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| The Proposed Tobacco Settlement: Issues from a Federal Perspective April 1998 |
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For over three decades, the Surgeon General and other public health officials have identified smoking as the leading preventable cause of disease and premature death in the United States. Thus, the overriding concern expressed by federal policymakers regarding the proposed settlement is to reduce cigarette consumption, especially among teenagers.
The combination of policy options included in the settlement represents the most comprehensive proposal ever considered for reducing tobacco consumption, short of completely banning the product itself. But as discussed earlier, the research literature is mixed on how effective the interventions proposed in the settlement's major provisions might be in reducing cigarette consumption by large amounts. Industry payments under the settlement depend ultimately on the effectiveness of those interventions.
The settlement does not establish explicit goals for reducing overall cigarette consumption, but it does establish targets for reducing the percentage of teenagers who smoke on a daily basis. It also requires additional payments from the industry if those targets are not met. In any event, the settlement's provisions would certainly discourage some teens from smoking. Such efforts might have a lasting effect on cigarette consumption, depending on whether teens who did not smoke later took up the habit as adults.
In addition to its impact on smoking levels, the settlement is likely to have other consequences. Issues discussed briefly below include:
Can Targets for Teenage Smoking Be Met?
The settlement would require sharp reductions in the use of cigarettes by young people who are below the legal age of 18 years or, at a state's option, a higher age. If the percentage of teenagers who smoke on a daily basis fell by less than 30 percent by the fifth year after the enactment of the settlement, by less than 50 percent by the seventh year, and by less than 60 percent by the 10th year, cigarette companies would be required to make additional payments. Those payments (the settlement calls them a surcharge) are intended to eliminate the profit from the sale of cigarettes to "extra" teenage smokers over the course of their lifetimes, measured in present-value terms.
The surcharge would be about $80 million for each percentage-point difference between the required reductions and the actual reductions in teen smoking. For example, if after five years the rate of teen smoking had fallen by only 10 percent instead of the required 30 percent, the settlement would require cigarette manufacturers to pay $1.6 billion in penalties. The maximum surcharge would be $2 billion per year (in 1998 dollars).
Two provisions in the settlement would reduce the financial burden of surcharges. First, the federal government would return up to 75 percent of a surcharge to the tobacco companies if the companies could prove to the Food and Drug Administration that they had fully complied with the settlement, taken all reasonable measures to reduce underage tobacco use, and not tried to undermine the achievement of the required reductions.
A second provision reduces the amount of the surcharges by preventing the double-counting of teenagers whose smoking had already resulted in the imposition of a surcharge. Following the previous example, in year 5 of the settlement, cigarette manufacturers would be assessed a surcharge of $1.6 billion if the proportion of teens who smoke had fallen by only 10 percent instead of the required 30 percent. If in year 6 of the settlement, the rate of teen smoking was unchanged, the surcharge for that year would not be $1.6 billion. Instead, the surcharge would be smaller, because the cigarette manufacturers would have already paid a surcharge for most of the existing teen smokers in year 5. The surcharge for year 6 presumably would be based on new teen smokers, but the settlement provides little guidance on how to calculate surcharges under such a circumstance.
It is quite unlikely that all of the teenage smoking targets established under the settlement would be met. The price of cigarettes would probably rise substantially and regulatory and public health efforts would also expand, but the effectiveness of each of those provisions in reducing teen smoking is highly uncertain. At best, a 63-cent one-time price increase might decrease youth smoking rates by about 23 percent. (That calculation uses an elasticity of -0.75.) The regulatory and public health provisions of the settlement might further reduce the prevalence of daily teenage smoking by 4.5 percent over five years. Thus, the combined effect of the settlement's provisions might be sufficient to achieve the five-year target. Another plausible outcome is that price increases would have little or no impact on teenagers' decisions to smoke, in which case the percentage of teen smokers might decline by much less than the targets. In any event, the seven- and 10-year goals would not be met under a 63-cent price increase. They could be met if the price was increased by $1.50 and the optimistic assumptions about teen responsiveness were correct.
Whether efforts to curtail smoking by teenagers would affect cigarette
consumption over the long term is also uncertain. Some teenagers who were
dissuaded from smoking during their teen years might take up smoking as
adults. But if the settlement was effective in permanently preventing teenagers
from smoking, total consumption of cigarettes might show sizable declines
over the course of several decades as generations with low smoking rates
came to dominate the population.
Other Consequences of the Settlement
The tobacco settlement would have consequences for manufacturers of tobacco products, retailers, advertisers, consumers, and all levels of government. Many of those consequences were specifically addressed in the settlement. Others that may not have been fully addressed could gain importance in the drafting of legislation.
Black-Market Cigarettes
Any legislation that would rapidly raise the price of a product by a third or more would almost certainly spawn a black market as people attempted to evade the high prices. Tobacco is no exception. Indeed, state and local officials periodically find cigarettes from states with low excise taxes being shipped to retailers in high-tax states even under the pricing and regulatory structure that affects cigarettes today. There have also been well-publicized instances of cigarettes being sold in large quantities through American Indian reservations (which are not subject to federal and state excise taxes) to purchasers in the United States and Canada who would otherwise face significantly higher prices.
