The Economics of Smoking

1. The Economics of Smoking

2. One of the potential problems (from an economic perspective) with smoking is that there may be an externality in consumption, so there may be difference between the private and social optimal level of cigarette consumption. • Smokers might impose costs on persons who do not smoke (e.g., second hand smoke and low birth weight in pregnant women) as well as society (e.g., health risks of smoking might lead to higher health care utilization).

3. Figure 1: External costs of smoking

4. In Figure 1 the initial equilibrium, might have too much consumption of cigarettes since the external costs are not factored into a smokers utility function, i.e., they only consider their marginal utility, so end up with a market equilibrium with too much smoking. • Solution, reduce consumption of cigarettes through corrective taxes or regulation (e.g., bans on smoking in public places, restrictions on who can buy cigarettes)

5. Regulation option to try reduce smoking might include: • Warning labels on cigarette packaging highlight the dangers of smoking • Bans or restrictions on cigarette advertising • Bans on smoking in public spaces or indoors • Restrictions on sales of cigarettes (e.g., must be a certain age to purchase cigarettes) • Regulation of ingredients in cigarette manufacuring (i.e., reducing “tar” levels as discussed in Viscusi’s paper on the reading list)

6. There can be differences across countries in how they pursue these regulatory options. • Consider the warning labels on cigarette packaging in Canada and the U.S.

7. U.S. Cigarette Package

8. Japanese Cigarette Package for U.S. Market

9. U.S. Cigarette Brand for Italian Market

10. Canadian Cigarette Package

11. Canadian Cigarette Package

12. Canadian Cigarette Package for Aboriginal Tobacco Product

13. Alternative to regulation is taxes. • Can use taxes to make smokers take into account external costs and reduce their consumption of taxes • Taxes that are used to correct externalities are referred to as “Pigouvian Taxes” • Alternative objectives of taxes are generating tax revenues and controlling consumption or other outcomes.

14. What are the tax rates on cigarettes? • In the U.S., taxes at the state level can range from about $0.07 per pack (in North Carolina) to about $2.00 per pack (in New Jersey); the federal tax rate is about $1.00 a pack (although it was at $0.39 a pack before it was increased). • In Canada tax rates tend to be higher, see the attached table.

15. Cigarette Prices in Canada by Province

16. Cigarette Taxes on a Carton of Cigarettes (10 packages of 20 cigarettes)

17. Evolution of Cigarette Taxes in Ontario

18. Evolution of Cigarette Taxes in Ontario • Tobacco tax rates as of April 28, 2017: • 16.475¢ per cigarette • 16.475¢ per gram or part gram of cut tobacco • Tax on cigars is 56.6% of the taxable price • Tobacco tax rates per pack/carton: • $3.30 on a pack of 20 cigarettes • $4.12 on a pack of 25 cigarettes • $32.95 on a carton of 200 cigarettes

19. Evolution of Cigarette Taxes in Ontario • In 2018 and 2019 tobacco taxes will be increased by an additional 2 cents per cigarette or gram of tobacco each year. This approach will replace the inflation-based tax increases announced in last year's Budget.

20. Grossman, Sindelar, Mullahy and Anderson discuss some of the objectives of taxing cigarettes and alcohol, sometimes referred as Sin Taxes. What is unique about these commodities is that they tend to have relatively inelastic demands so you don’t get much of a drop in a quantity when the price goes up in response to the tax, this makes them a favourite option of governments.

21. Some examples of link between tax revenue and elasticity (U.S. data)

22. Revenues from taxes can sometimes be directed to at particular public projects. • As an example, gasoline taxe revenues are often used to build and maintain roads and highways. Since people who drive use the roads the fuel taxes can collect revenues who actually use the roads

23. Can make a similar argument for smoking, taxes from cigarettes can be used to pay for the healthcare costs of smokers. Smoking is generally known to be a risk factor for heart disease and some respiratory diseases and can cause cancer (lungs, mouth, throat) . However, things are a little trickier, since some of these cancers and other health problems can also be caused by other risk factors.

24. Another reason for taxing cigarettes is to reduce consumption of cigarettes. • The health risks of smoking have been well known for some time, but the report of the Surgeon General of the U.S. in 1964 brought greater attention to the health risks of smoking. • Governments might be concerned with healthcare costs associated with smoking and might want to reduce smoking

25. Cigarettes are an addictive good, so current consumption is linked to past consumption. This means that reducing consumption today would also reduce consumption in the future. • Smokers often begin smoking when they are young (teenagers and early-twenties) and keep the “habit” as they age • This means that policies that prevent people from smoking at an early age reduce consumption at different segments of the population

26. Why focus on youths? • Answer, the elasticity of their demand curves • Is it possible to target youth smokers with cigarette taxes? • Would depend on elasticities, if youth smokers have more elastic demand than the answer would be yes Long-run demand is more elastic than the short-run demand, easier to quit over time, but in the short-run you are hooked. • Youth smokers also tend to have much more elastic demand curves than adult smokers (restricted incomes)

27. Elasticity of Demand for Cigarettes by Age

28. Complication, smokers can respond to taxes in other ways • Switch to discount brands (cost less than a premium brand) • Switch to different cigarettes (e.g., a cigarette with more “tar” and nicotine) • Adjust how they smoke (e.g., inhale, frequency) • Switch to smuggled cigarettes • Heated Tobacco Products/Vaping/E-cigarettes

29. Taxes can also be used for corrective purposes. • One potential externality of smoking is second hand smoke, so non-smokers can get smoking related illnesses even though they don’t smoke and pregnant women can put their babies at risk of poor health outcomes • Could try to modify the behavior of women who smoke (e.g., highlight the dangers of smoking for pregnant women) or could use taxes to compensate for the externalities

30. Estimates of Optimal Tax Rates to Correct for Externalities of Smoking

32. An alternative calculation of the optimal taxes are in Viscusi, see next slide.

34. Which set of optimal tax rates are really optimal? • First set of optimal tax rates indicate we should be taxing cigarettes. • Second set of optimal tax rates (from Viscusi) indicate we should be subsidizing smoking, i.e., we should pay people to smoke. • Which is right?

35. The Answer… • It really depends on the assumptions you make. • In a cost-benefit analysis a number is just that a number; to really understand whether it’s a reasonable number you need to go through each assumption you make • For example, what’s the discount rate; how are we measuring costs; etc. And assess which set of assumptions is more reasonable or plausible.

36. The calculations in Grossman et al (in the Table) and those in Viscusi also provide some insights into smoking policy in Canada and the U.S. • The calculations in the table are consistent with Canada, tax rates are higher and there are more restrictions on smoking behavior • The calculations in Viscusi are more consistent with the U.S.; tax rates are lower and there are less restrictions on smoking behavior.

37. Which policy approach to take really depends on the cost-benefit analysis and the assumptions that underlie it.

38. We’ve discussed three different uses of taxes for three different objectives. • From a policy perspective you need to be clear what the objectives are before you decide on what a tax should be.