreement.

The basis of the state's settlement agreement was that the state incurred additional expenses for treating tobacco-related illnesses in the Medi-Cal Program and other health programs, and thus, had limited funds with which to expand health coverage to the uninsured. Accordingly, there has been significant public and legislative interest in dedicating those funds to smoking cessation programs and proposals to expand access to health care for the uninsured. Several bills have been introduced in the Legislature seeking to accomplish this funding dedication goal, including SB 673 (Escutia), although none were enacted.

The Governor's Budget Proposal. The budget assumes total tobacco settlement revenues of $468 million in fiscal year 2001-02. Under the Governor's plan, all of this revenue would be deposited in a newly established Tobacco Settlement Fund (TSF), and earmarked for specific health care initiatives. Of the total amount, $295 million would be allocated to the Department of Health Services budget and $150 million would be allocated to the Managed Risk Medical Insurance Board. The remainder would be used to establish a 5 percent reserve for the new fund.

Figure 2 shows the specific programs for which the money is budgeted.

Tobacco Settlement Fund Not A Reliable Long-Term Funding Stream

Our analysis indicates that most of the funding in the Tobacco Settlement Fund (TSF) would be used for existing, ongoing programs now supported by the General Fund. Only about 24 percent of the TSF would be allocated for new health care initiatives. The fund is not a viable long-term source of support for the proposed mix of programs since its revenues are likely to decline over time. For this reason, we recommend amending the proposed budget trailer bill to establish a 10 percent reserve for the fund, instead of the proposed 5 percent reserve.

Fund Includes Mostly Base Expenditures. During the past two years, legislation has been enacted to reduce the number of uninsured children and adults by expanding eligibility in the Medi-Cal and Healthy Families Programs. In 1999, Medi-Cal was expanded to cover working poor adults with income up to 100 percent of the federal poverty level (FPL) (referred to as 1931 [b] expansion in Figure 2). In addition, Healthy Families was expanded to include children with incomes between 201 percent and 250 percent of the FPL, as well as legal immigrant children. Last year, Medi-Cal was again expanded to provide no-cost coverage to low-income aged, blind, and disabled persons with incomes up to 133 percent of the FPL. The state support for these expansions came from the General Fund.

The 2001-02 Governor's Budget would in effect shift the costs of these prior-year expensions to the TSF. Of the $445 million of proposed expenditures from the fund, approximately $339 million, or 76 percent, represents expenditures for existing ongoing programs that would be shifted from the General Fund to the TSF. Of that amount, more than $100 million would cover projected caseload growth in the Medi-Cal, Healthy Families, and Child Health and Disability Prevention programs. The remaining $106 million, or about 24 percent of the total funds allocated, is for new health proposals, including $76 million to expand Healthy Families to parents, $20 million for new smoking prevention programs, and $10 million to expand the Prostate Cancer Screening and Treatment program.

Tobacco Settlement Not a Stable Source of Revenue. If the downward trend in smoking continues, tobacco settlement revenues are likely to continue to decline. During the past twelve years, the state has spent more than $781 million, an average of about $65 million a year, on antitobacco and smoking prevention programs. In addition, new state laws prohibited smoking in public places and increased taxes on tobacco products. These changes appear to have reduced the prevalence of smoking during this period. The 2001-02 budget proposes to allocate $106 million (mostly Proposition 99 funds) to continue antitobacco and smoking prevention programs, including $20 million in new spending from the TSF. If these programs and other measures continue to be effective in reducing smoking, tobacco settlement payments to the state could go even lower because its payments are linked to the volume of tobacco sales.

New Fund Not Viable in the Long Term. We believe that the Governor's plan to fund the specified programs on an ongoing basis from the TSF is not viable in the long term. As we discussed above, the tobacco settlement is likely to be a declining revenue stream. Yet, under the Governor's proposal, the fund would be heavily committed to programs with growing caseloads. Our analysis indicates that the combination of declining revenue and growing caseload makes the fund unreliable as the sole source of funding for these programs in the long term.

If the Governor's caseload projections are correct, this problem could surface as soon as 2002-03. We note that the budget plan assumes all of the expansions would reach full implementation by the end of the budget year. If this actually were to occur, the fund would likely be overextended by 2002-03 as budgets for Medi-Cal and Healthy Families would be adjusted to account for inflation in health care costs. At this point, the Legislature and Governor would need to find alternative funding sources for the additional costs. Given the magnitude of the programs included within the fund, it is possible that the 5 percent reserve would be inadequate to cover future cost adjustments.

As we discuss below, we believe the Healthy Families Program is actually overbudgeted in 2001-02. However, that would only delay the inevitable point at which expenditures for these programs will expand beyond the ability of the fund to support them.

Budget-Year Funds Available for Limited-Term Spending. Our enrollment projection for Healthy Families indicates that this program is not likely to reach full enrollment in 2001-02. We estimate there will be TSF savings of $33 million from the Healthy Families Program. (See our analysis of the Healthy Families Program for a more detailed discussion of these caseload issues.) We would caution the Legislature against allocating these savings for other purposes, however. This is because the funds will likely be needed in fiscal year 2002-03 to support the continued phase-in of the Healthy Families expansions.

Analyst's Recommendation. For these reasons, we recommend amending the proposed budget trailer bill to establish a 10 percent reserve for the fund, instead of the proposed 5 percent reserve. This would ensure that needed funding is available when the caseload programs are fully phased in. It would also protect the noncaseload programs from reductions in the event there is a sudden surge in enrollment or lower-than-anticipated tobacco settlement revenues.

In addition, the Legislature may wish to consider whether certain programs should be shifted back to the General Fund. As we indicated above, the TSF is heavily dedicated to caseload programs, thus, placing the fund at risk of not remaining viable in the long term. An alternative approach is to replace one of the caseload programs, such as the Medi-Cal 1931 (b) expansion, for example, with a noncaseload program, such as one of the proposed Proposition 99-funded smoking cessation programs. This would relieve some of the fiscal pressure on the fund. It also would allow the noncaseload driven programs, such as the tobacco prevention programs to remain in the fund with less risk of being cut in the future because of caseload growth in the Medi-Cal and Healthy Families Programs.