Article The Costs of Cigarettes: The Economic Case for Ex Post Incentive-Based Regulation Jon D. HansonT & Kyle D. Logue" CONTENTS I. INTRODUCTION: DEFINING THE PROBLEM ................. 1167 A. A Brief History of Cigarette Regulation................ 1167 B. An Introduction to hncentive-Based Regulation aid Enterprise Liability. ....................................... 1173 C. The Absence of hIcentive-Based Regulation in the Proposed Settlement....................................... 1178 D. Overview......................................... 1179 t Professor, Harvard Law School. •t. Assistant Professor. Michigan Law School. We are grateful to Cath> Ahn. Ali Akhtar. Jeanette Boot, John Delaney, Grant Dixton. Jonathan Hooks. Michelle Jones. Paticia Petro..k. Kino Peluo, Kenneth Pippin. Caroline Sheerin. Carl Sussman. Gerald Song. Ed%%in U. and Michaiel Zainore ior recearch assistance; to Carol Igoe and Chris Pierce for secretarial assistance, to Carl Bogus. Richard Da> nard. Jctfre Harris, Don Herzog, Duncan Kennedy. Rick Lempen. Bill Miller, Rick Pildes. Vaughan 0 Ste%%art. Da%id Sweanor, Ken Warner, and Norwood Wilner and to participants at the Facult, Workshop of Roger Whillians University School of Las, at the Harvard Las. School Conference on the Proposed Tobacco Settlement. "Should Tort Law Be on the Table?". and at the Umnersit% of Wisconsin-Madison "'Conlcrence on the So. Called Tobacco Settlement: Its Implications for Public Health and Public Pohc" for helptul conment. and to the Harvard Summer Research Program and the Cook Fund at the Lniersiit ot Michigan Ia.% School for funding portions of our research. Special thank%are o%,ed to Ste e ('role%. August flors'ath, and Andrew Ruffino, who each contributed significantl% to initial drafts of this Article h-malls'.. s, %.ant to express our deepest gratitude to Kathleen. Emil%. and Erin Ianson and to Ruth Ann. Hannah. Mull'. and Thomas Logue, all nonsmokers who have nesertheless generousl, borne icheir ossn share of the .oNts ot cigarettes. 1163 1164 The Yale Law Journal [Vol. 107: 1163 II. THE FIRST SOURCE OF CONSUMER UNDETERRABILITY: IMPERFECT INFORMATION ............................ 1181 A. Current Views of Consumer Risk Perceptions ........... 1181 B. A Critique of the Conventional Wisdom ............... 1186 1. The Third-Person Effect ....................... 1186 2. The Problems of Imperfect Brand-Specific Information . 1188 3. The Problem of Imperfect Relative-Risk Information .... 1190 4. The Potential Significance of Addiction and Other Related Sources of Imperfect Information ................. 1193 a. The Industry's Claims ...................... 1194 b. Identifying the Relevant Margin: The Problem of Path Dependence ............................. 1196 c. Temporal Separation of Benefits and Costs: The Problem of Myopia ..................... 1203 d. DisaggregatedBenefits and Pooled Costs: The Problem of Multiple Selves ............... 1205 e. The Economists' Response ................... 1209 i. The Premier Experiment ................ 1209 ii. Evidence of Rational Decisionmaking ....... 1213 iii. Summary ........................... 1221 C. The Informational Effect of Ex Post Incentive-Based Regulation Revisited ..................................... 1221 III. THE SECOND SOURCE OF CONSUMER UNDETERRABILITY: NEGATIVE EXTERNALITIES ............................ 1223 A. Insurance Externalities ........................... 1224 B. Noninsurance Externalities ........................ 1229 C. A Review of and Critical Response to, the Economists' Rebuttal ..................................... 1232 1. Summary of the Economists' Cigarette Studies ........ 1232 2. Critique of the Economists' Cigarette Studies ........ 1236 a. A Closer Look at Negative Externalities: Incorporating the Imperfect Information Argument ............ 1236 i. Costs to the Smoker's Family and Other Third Parties ............................. 1237 ii. Insurance Externalities ................. 1240 iii. Costs to the Smoker ................... 1240 iv. Additional Concerns ................... 1243 b. A Closer Look at the Positive Externalities ....... 1247 i. Assets Enjoyed (and Not Enjoyed) by Others . 1249 ii. Do Smokers Really Externalize Forgone "Benefits"?. ......................... 1249 iii. What About the Current Level of Excise Taxes? 1254 1998] The Costs of Cigarettes 1165 iv. Morality and Social Norms ............... 1255 D. The Potential Internalizing Effects of Ex Post Incentive-Based Regulation .................................... 1260 E. Summary......................................... 1262 IV. CHOOSING AMONG REGULATORY APPROACHES ............... 1263 A. The Disadvantagesof Command-and-Control Regulation . 1264 B. The Disadvantagesof Performance-BasedRegulation ...... 