AUGUST 2012 SEMESTER

ECON201: Public Sector Economics

Case Study 1- Smoking

Prepared For: Professor Christine Ho

Submitted By
Lim Jingyi Vanshika Khemka Lee Chek Haw Tan Chun Wee Group G1

Wednesday, 19 September 2012

1

Introduction Tobacco kills approximately six million1 people worldwide according to a report from World Health Organisation (WHO). About 85% to 90% of the smoke coming out of a lit cigarette ends up in the air as Environment Tobacco Smoke (ETS). When exposed to ETS, non smokers are also at risk of developing similar health conditions similar to smokers such as lung cancer especially with heavy exposure at work or in public. In this paper, we will look into the effects of smoking, define the externality, discuss how the social costs are measured and analyse the solutions recommended by the paper. In addition, we will provide additional measures that are not covered in the paper , do a cost-benefit analysis and show a case study to conclude whether smoking is beneficial. Smoking as a Negative Externality Tobacco in itself is a private good, but when lit, the smoke pollutes the air and causes harm to the people breathing the air. Hence, it is a negative consumption externality, whereby the exposure to it can cause serious health problems or even deaths. Smokers(the consumer) ignore the harmful effect of ETS, thereby causing harm to non smokers who inhale it. Therefore, social marginal benefit is lower than private marginal benefit as shown below. Overconsumption of tobacco will lead to a potential welfare loss which is a cost to the society.

Due to the negative externality, it is a form of market failure as the consumption is not at its optimal point. This suggests that there should be some form of government intervention to correct the market equilibrium such that consumption is at Q* instead. Measuring Social Cost of Smoking (Potential Welfare Loss) The social cost associated with smoking are namely, direct cost, morbidity cost and mortality cost2 as shown below

1

WHO urges more countries to require large, graphic health warnings on tobacco packaging: the WHO report on the global tobacco epidemic, 2011 examines anti-tobacco mass-media campaigns. (2011). Central European Journal of Public Health, 19(3), 133. 2 Direct costs refers to hospitalisation fees, morbidity cost is cost incurred due to lost production due to falling ill and mortality cost refers to cost incurred from people who died early due to smoking related diseases

Another way of measuring social cost is the human capital approach. In this approach, the cost to the society is measured by tabulating the loss in Gross National Product (GNP) by taking the loss in population due to smoking and multiplying it by the GNP per capita as shown below. .

Bearing both approaches in mind, and looking at the tobacco tax revenue (as above) collected by the Singapore government, it seems that they tax the tobacco users to cover the social cost of smoking. Despite high taxes, there is still an increase in the smoking trend. This could be due to factors like tobacco is an inelastic good and it is very addictive, thereby attributing to such results.

Six Measures highlighted in the article 1. Improve the quality of data The current situation in the world is that all countries, including WHO, do not have up-todate and accurate information about the world smoking population. The most important benefit that better data could bring will be that policy makers will be able to better gauge and quantify the amount of damage that tobacco usage brings to the society, both active and passive smokers. The end result is that more appropriate tax levels and policies will be better introduced to internalize the negative externality of tobacco usage, eventually curbing tobacco usage to a larger extent than before. However, there are downsides to this measure as well. Firstly, it has always been a problem for such data to be collected accurately. And why is this so? The first problem is quantifying the value of human lives. This is a debatable issue, as human rights activists argue that there should not be any value assigned to a human life. Also, since different people value their lives differently, no single value should be used. Secondly, it is difficult to tabulate the figures as many uncertainties are present such as underage smoking and behavioural changes. 2. Impose sweeping Irish-style smoking bans Only 5% of the world population is covered by such bans, whereby smoking is prohibited in workplaces and public areas. With widespread implementation, governments will be able to curb tobacco usage in each of their own countries, eventually eradicating smoking. Less people will then be exposed to the risk of ETS, reducing the negative externality of passive smoking. However, this end result might not be ideal for the government, as this could affect their tax revenues. Loss of tobacco taxes might actually shift the tax burden to the society through higher income taxes and other policies. Also, addicted smokers might resort to illegal measures to smoke in banned places, thus causing further social issues. 3. Intensify efforts to induce and assist smokers to drop the habit According to recent findings by Levy and Romano (2002), it is important that anti-smoking campaigns meet the following six conditions to have a higher success rate in curbing smoking. The campaign strategies are based on sound social marketing principles The effort is large and intense enough Target groups are carefully differentiated Messages for specific target groups are based on empirical findings regarding the needs and interests of the group The campaign is of sufficient duration It is complemented by other tobacco control measures and/or school- or communitybased programs

