The November special election is coming up in Oregon and in it Oregonians are being asked to vote on two measures, 49 and 50. 49 amends measure 37 and is something I will address in the coming days. Today I am going to give an economist’s perspective on Measure 50. Measure 50, if passed, would increase the state tax on tobacco and dedicates the new revenue to provide affordable health care for uninsured children in the state. Measure 50 brings up a host of economic questions, questions to which the answers are not at all clear. As a result, and I’ll say this at the outset, I remain conflicted about this bill.
Let’s begin by outlining the economic issues that I see as pertinent to this measure. First is the nature and size of the externality that comes with smoking. Second is the price elasticity of demand for cigarettes. Finally, and complicatedly, is the issue of the uninsured in society and what should be done. Now I’ll address these in order.
Externalities are the costs and benefits of an activity that are not born or enjoyed by the person (group, agent, firm, etc.) engaging in the activity. When externalities are costly we call these negative externalities and when they are beneficial, we call them positive externalities. To give an example of both, I can relate a story from my graduate student years. When I was in the first year of my Ph.D. studies at Cornell (the first year in economics programs are notoriously intense) I lived in an apartment house directly above a couple who were physics Ph.D. students. (In other words, wicked smart and slightly deranged) Anyway, the woman was an accomplished violinist and many evenings as I was studying furiously, the wonderful sounds of classical music from her violin could be heard clearly in my apartment. It was beautiful and soothing and if there had been such a market, I would have gladly paid her some small sum to keep it up longer. Her music, therefore, was a positive externality something that imparted benefits to non-participants and for which there was no remuneration. In the absence of remuneration she played less music than was socially optimal. In stark contrast her highly erratic boyfriend would sometimes, inexplicably, late at night turn his stereo up to eleven and blast the most god awful goth rock so loud you would have though it was coming from my own stereo. His was most definitely a negative externality and one which he did not have to pay the cost of my discomfort (save for the fact that I screamed at him once – and that was the last time it happened). Thus, since he did not have to pay the price of others discomfort, he played his music too loud and too often relative to the socially optimal amount. I make this long digression to point out that externalities are not just factories belching toxic smoke, but are often individuals undertaking some activity that imposes a cost on others. (By the way, as I write this, an OSU groundskeeper is blowing leaves around under my window with the loudest leaf blower ever conceived)
So, finally to the point: Cigarette smoking produces two main negative externalities. The first is the smoke that is potentially harmful to non-smokers in the vicinity. The second is the smoking related illnesses whose costs are often partially (or fully) covered by the state and federal government. These are both costs that do not accrue fully to the persons partaking in the activity. So, for this reason I have absolutely no sympathy for ‘smokers rights’ arguments, just as I have no sympathy for those that would argue liberty in support of no helmet laws, for example. Prove that you are fully self-insured and I’m happy to have people do all of the life threatening things they want. But if your going to do something that potentially imposes a cost on me and I (or my agent, the state) have a right to intercede. Given that these externalities exist, there is a very good economic argument for state intervention. The state regulates tobacco and taxes it. In fact there is even a theory of optimal taxation given externalities, it is called Pigouvian Taxes. The idea is pretty simple. Suppose we knew that each pack of cigarette imposed a sum total of $1 in external costs. By taxing cigarettes at $1 a pack, we would align the private costs of cigarette consumption with the social costs of cigarette consumption and the result of the market would be efficiency. In addition, the revenue raised from this tax can be used to defray the costs of the harmful effects of the activity.