1266 C. The Disadvantages of Ex Ante Incentive-Based Regulation . 1268 1. The Informational Demands of an Ideal Pigouvian 7a . 1268 2. Additional Deterrence Problems with Current Ercise Ta.es: The Unraveling Effect and Errors of Omission and Commission ..................................1271 D. The Advantages of Ex Post Incentive-Based Regulation .... 1273 1. The Reduction of Infornation Problems ............ 1273 2. The Reduction of Overdeterrence Problems When Infornation Varies Across Consumers ............... 1274 3. The Prevention of Unraveling .................... 1278 E. The Advantages of Victim-Initiated over State-Initiated Ex Post Incentive-Based Regulation ................... 1278 F. Summar. ........................................ 1281 V. IMPLEMENTING A VICTIM-INITIATED Ex POST INCENTIVE-BASED SYSTEM ........................... 1281 A. Alternative Victim-Initiated Er Post Incentive-Based Systems . 1281 1. Enterprise Liabilit" .............................. 1282 2. Smokers' Compensation ........................ 1283 a. Causation ................................ 1287 i. General Causation . .................... 1287 ii. Specific Causation...................... 1289 b. The Cigarette Card.......................... 1291 c. Damages ................................. 1295 3. Sunmar ..................................... 1296 B. What Might the Cigarette Market Look Like in a World with Et" Post Incentive-Based Regulation? ..................... 1296 1. Safer Cigarettes and Safer Smokers ............... 1296 2. Black Market Cigarettes ........................ 1298 C. The Problem of Transition and the Case for Supplenentar Ex Ante Regulation ................................ 1301 1. Making the Transition to Ex Post Incentive-Based Regulation: The Retroactivity Question .............. 1301 2. The Judgment-ProofProblem ..................... 1307 1166 The Yale Law Journal [Vol. 107: 1163 3. Widely Dispersed Harm: Dealing with Public ETS Exposure .................................. 1312 D. Summary ..................................... 1315 VI. AN ASSESSMENT OF THE PROPOSED NATIONAL TOBACCO SETTLEMENT ..................................... 1316 A. The Complete Rejection of Ex Post Incentive-Based Regulation 1318 1. The Proposal'sCivil Liability Provisions ............ 1318 2. The Effect of Civil Liability Provisions ............. 1319 B. The Proposal'sAttempt To Inform Consumers ........... 1322 1. Warning Requirements ........................ 1322 a. Summary of Provision ...................... 1322 b. Critique ................................ 1323 2. Marketing Restrictions and Antismoking Advertising .... 1324 a. Summary of Provisions ..................... 1324 b. Critique ................................ 1326 3. The "Look-Back" Provision ..................... 1331 a. Summary of Provision ...................... 1331 b. Critique ................................ 1331 4. The Proposal's General Price Effects: The Excise Tax Model .................................... 1336 a. Summary of Provision ...................... 1336 b. Critique ................................ 1336 C. The Proposal'sAttempt To Reduce Noninsurance Externalities 1337 D. Specific Provisions Intended To Improve Manufacturer Care Levels ....................................... 1338 1. Command-and-ControlRegulations ............... 1338 2. Performance-BasedRegulations .................. 1340 E. Transition Issues ............................... 1342 1. The Distinction Between Past and Future Harms: $368.5 Billion for What? ....................... 1342 2. Barriers to Entry ............................ 1343 F. Assessing the Proposalfrom a Distance ............... 1345 VII. CONCLUSION .................................... 1349 APPENDIX: A CLOSER LOOK AT VISCUSI'S SURVEY DATA .......... 1354 A. A Questionable Reference Point ..................... 1354 B. Qualitative Versus Quantitative Data ................. 1357 1998] The Costs of Cigarettes 1167 I. INTRODUCTION: DEFINING THE PROBLEM A. A Brief History of Cigarette Regulation Cigarette smoking causes over 420,000 deaths annually in the United States, roughly twenty percent of all U.S. deaths,' making cigarettes the single greatest preventable cause of death in this country.2 Indeed, tobacco kills more people every year than alcohol, illicit drugs, automobile accidents, violent crime, and AIDS combined.3 And not only are cigarettes deadly to smokers; they kill nonsmokers as well. According to a recent report from the Environmental Protection Agency (EPA), the "sidestream" or "passive" smoke from cigarettes-so-called environmental tobacco smoke (ETS)-is responsible annually for approximately 3000 lung cancer deaths, between 150,000 and 300,000 lower respiratory ailments in children, and approximately 37,000 heart disease deaths.4 Considering