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The Tobacco Industry's Pricing Strategy

Following its defeat at the polls on November 8, 1988, the tobacco industry immediately adopted marketing, political, and legal strategies to counter the effects of Proposition 99 on its sales. It developed marketing strategies to blunt the effect of the price increase brought about by the tax increase so that people would not quit smoking. It also intervened politically to try to get the Board of Equalization, the state agency that collects the tobacco tax, to set a low tax rate on tobacco products other than cigarettes. It also sued to try to overturn Proposition 99.

The tobacco companies knew that smokers were sensitive to the price of cigarettes. (Indeed, the fact that price increases reduce consumption was one of the arguments that the ALA and others used to justify creating Proposition 99 in the first place.) After losing the election, RJ Reynolds decided to push its lower-priced brands, especially Doral and Magna, because “we do plan to capitalize aggressively on business shifts that will undoubtedly occur as a result of the California tax increase.”[3] The company's marketers told management, “We will be developing and recommending programs on DORAL that include newspaper advertising, direct mail, on-carton coupons, and pack purchase incentives. On MAGNA, we will be looking at additional pack purchase incentives to help generate trail for this brand.”[4] Philip Morris planned strategies to protect all of its brands, including such premium-price brands as Marlboro.[5] Specific promotions consisted of packaging lighters with Marlboro two-packs at the beginning of January, coupons to reduce the effective price for cartons of Marlboros at the end of December and for the Benson & Hedges, Merit, and Virginia Slims brands, a two-for-one promotion for Merit Ultra Lights at the end of December, coupons to reduce the effective price of Cambridge cigarettes during January, and the launch of Alpine cigarettes, a lower-priced brand, at the beginning of that month.

In late November 1988, the tobacco distributors mounted an effort to establish a low tax rate on non-cigarette tobacco products. The initiative


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had established a tax increase of twenty-five cents on each pack of cigarettes (1.25 cents per cigarette), but had left other tobacco products to be taxed at a rate “equivalent to the combined rate of tax imposed on cigarettes” established by the State Board of Equalization. Proposition 99 proponents wanted a high rate while the tobacco industry and tobacco distributors wanted a low rate based on weight rather than wholesale price.

On November 30 the Coalition presented its case to the board, which decided to establish a tax rate of 42 percent on the wholesale price of tobacco products, calculated by dividing the per pack tax on cigarettes (thirty-five cents) by the average wholesale price of cigarettes (eighty-four cents). Tobacco distributors had lobbied for 19 percent, using a complex formula that Assembly Member Lloyd Connelly said would “befuddle Albert Einstein.”[6] The Board of Equalization agreed with the Coalition and established the higher rate.

The tobacco industry then took its case to the Legislature, and in February 1989 Senator William Campbell (R-Industry) introduced a resolution urging the Board of Equalization to adopt an alternative method of computing the tax rate on tobacco products, one favorable to the tobacco industry, whereby one cigarette “is the equivalent of one cigar, one-twentieth of a can of snuff, or one bowl of pipe tobacco.” The bill died in the Senate Revenue and Taxation Committee, representing a victory for the Coalition.

The tobacco industry sued to void Proposition 99 after it passed. On January 17, 1989, Kennedy Wholesalers, Inc., a tobacco distributor, filed a lawsuit claiming that Proposition 99 was unconstitutional. The distributor claimed that Proposition 99 violated Proposition 13, needed approval by a two-thirds vote of both houses of the legislature, restricted the appropriations power of future legislatures, burdened one class of persons with a tax that benefited the public generally where no rational relationship exists, and violated the rule that required initiatives to cover only one subject. The arguments were identical to those in the suit filed by the tobacco industry in July 1988 in their failed effort to keep the initiative off the November ballot. The Coalition opposed the industry in court, and on March 17, 1989, Sacramento Superior Court Judge Anthony DeCristoforo denied the motion to declare Proposition 99 unconstitutional.

The industry appealed, and the suit eventually went to the state Supreme Court, which in 1991 upheld the lower court and unanimously rejected the claim that Proposition 13 required any new tax, including


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one passed by citizen initiative, to be approved by two-thirds of the legislature. The court found that Proposition 13 was designed to limit the power of the legislature but not the public's power. The court also rejected claims that the initiative violated the single subject rule.[7] All the industry's legal maneuvering, although unsuccessful, hurt the Coalition, which had to raise money to pay the legal fees incurred in fighting the tobacco industry in court.[8]


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