In fact, most campaigns do not sufficiently meet these conditions, thus, a need to intensify the efforts. This measure helps smokers quit smoking easier and aim to deter young people from picking up smoking.
4

However, in some cases, there might be conflict of interests between smokers and the government. This is because while the government sees smoking as a net social cost, the smokers might not want to quit smoking, as they feel that they enjoy net benefits compared to the damage that they are doing to themselves and society. Also, the amount of money put into such efforts might not reap sufficient results, as compared to direct measures such as higher taxes. 4. Print large grotesque pictures According to WHO, people are often unaware of the health consequences related to smoking and therefore pick up smoking or continue smoking. A total of 143 different warnings from health consequences to avenues in getting help to quit smoking were printed on cigarette packets. These cigarette packets are then rotated for sale every six months to ensure that smokers are able to come across all 14 messages. A review commissioned by the European Union (EU) in 2009 showed that a significant portion (19% - 78%) of smokers and non-smokers found that the combination of grotesque pictorial images and text warnings have been effective in conveying the health consequences of smoking to them. 37% to 63% of the smokers and non-smokers have also discussed the health impact of smoking with their acquaintances, which is often a pre-cursor to quit smoking. However it is not possible to quantify the exact figures due to other factors such as other tobacco policies in force and social trends.

5. Complete ban on tobacco marketing Tobacco advertising is completely banned in Singapore since 1972. However each year, tobacco companies spend large sums of money on product placement in supermarkets and convenience stores. This indirect form of marketing gives tobacco products an inordinately high level of exposure to consumers. WHO concluded that only a complete ban on tobacco marketing would be sufficient to stop companies from seeking creative avenues to sell their products.

6. Increase taxes This approach could increase the retail price of tobacco by as much as 70%. WHO believes that this measure is able to reduce global death due to smoking by 25%. A finding has shown that an increase of taxation by 10% might reduce consumption of tobacco by 4% in rich country and 8% in poor country. Based on this finding, there has been suggestion that tobacco tax may be a form of progressive tax that benefits the poor. The suggestion that cigarette tax is progressive is rather contentious. Overwhelmingly and increasingly, smokers are concentrated among the poor. For tobacco tax to be progressive, low income consumers should be price sensitive with an elastic demand for tobacco. However, an empirical study4 has found that low income consumers are only marginally more price sensitive than high income consumers and therefore tobacco tax is regressive

3 4

Refer to appendix 1.1 for messages Colman and Remler (2008)

instead. Therefore by increasing tobacco tax, a disproportionate burden will be placed on low income group and alternatives such as the earlier points mentioned may be more effective in getting smokers to quit.

Additional Solutions Firstly, we can impose a higher age limit for smoking. This discourages new and young smokers and based on past research, the number of smokers has been decreasing over the years. This decrease is most noticeable in the 18-24-age range; hence making this a potentially effective strategy. Secondly, we can convince smokers to switch to cigarettes with lower tar content in an attempt to ultimately give up smoking. Based on a 1994 study, when the consumers were informed of the dangers of tar content in cigarettes, the tar-adjusted cigarette consumption levels declined. This happened long before on-product cigarette warnings; hence, if it was effective then, it could have a larger impact in todays day and age.

