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I I I I I I I I I I I I I I I I Cigarette Taxes to Fund Health Care Reform: An Economic Analysis Jane G. Gravelle Senior Specialist in Economic Policy Office of Senior Specialists and Dennis Zim,merman Specialist in Public Finance Economics Division March 8, 1994 94-214 E 0 if ® CRS I liiq t/tN MMIf<M Uiil kil /R1

I I I I I I I I I I I I I I I I CRS-19 Information on Habit-Formation and Addiction In addition to inaccurate risk assessment, market failure also could result if individuals incorrectly assess the impact the addictive properties of tobacco will have on any future attempt to quit. According to the economic theories applied to addictive behavior, simply because individuals engage in behavior that involves habit formation or addiction does not mean they are making a mistake, as long as the individual recognizes the difficulty of modifying behavior in the future and the possibility of a need for such modification.' Individuals make many decisions that are difficult to change (and that they are probably aware are difficult to change}-marriage, job, purchasing a home, locating in a given area-without those decisions being seen as bad choices and appropriate targets for government intervention. n Much of this overestimation of risk is due to orroreetimation of the risk of lung cancer. 7A Some argue that an individual's peroeption of risk differs when con.ideriag the risk for people as a group versus the risk for him or herself. Uafortunately, no quantitative measure ezists to asaertain the e:tent, if any, of this difference. See U.S. Department of Health and ~ ~ Human Services. Reducing the Health Conacquenxi of Smoking: 25 Yearr of Progms. A Report of the Surgeon General 1989, DHHS Publication No. (CDC) 89-8411, p. 216, hereafter Surgeon ~ General's Report, Chapter 4 for a disctusion of this iarue. ~ C.~ 29 For a model of rational addiction, see Frank Chalouplu., 'Rational Addictive Behavior and CO Cigarette Smoking,' Journal of Political Economy, Vol. 99, no. 4, August 1991. pp. 722-742. Ca ~ Cit C,C I

CRS-20 I I I I I I I I I I I I I I I I I From this perspective, when smokers make a mistake it`ig due to a failure of information-a failure to understand either the difficulty of altering future behavior or the likelihood that alteration will be desired. It is not easy to assess the extent to which this problem occurs. A variety of observations support both the view that incomplete information is a serious problem and the view that it is a less important problem. - Two types of evidence might shed some light on the severity of this information problem. The first is evidence of the strength of the addiction problem. The less pronounced the addiction problem, the less serious is any failure to understand the problem. Second, if the addiction problem is serious, is there evidence that individuals are aware of the problem? 1. Evidence on habit formation and addiction The evidence supporting the problem of habit formation is straightforward. That smoking is habit forming is essentially beyond dispute. There is also a substance in tobacco, nicotine, that is physically addictive to some degree.JO A very large number of smokers say they would like to quit or have tried to quit at least once,31 and quitters experience a high rate of recidivism.' Individuals also continue to spend money on smoking cessation programs. Other observations suggest, however, that addiction is not serious enough to make smoking decisions significantly different from many other decisions in which the government does not intervene. For eza.mple, although many smokers have tried to quit and failed, many also have tried and succeeded, the vast majority without help.' The number of former smokers is now as large as the number of current smokers. Smoking decisions also respond to changes in prices in a way that is consistent with consumption decisions about many other products, and increased publicity about health risks did reduce smoking substantially. Thus, individuals appear to be able to cease smoking when the price (either in actual cost or in implicit, perceived health costs) increases substantially. 30 This iasue is diacured in U.S. Department of Health and Human Servioes, The Health Conuqu.otccs of Smoking: Nicotinr Addiction, 1988, Surgeon General Report, DHHS Publication No. (CDC) 88-8406. Another diicuasion that takes the poation that there is a serious problem with phyacal addiction and that is written for the general public is in the chapter on .moldng in Jeffrey Harris, Dcadly Choitrs: Coping with Health Risks in Eucryday Li(e, Basic Bootis, New York: Harper-Collins Publiahers, 1993, p. 167. 31 Seventy peroent of current smokers have made at least one serious attempt to quit. See Congreeeional Budget Office. Faieral Taxation of Tobacco, Alcaholic Beverages, and Motor Fuc1.. Waalungwn, D.C.: U.S. Government Printing Offioe, August 1990. U For data on rdapeee after quittusg attempts, see Harris (1993), p. 167. 33 Surgeon Creneral's Report (1989).

