On April 1, 2016, the Texas Supreme Court ruled that the state could impose a special tax on cigarette manufacturers that were not part of a multibillion-dollar settlement agreement reached with the major tobacco companies in the late 1990s.

The origins of the case date back to 1998, when Texas had reached a major settlement with the major tobacco companies over their advertising practices.  The settlement established yearly fees for the settling companies to pay, which would then be used to fund health programs.  Similar companies that were not part of the agreement were not required to participate.

Then, in 2013, the Texas Legislature passed a law that levied a tax of 55 cents per pack on the nonsettling tobacco companies as well. The Texas Small Tobacco Coalition sued the state, saying the tax was unconstitutional. The lower court found that the tax was unconstitutional and permanently enjoined the state from assessing, collecting or enforcing the tax.  A Texas appeals court then upheld the trial court, saying that protecting company market shares does not justify unequal treatment of identical products and neither do the 2013 law’s “more laudable purposes.”

The Texas Supreme Court reversed.

In Hegar et al. v. Texas Small Tobacco Coalition et al., case number 14-0747, the Texas Supreme Court ruled against the Texas Small Tobacco Coalition.  The court found that the tax does not violate the state constitution’s equal and uniform tax clause, finding that Texas had a rational basis for the tax scheme.

In an opinion written by Justice Don Willett, the high court held the classification of manufacturers based on the settlement is rational and reasonably related to the purpose of the tax. Justice Willett said the state Legislature has the discretion to differentiate between groups of taxpayers. “That discretion does not require the Legislature to turn a blind eye to the real-world consequences of litigation,” he said. “Such a blinkered approach would be irrational. At least when the effect of a settlement is to fundamentally transform an entity’s business operation, that effect can be considered. We think that incurring a perpetual $500-million-per-year burden is a sufficiently fundamental transformation that distinguishes settling manufacturers from the coalition, which, in its own words, ‘would not be paying anything’ absent this tax.”

Legislators imposed the tax to recover smoking-related health care costs from all manufacturers and to remove a marketing advantage that allowed smaller tobacco companies to sell cheaper products, with the lower cost being an added enticement for underage smokers.

The lawsuit that sparked Friday’s ruling, however, isn’t over. The Supreme Court returned the matter to the 3rd Court of Appeals with instructions to consider other points raised by the smaller companies but not yet ruled upon, including arguments that the tax was an improper attempt to protect the major tobacco companies’ market share.

For questions and/or comments, please contact Bryan Haynes, at 804.697.1420 or by email.