Cost-Benefit Analysis of Smoking Benefits The high taxes on cigarettes provide a huge source of income for the government. The tax revenue derived is far greater than the money spent on tobacco control. According to a study in 2003, tobacco companies provide employment for almost 100 million people, worldwide, at all stages of the production and distribution process. It is a huge industry and companies spend more than $23 to market tobacco products in the U.S. for every dollar spent on control programs.5 Costs Cigarettes adversely affect the environment; 1.7 billion pounds of cigarette butts are eliminated in lakes and oceans and 4.3 trillion butts litter the earth every year; releasing calcium, lead and arsenic into the atmosphere. Active and passive smoking cause health problems ranging from nasal irritations to lung cancer in adults and children alike. Passive smoking can be just as dangerous.

5

The 1998 State Tobacco Settlement 13 Years Later (2004)

In the U.S. alone, $3 billion is spent in cleaning and maintenance every year and smoking was the cause of 40% of deaths and 16% of injuries from apartment fires.

Case Study Clearly, smoking is harmful and not beneficial. But looking at the other side of the story; in 1999, Philip Morris commissioned a study in the Czech Republic which claimed the benefits of smoking outweigh the costs.

The positive effects were attributable to excise tax, VAT, healthcare cost savings due to early mortality, corporate income tax, custom duties, pension and social expense savings and savings on housing. The negative aspects were attributable to direct and indirect healthcare costs, social benefits, lost income tax due to higher morbidity, mortality and fire induced costs. However this paper is flawed and is used simply to provide the alternative scenario. The paper inaccurately estimates costs and fails to include important costs linked directly to the budget and the costs employers have to incur for smokers in their companies. It also excludes external costs like ETS related premature deaths and loss of human capital. Conclusion Thus, to conclude, even though the measures mentioned by the WHO are important, strict implementation is required for them to be successful. However, it is not economically optimal to completely eradicate smoking as partly the government can collect huge tax revenues from this industry. Governments should aim to reach the optimal consumption level. And of course, we can never accurately estimate the social cost of smoking due to the inability to put a value on human life.

References WHO urges more countries to require large, graphic health warnings on tobacco packaging: the WHO report on the global tobacco epidemic, 2011 examines anti-tobacco mass-media campaigns. (2011). Central European Journal Of Public Health, 19(3), 133. Quah, E., Tan, K., Saw, S., & Yong, J. (2002). The social cost of smoking in Singapore. Singapore Medical Journal, 43(7), 340-344. Singapore customs media release: Singapore customs enforcement efforts continue to yield positive results. (2012, January 27). Retrieved from http://www.customs.gov.sg/NR/rdonlyres/0267A0EF-CE41-4453-8D1C082277D9C6CD/0/MediaRelease_2011EnforcementResults_Finalforweb.pdf Colman, G. J., & Remler, D. K. (2008). Vertical Equity Consequences of Very High Cigarette Tax Increases: If the Poor Are the Ones Smoking, How Could Cigarette Tax Increases Be Progressive?. Journal Of Policy Analysis And Management, 27(2), 376-400. Sambrook Research International.(2009). A review of the science base to support the development of health warnings for tobacco packages. Retrieved September 10, 2012, from http://ec.europa.eu/health/tobacco/docs/warnings_report_en.pdf Federak Trade Commission. (2009). Cigarette Report for 2006. Retrieved September 10, 2012, from http://www.ftc.gov/os/2009/08/090812cigarettereport.pdf Appendix 1.1 Warning messages: WARNING 1: Smokers die younger WARNING 2: Smoking clogs the arteries and causes heart attacks and strokes WARNING 3: Smoking causes fatal lung cancer WARNING 4: Smoking is highly addictive, dont start WARNING 5: Stopping smoking reduces the risk of fatal heart and lung diseases WARNING 6: Smoking can cause a slow and painful death WARNING 7: Smoking causes ageing of the skin WARNING 8: Smoking can damage the sperm and decrease fertility WARNING 9: Smoking may reduce the blood flow and causes impotence WARNING 10: Smoke contains benzene, formaldehyde and hydrogen cyanide WARNING 11: Smoking when pregnant harms your baby WARNING 12: Protect children: dont make them breathe your smoke WARNING 13: Your doctor or your pharmacist can help you stop smoking WARNING 14: Get help to stop smoking