Magazine article Regulation

Smoking's 'Internalities': Given Smokers' Future Preferences, Lawmakers Should Raise Cigarette Taxes. (Health & Medicine)

Magazine article Regulation

Smoking's 'Internalities': Given Smokers' Future Preferences, Lawmakers Should Raise Cigarette Taxes. (Health & Medicine)

Article excerpt

THE PAST SIX YEARS HAVE SEEN AN enormous change in the treatment of smoking by both policymakers and the legal system. In 1995, federal and state excise taxes on cigarettes were one-third lower, in real terms, than their peak level of the mid-1960s. But taxes rose by 40 percent over the next six years, or 22 Cents per pack, and now stand at 78 Cents per pack. As of 1995, despite decades of smoking-related lawsuits, the tobacco industry had yet to pay out a penny of damages to smokers. But, by 1998, the industry had signed a settlement committing to over $250 billion in payments to the states over the next 25 years.

From a traditional economic perspective, the shift in both government policy and the legal system is unwarranted. In the standard economic model, fully informed, forward-looking, rational consumers make the decision over whether to smoke, weighing the benefits of doing so in terms of smoking enjoyment against the costs in terms of health and other risks. The only call for intervention in such a model is the externalities that smokers impose on others, such as increased medical costs for public insurance programs. But such externalities are fairly small by most measures because the costs are offset by the savings from earlier mortality of smokers who pay a lifetime of Social Security taxes but often do not live long enough to collect their benefits. As a result, the traditional economic model would suggest that the "optimal" tax on cigarettes might be below the 1995 level.

But that model, in fact, has little evidence to recommend it. The model is predicated on a description of the smoking decision that is at odds with laboratory evidence, the behavior of smokers, econometric analysis, and common sense. Moreover, alternative models that only deviate modestly from the traditional formulation have radically different implications for government policy, rationalizing large taxes on cigarettes and the implementation of other types of regulatory controls.


The traditional economic model of smoking follows the standard economic approach to modeling any decision that involves tradeoffs overtime. Smoking a cigarette today increases utility today, but lowers it in the future through reduced health. Fully informed, forward-looking, rational consumers trade off the present gains against the future costs, and decide to smoke only if the former outweigh the latter.

Of course, smoking is not like many other activities; it is well established that smoking is a highly addictive behavior. But Nobel-prize winning economist Gary Becker (along with his prominent co-author Kevin Murphy) showed in the late 1980s that addiction does not, per se, invalidate the conclusions of the standard model. All addiction does is complicate the analysis. The consumer has to consider not just the costs and benefits of a given cigarette, but also the fact that smoking the cigarette increases his level of addiction, committing him to future consumption. The underlying principle is the same: Individuals will only smoke if the benefits exceed the costs, including both the health costs of that cigarette and the monetary and health costs of all future cigarettes that the addicted smoker is committing himself to.

Externalities The "rational addiction" approach to modeling addictive behaviors was appealing to economists, and it has been adopted, either explicitly or implicitly, as the standard model in our field. The approach's key implication is that the appropriate role for government (and, by extension, the legal system) is solely a function of the externalities that smokers impose on others. Because smoking, like all other consumption decisions, is governed by rational choice, the fact that smokers impose enormous costs on themselves is irrelevant; it is only the costs they impose on others that give rise to a mandate for government action.

There is a large literature devoted to measuring the externalities associated with smoking. …

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