But the rub is, of course, that we do not know exactly what these costs are. The “Economic Fairness Coalition of Our Oregon” (an advocacy group the supports the measure) claims that, all tolled, the true ‘cost’ of a pack of cigarettes is $11.16. Suppose this is true, then the proposed tax is wildly inadequate. What if it is a lot less? Is the tax potentially too high? I think common sense dictates that the $11.16 figure is probably pretty extreme, but that (given the rising costs of health care) $2.025 that is being proposed is probably not enough to make it truly in line with actual costs. But true evidence is so hard to come by that any attempt at a true Pigouvian tax is really a shot in the dark. Still, on this score I would have to score one for the measure, I think it doubtful it is too high and it is a step in the right direction. Oh and one little side note that observant readers will notice: the real cost of an individuals smoking depends on many things, so the cost we are looking for is an average and thus some will pay ‘too much’ and some ‘too little’ if a Pigouvian tax were enacted.
The next issue is how much revenue will be raised by an increase in taxes. Yes, the per-pack tax will rise, but the number of packs consumed will thus fall. Consumers will stop smoking or smoke less. They will switch to substitutes (nicotine gum?). They may start purchasing more cigarettes when on vacation or in duty-free shops. Whatever the cause, to estimate the reduction in sales of packs of cigs in Oregon, we need to know the price elasticity of demand for cigarettes. This is simply, in percentage terms, by how much the quantity of cigarette packs will fall, given a 1% rise in price. I looked the economics literature and, surprise, surprise, estimates vary widely. I would say that about -0.50 overall is about average (or even a bit overstated) and it is a bit higher for youngsters. So this means we should see about a 1% decline in cigarette consumption for a 2% raise in price. Since Oregon’s tax increase would raise prices roughly 20%, we should see a 10% drop in sales. So revenues should increase by roughly 10% (though equilibrium price should settle even higher) of which the states share has increased 71% so tax revenues could be expected to increase by about 61%. This looks like about an extra $162 million. So my extremely crude back-of-the-envelope calculations are pretty close to what I have seen is the state’s projections (though I am not sure why this is supposed to rise dramatically after the first biennium as they predict).
Finally, the last issue is a population without adequate health insurance. This is not really related to smoking and is probably the reason I have so much trouble with this bill. Perhaps I am hopelessly naïve, but this bill is pure populism: let’s tax smokers (boo) and give kids health insurance (yeay). If smoking and its affects are the point of concern than create policy that deals with this. Use tax revenues to support health care for uninsured sufferers of emphysema and lung cancer. If uninsured children are a concern than create a new plan that is funded from general revenues. This creating and ear marking of specific taxes is troubling to me. I don’t like the ends-justify-the-means arguments and I don’t like it in policy either. ‘Sin’ taxes are a political expedient, but are not necessarily good policy (see the beer tax debate from the last legislative session).
But in the end I’ll probably vote for it. What the hell? I don’t smoke!
Let’s begin by outlining the economic issues that I see as pertinent to this measure. First is the nature and size of the externality that comes with smoking. Second is the price elasticity of demand for cigarettes. Finally, and complicatedly, is the issue of the uninsured in society and what should be done. Now I’ll address these in order.