Because the settlement would be national in scope, interstate sales of cigarettes would not avoid the higher prices or other restrictions placed on them. The settlement states that its rules would apply to all cigarettes sold in the United States as well as in lands under the jurisdiction of an American Indian tribe. Moreover, scheduled payments would be levied on all manufacturers of cigarettes sold in the United States by both domestic and foreign producers. Payments would be allocated to each producer according to its share of the previous year's sales.
Enforcement of those requirements would be the key to limiting the growth of black markets for cigarettes. With cigarette prices spurting up solely because of federally mandated penalties but no change in the other costs of manufacturing cigarettes, a strong incentive would be created to develop alternative production capacity or to divert some of what is being produced already from current manufacturers into the black market without federal inspectors knowing that those cigarettes had been produced. Counterfeit or look-alike versions of popular American brands could also become more common in the U.S. market.
Another potential outcome is that foreign countries would become a source of cigarettes for U.S. black markets. American tobacco manufacturers could continue to legitimately ship large quantities of cigarettes to their foreign distributors, and those cigarettes would not have the added costs imposed by the scheduled payments. Some wholesalers outside the United States would find it profitable to ship American cigarettes back into this country, where the product could be sold illegally at bargain prices.
Individual smokers would benefit from lower prices for black-market cigarettes, particularly if they dealt directly with cigarette smugglers. Some of the illegal trade might also take place between a few small retailers and their suppliers, with black-market cigarettes displacing legal cigarettes on retail shelves. In that case, illegal cigarettes would probably be sold at the price prevailing for the legal product to minimize detection by law enforcement officials and to maximize returns.
Funding the Settlement Through an Excise Tax Increase
As noted earlier, the scheduled payments that would be made by the tobacco industry under the settlement are equivalent to a 63-cent-per-pack excise tax, adjusted for inflation. The settlement, however, would not simply impose such a tax on cigarettes; instead, it would levy scheduled payments on tobacco firms and allow any price increases to be determined in the market.
The market-driven price increases would be substantial because the scheduled payments themselves are substantial. Yet the actual price increase that would occur is uncertain. One plausible assumption is that retail prices would increase by about 63 cents per pack, passing through the costs of the settlement. That increase would result if there was a high degree of price competition among the tobacco firms. But price increases might be higher if the industry behaved more monopolistically.
Analysts agree that raising cigarette prices would be the single most effective deterrent to smoking. To avoid some of the uncertainty surrounding price increases under the settlement, one could instead impose a large excise tax increase on cigarettes. Such a tax could have an automatic adjustment for inflation that would increase the nominal tax per pack every year.
Levels of Funding for Public Health Programs
Nearly $100 billion would be paid under the settlement over 25 years to fund a variety of tobacco-related public health and research programs. Three-quarters of that money would pay for smoking cessation and prevention programs, media campaigns, and state and local government enforcement efforts. Such programs have never before been funded on that scale, and a significant part of the reduction in cigarette consumption that could be expected would be the result of the huge increase in public health efforts.
The funding of public health programs would not automatically grow by the full amounts implied by the settlement, however. Some of the funds might be diverted to other programs that were less directly related to the goal of reducing tobacco use. If key programs, such as clinical interventions to assist smokers who wanted to quit, were funded at very low levels compared with the levels that the settlement might have implied, then tobacco consumption would not decline by as much as CBO has projected.
Impacts on Tobacco Growers and Others
In 1996, tobacco was grown on over 124,000 farms in the United States. Including growers, the tobacco industry directly supports over 600,000 jobs for people who produce and deliver tobacco products. In addition, cigarettes and tobacco products contribute to the revenues of hundreds of thousands of retail establishments. The settlement would reduce the demand for cigarettes, which in turn would probably reduce the incomes of many of those people. The economic impact of the reduced demand would be concentrated geographically in six southeastern states, which account for the vast majority of tobacco growing and manufacture in the United States.
Impact on the Costs of Publicly Funded Health Care
Without question, cigarette smoking increases the mortality and morbidity of smokers, and the treatment of smoking-related illnesses is costly. Much of that cost is financed by Medicare and Medicaid, with additional amounts being covered by veterans' health care and other public health programs. The extent to which public health care costs might decline under the proposed settlement is unclear.
In the near term, the costs of Medicare, Medicaid, and other programs would be unlikely to change perceptibly as a result of the settlement. Under the most optimistic assumptions for the cost pass-through price scenario, the incremental decline in total cigarette consumption produced by the settlement might be as much as 10 percentage points by the 10th year--but any savings associated with such a reduction would only be realized decades later. That is particularly true for the Medicare program, which primarily covers people over the age of 65.
If the settlement was effective in curbing teen smoking and if that outcome translated into permanently lower cigarette consumption as those people grew older, tobacco-related health care costs in the long run could drop significantly. However, reduced cigarette consumption might also increase program costs somewhat in the long run because people might live longer and use additional health care services during those years.
