THE $300 BILLION QUESTION

By Daniel Kadlec

When is $300 billion not a lot of money? It would make every resident of Buffalo, N.Y., an instant millionaire. It equals 40 years of profit for Exxon. But if it comes from the tobacco industry, well, for a growing number of folks $300 billion is a sum to sniff at. This is the nightmare that proponents of a sweeping congressional tobacco settlement most feared: a greedfest from plaintiffs' lawyers and the public now that tobacco executives have come to the bargaining table. Consider the state of Missouri, which so far has steered clear of the tobacco suits. "I expect us to get in," Governor Mel Carnahan says. Why now? If there's a windfall, Carnahan would like a slice to fund a pet program to cover kids who lack health insurance. Good politics, that.

Tobacco execs no doubt expected some piling on. And I'm all for Philip Morris and its peers paying through the nose if they are to negotiate away their legal woes. But there are limits to how much they can cough up. A payment so large that it cripples the business defeats the purpose of their settling, although that point seems to be getting lost. Besides, no tobacco chief is going to cut his shareholders' throats. Just how much can the industry afford? Tobacco execs have been mum on the subject. It was the antitobacco side that floated $300 billion, to be paid over 25 years, and even to many of them the amount originally seemed pie-in-the-sky high. Then something interesting happened: tobacco stocks rallied as Wall Street ground down a few hundred pencils figuring out that the entire $300 billion could be funded with a price increase and an additional tax of 50[cents] a pack. Think of the possibilities with a total increase of $1 or $2, now goes the thinking. Think again.

The theory is that the tobacco industry enjoys enormous price elasticity--i.e., it can raise prices on its addictive product and not lose sales. In England a pack of smokes goes for nearly $5, vs. less than $2 in the U.S., and yet they still have plenty of smokers. But tobacco users are more price sensitive than you might imagine. Canada in 1994 had to repeal a stiff tobacco tax that had pushed prices past $5 a pack because a violent black market developed. U.S. consumption peaked at 640 billion cigarettes in 1981, which is when the industry started raising prices aggressively. When prices stabilized around 1992, so did demand.

Martin Feldman, tobacco analyst at Smith Barney, estimates that an additional tax today of 50[cents] a pack would curb cigarette sales by 8%. That would be O.K. with investors, who would gladly accept a smaller revenue stream so long as profits were protected against lawsuits. But any big increase above that starts to make the industry's economics go awry, including its 30% operating margins. I have no idea where the breaking point is but there surely is one. To me, $300 billion is a lot of money, no matter who's paying. If Big Tobacco can afford a bit more, fine. But if this is about money--which it seems to be--it's a mistake to suddenly confuse tobacco execs for bottomless atms. It took four decades to get them this close to owning up to any culpability. It's a bigger coming out than Ellen DeGeneres'. Let's get the money before they run back to court for another decade.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at kadlec@time.com