Externalities are the costs and benefits of an activity that are not born or enjoyed by the person (group, agent, firm, etc.) engaging in the activity. When externalities are costly we call these negative externalities and when they are beneficial, we call them positive externalities. To give an example of both, I can relate a story from my graduate student years. When I was in the first year of my Ph.D. studies at Cornell (the first year in economics programs are notoriously intense) I lived in an apartment house directly above a couple who were physics Ph.D. students. (In other words, wicked smart and slightly deranged) Anyway, the woman was an accomplished violinist and many evenings as I was studying furiously, the wonderful sounds of classical music from her violin could be heard clearly in my apartment. It was beautiful and soothing and if there had been such a market, I would have gladly paid her some small sum to keep it up longer. Her music, therefore, was a positive externality something that imparted benefits to non-participants and for which there was no remuneration. In the absence of remuneration she played less music than was socially optimal. In stark contrast her highly erratic boyfriend would sometimes, inexplicably, late at night turn his stereo up to eleven and blast the most god awful goth rock so loud you would have though it was coming from my own stereo. His was most definitely a negative externality and one which he did not have to pay the cost of my discomfort (save for the fact that I screamed at him once – and that was the last time it happened). Thus, since he did not have to pay the price of others discomfort, he played his music too loud and too often relative to the socially optimal amount. I make this long digression to point out that externalities are not just factories belching toxic smoke, but are often individuals undertaking some activity that imposes a cost on others. (By the way, as I write this, an OSU groundskeeper is blowing leaves around under my window with the loudest leaf blower ever conceived)
So, finally to the point: Cigarette smoking produces two main negative externalities. The first is the smoke that is potentially harmful to non-smokers in the vicinity. The second is the smoking related illnesses whose costs are often partially (or fully) covered by the state and federal government. These are both costs that do not accrue fully to the persons partaking in the activity. So, for this reason I have absolutely no sympathy for ‘smokers rights’ arguments, just as I have no sympathy for those that would argue liberty in support of no helmet laws, for example. Prove that you are fully self-insured and I’m happy to have people do all of the life threatening things they want. But if your going to do something that potentially imposes a cost on me and I (or my agent, the state) have a right to intercede. Given that these externalities exist, there is a very good economic argument for state intervention. The state regulates tobacco and taxes it. In fact there is even a theory of optimal taxation given externalities, it is called Pigouvian Taxes. The idea is pretty simple. Suppose we knew that each pack of cigarette imposed a sum total of $1 in external costs. By taxing cigarettes at $1 a pack, we would align the private costs of cigarette consumption with the social costs of cigarette consumption and the result of the market would be efficiency. In addition, the revenue raised from this tax can be used to defray the costs of the harmful effects of the activity.
But the rub is, of course, that we do not know exactly what these costs are. The “Economic Fairness Coalition of Our Oregon” (an advocacy group the supports the measure) claims that, all tolled, the true ‘cost’ of a pack of cigarettes is $11.16. Suppose this is true, then the proposed tax is wildly inadequate. What if it is a lot less? Is the tax potentially too high? I think common sense dictates that the $11.16 figure is probably pretty extreme, but that (given the rising costs of health care) $2.025 that is being proposed is probably not enough to make it truly in line with actual costs. But true evidence is so hard to come by that any attempt at a true Pigouvian tax is really a shot in the dark. Still, on this score I would have to score one for the measure, I think it doubtful it is too high and it is a step in the right direction. Oh and one little side note that observant readers will notice: the real cost of an individuals smoking depends on many things, so the cost we are looking for is an average and thus some will pay ‘too much’ and some ‘too little’ if a Pigouvian tax were enacted.
The next issue is how much revenue will be raised by an increase in taxes. Yes, the per-pack tax will rise, but the number of packs consumed will thus fall. Consumers will stop smoking or smoke less. They will switch to substitutes (nicotine gum?). They may start purchasing more cigarettes when on vacation or in duty-free shops. Whatever the cause, to estimate the reduction in sales of packs of cigs in Oregon, we need to know the price elasticity of demand for cigarettes. This is simply, in percentage terms, by how much the quantity of cigarette packs will fall, given a 1% rise in price. I looked the economics literature and, surprise, surprise, estimates vary widely. I would say that about -0.50 overall is about average (or even a bit overstated) and it is a bit higher for youngsters. So this means we should see about a 1% decline in cigarette consumption for a 2% raise in price. Since Oregon’s tax increase would raise prices roughly 20%, we should see a 10% drop in sales. So revenues should increase by roughly 10% (though equilibrium price should settle even higher) of which the states share has increased 71% so tax revenues could be expected to increase by about 61%. This looks like about an extra $162 million. So my extremely crude back-of-the-envelope calculations are pretty close to what I have seen is the state’s projections (though I am not sure why this is supposed to rise dramatically after the first biennium as they predict).
