NEW YORK (Bloomberg) — Higher federal and state taxes on cigarettes this year may bring the biggest drop in smoking ever, reducing the tobacco industry's annual payments to states by as much as $500 million and threatening the repayment of $37 billion in municipal bonds backed by that money.

An expansion of the State Children's Health Insurance Programme this month will raise the federal tax by 62 cents to $1.01 a pack, bringing the average price of a pack of cigarettes nationally to around $5. The tax increase alone will save 900,000 lives, according to the American Cancer Society's Cancer Action Network.

Combined with new levies under consideration in about a dozen states, the higher prices could cut US cigarette consumption by as much as 10 percent, said Richard Larkin, research director at Herbert J. Sims & Co., a municipal-bond firm in Iselin, New Jersey.

A reduction of that size, which is about 2.5 times the yearly average over the past decade, would decrease payments to states under the 1998 Master Settlement Agreement, or MSA, to $6.5 billion in 2010 from an estimated $7 billion this year, Larkin said.

"While settlement revenues may be shrinking, most tobacco bond structures have debt service requirements with built-in increases for future years," he said.

A $500 million decline — coming amid the industry"s attempts to recoup parts of some previous payments — could force some issuers to dip into reserves for debt service, said Larkin.

States including California, Florida, Kentucky, Utah and Washington are considering tax increases on cigarettes to help close budget gaps, pay for education and health programs or discourage smoking. The push comes as state governments confront a combined $47.4 billion in budget shortfalls this year.

In Virginia, where lawmakers this month rejected Governor Timothy Kaine's proposal to double the 30-cent per pack tax, the Tobacco Settlement Financing Corp. receives 50 percent of the annual MSA payment — about $66.4 million in 2008.