CRS-21 I I I I I I I I I I I I I I I The fact that many individuals say they would like to.q~u-it is indicative of the difficulty of breaking pleasurable habits but does not necessarily prove a serious addiction problem. As an illustration of how one might interpret discrepancies between statements of preferences and action, Viscusi notes that half of the people who live in Los Angeles say they would like to leave. The fact that they do not leave does not mean that they have no control over the decision, but rather that they perceive the benefits of staying to be greater than the benefits of leaving. Similarly, individuals may say they would like to quit, but when dealing with the actual decision continue to smoke because they enjoy it and cessation is a deprivation of an accustomed pleasure. Indeed, some of the arguments used to support the case that smoking, addiction, and the difficulty of changing behavior is a serious problem are applicable to many other activities. Individuals not only engage in risky activities, but they also fail to initiate or persist in many behaviors that would contribute to their health (e.g. diet and exercise). When they do initiate changes, they exhibit a high rate of failure to follow through even when considerable money is spent on programs to attain these ends. Many overweight individuals have made a serious attempt to lose weight and failed; many sedentary individuals have made an effort to initiate and maintain a regular exercise program and failed. Few suggest these behaviors justify government intervention. 2 Evidence on infonnation regarding addiction Even if addiction is a serious problem, there is no market failure if individuals are aware of it when they make the initial smoking decision. The argument that incomplete information is a serious problem begins with the observation that most smokers begin early in life, typically in the teenage years, when a lack of information or understanding may be more severe. A survey of teenagers showed that half expect not to be smoking in five yeara,' whereas data show that smoking participation generally does not decrease until much later in life. This evidence suggests that teenagers may well have incorrect perceptions about their ability to stop smoking. On the other hand, some data indicate that even the very young are aware that it is difficult to quit smoking. About 75 percent of those 14 and younger, when queried about the difficulty of stopping smoking, identified as true the statement It is very hard to stop smoking."36 u 9urgeon General's Report, 1989. 3'5 Yucusi (1992). It ii poeaible that young teenagers who rmoke miy have differen,. peroeptioni from the average, howewr.

I I I I I I I I I I I I CRS-22 Policy B.eaponses The fundamental tax policy issue is twofold. If smoking decisions are assumed to be reasonably informed, then the government should not intervene beyond correcting for spillover effects. If, however, the decision is assumed not to be informed, then intervention may be appropriate and a tax might make smokers better off in the long run if it led them to quit or fail to take up the habit. The preceding discussion suggests uncertainty about the degree to which the smoking decision is a wrong decision when it is placed in the context of individual preferences. The evidence presented suggests that there is not much of a case for a market failure with respect to information on the health hazards of smoking. Indeed, it is possible that individuals overestimate these health costs, on average. Whether individuals are informed about the difficulties of changing future smoking behavior is much less certain. As a correction to information problems regarding addiction, a tax has certain shortcomings. First, use of a tax that is set properly requires a quantification of the degree to which information is incorrect, a measure that cannot be made based on current information and that would presumably vary widely across individuals. - Second, the tax would be an effective deterrent to smoking primarily for those who have not yet begun and for those smokers who are least addicted. This is not an inconsequential step, but the tax would not be an effective remedy for correcting behavior for those who have already made an uninformed choice. Finally, as in the case of spillover effects within the family, a tax aimed at "helping the smoker" produces distributional or equity effects that blur the desirability of the policy overall. Consider, for example, a tax of the magnitude proposed by the health care plan. Based on the elasticities used in section II, the short-run participation elasticity of tobacco consumption (percentage change in share of individuals smoking divided by the percentage change in price) is about -0.3 and the long run elasticity is about -1.2. Assuming a constant elastic function with a 75-cent tax, about ten percent of individual smokers will quit smoking in the short run. In the long run, the reduction will be about a third. This is troubling because the tax makes worse off the majority of those it is intended to help, and is particularly burdensome to lower-income individuals. On the whole, therefore, a tax may not be the most appropriate policy instrument to deal with the information problem. It is true that some estimates of behavioral response suggest that taxes can elicit a large response from teenage smokers (a reduction for the 75-cent tax increase up to a third). But I

I 1 I I I I I I I I I I I I I I CRS-23 adolescent smokers account for only six percent of all smokers.m Non-tax alternatives may be better targeted. If lack of information about addiction is the primary problem, perhaps a better response is to disseminate information to the young about the dangers of addiction throLgh educational programe in the schools, general advertising, and perhaps through warning labels. If the age of initiating smoking and immaturity of decision-making by young smokers seems to be the primary problem, an approach might be to introduce stricter laws limiting the sale of cigarettes to minors and to enforce those laws." To help current smokers who will constitute the great majority of smokers in the near and medium term, more assistance for quitting (including information and better nicotine replacement devices) may be a desirable public policy.' Indeed, one feature that may be desirable in a health care plan is to provide coverage for expenditures on smoking cessation. Finally, a policy option that might help all individuals would be the development of a less dangerous cigarette.J° M Calctiilated frnm data in National Cancer Inrtitute, The Impact o f Cigarettr Esaix Taus on Smoking Among Childras and Adults, Summ•*y Report of a National Cancer Institute Expert Panel, Auaust 1993. I" It his be.n argued that laws barring sales of cigarettes to minors are enforoed in only two of the 47 states with such laws. 3ee 'U.9. Urged to E+calate Tobacao War,' Washingmn Post, January ]2, p. A16. See also the discussion in the 1989 Surgeon General's Report, pp. 587-588 and 596-608 regirding smoldng policies in public schools, Stata laws regardiag.ale and poe.esion by minors, and enforcement iisuee. 38 Jeffrey Harris, Deadly Choices: Coping with Xea.lth Ri.le.s in Everyday Lije, New York: Harper-Collins Publishers, 1993, su.ggests that nicotine replaoement devices might be improved. 39 Viscusi (1992) indicates that public health offiaaL have not encouraged such improv+ementa, such as a'smokele.s' cigarette that would continue to deliver niaotine and mimic actual amoidng ..nthout many other adverse effecu.