Finally, the last issue is a population without adequate health insurance. This is not really related to smoking and is probably the reason I have so much trouble with this bill. Perhaps I am hopelessly naïve, but this bill is pure populism: let’s tax smokers (boo) and give kids health insurance (yeay). If smoking and its affects are the point of concern than create policy that deals with this. Use tax revenues to support health care for uninsured sufferers of emphysema and lung cancer. If uninsured children are a concern than create a new plan that is funded from general revenues. This creating and ear marking of specific taxes is troubling to me. I don’t like the ends-justify-the-means arguments and I don’t like it in policy either. ‘Sin’ taxes are a political expedient, but are not necessarily good policy (see the beer tax debate from the last legislative session).
But in the end I’ll probably vote for it. What the hell? I don’t smoke!
5 comments:
The final point, on populism, may be hard to support as a matter of economics, but public policy often requires a hook--and none is stronger than populism--to create energy. I personally have no issue with ginning up emotion about an issue so long as the purpose is well-established as a matter of policy.
It sounds like you think it is. Or at least is close enough to vote for.
Another point to consider is the cost of the uninsured on society. When uninsured folks get sick, they are forced into the ER where the cost of treatment is nine-times more expensive than early preventative medicine. The cost of uncompensated care from the uninsured is then borne by increasing the premiums of the uninsured (estimates are about 10% of premiums are attributable to the cost of the uninsured). More insured children and adults means less ER visits (and cheaper, more effective and efficient care), which means less uncompensated care and slower premium increases for the insured which is good for private business and the public sector alike. That's another social benefit of M50.
Jeff,
Yes, when I wear my economist's hat, I dislike populist arguments. But as a citizen, I understand not everyone thinks like an economist (and society is no-doubt much better for it) and thus it is often imperative to have a hook (especially with ballot measures). I worry though that if we become accustomed to needing a 'hook' every time it can lead to a morass of special taxes that distort markets. I wish we could say that uninsured children in Oregon is unacceptable and therefore we should make insurance happed as a general funds expenditure. We may also say that smoking is very costly to all Oregonians and we want to addrress that as well. So what is wrong with accompliashing both in one fell swoop? Because then the cigarette tax is not about dealing with the smokers health problem but about kids insurance. I am firm in my believe that the path to good policy is in understanding issues on their own, comflation of issues I fear too often leads to bad policy. But as I say, I am not about to suggest voting against it on that principle alone - the ends, I guess, do justify the means sometimes. Doesn't mean I can't wish for better policy.
I agree with your policy misgivings but also have decided in the end to vote yes on M50. As a public health person I've argued on BlueOregon that I'd be glad to support a cigarrette tax that was dedicated purely to smoking prevention and cessation efforts, curious what you think.
Your discussion of externalities is interesting but the application to smoking reflects one problem I have with marginal utility economics at times. To me the greatest negative externality about smoking is the premature loss of human lives, not reduced to a balance sheet of income, productivity and costs, but persons and all the human ties that envelop them, cutting of which harms others. I've felt such smoking costs myself, observed it in others, and fear it for certain friends.
Anyway, this looks like a promising, thoughtful and thought-provoking blog, so I'm glad Jeff drew attention to it over at BlueOregon.
I don't understand, exactly, how smokers cost the state more than non-smokers -- certainly not the $11. I understand that smoking is associated with illness and a shorter life-span. By contrast, non-smoking is associated with a longer life-span; ending, of course, in illness at some point. I don't mean to be crude, but everybody eventually gets ill and dies; and being sick is expensive, and some of those costs are borne by the state. If smokers' illnesses are more expensive than others, I would think that at least some of these costs would be defrayed by the fact that they are likely to pull for a shorter time on social security, retirement insurance, and in general the social expenses of living old.
On the other hand, it is easy to understand that sales taxes are regressive -- they unfairly target the poor. Not only is this a sales tax, but it is one targeted at a specific segment of society that is poorer than average. I can't see how this bill isn't, in economic terms, the bullying of a discreet minority, who perhaps lack the political weight to defend their economic self-interests.
Sorry, I had to get that off my chest. This blog is an exciting new addition to Oregon politics.
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