Chapter 6 Economic Approaches Introduction 295 Supply of Tobacco and Tobacco Products 295 Tobacco Price Supports 298 Minimum Prices, Nonrecourse Loans, and Quotas 300 Effects of Price Supports on Market Prices 300 Assessments to Offset Federal Costs of Price Supports 301 Discussion 302 Evolution of the U.S. Cigarette Industry 306 Economic Implications of Concentrated Tobacco Production 308 High Tobacco Concentration and the Impact of Prevention Policies 308 Discussion 311 Trade Policy, Tobacco, and Tobacco Products 311 Past Tobacco-Related Trade Policy 312 Section 301 of the Trade Act of 1974 312 Multinational Trade Agreements 316 Discussion and Recent Developments 318 Economic Impact of the U.S. Tobacco Industry 320 Effect of Price on Demand for Tobacco Products 322 Studies Using Aggregate Data 323 Studies Using Individual-Level Data 327 Behavioral Economics Studies of Cigarette Demand 335 Studies of Smokeless Tobacco Use and Price 335 Cigarette Prices and Other Substance Use 336 Discussion 337 Taxation of Tobacco Products 337 Rationales for Tobacco Taxation 338 Historical or Comparative Standard 338 Cigarette Taxes and Cigarette Prices 341 International Tobacco Taxes 345 Discussion 350 Fairness Standard and Optimal Cigarette Taxes 350 Equity, Incidence, and Distribution of the Tobacco Tax Burden 350 Estimates of the Costs of Smoking 352 Theoretically Optimal Cigarette Taxes 353 Cigarette Taxes and Health 355 Tobacco Taxation and Revenues 357 Conclusions 359 References 360 Surgeon General's Report 294 Chapter 6 Reducing Tobacco Use Introduction This chapter reviews recent research on economic economic impact of tobacco on the U.S. economy and aspects of tobacco production and the use of tobacco its implications for policy are described. products in the United States. Much of the chapter In the second part of the chapter, economic stud­ focuses on the impact of various governmental ies of the demand for tobacco are reviewed. Although policies related to tobacco. As was the case with the several factors affect the demand for tobacco products, regulatory effects examined in Chapter 5, the “interven­ this section focuses on the effects of tobacco prices (par­ tions” recounted here require a broader definition and ticularly as they are raised by increasing tobacco taxes) a different set of measurement tools (see Chapter 1). on demand. Recent econometric and other informa­ The chapter first considers the supply of tobacco tive studies of the demand for tobacco products are and tobacco products. The history of tobacco and the described. (A more detailed review of early studies is evolution of the cigarette industry in the United States contained in the 1989 Surgeon General’s report Reduc­ are briefly discussed. More comprehensive summa­ ing the Health Consequences of Smoking: 25 Years of ries can be found in the 1992 Surgeon General’s report Progress [USDHHS 1989].) Smoking and Health in the Americas (U.S. Department of The third part of the chapter focuses on the most Health and Human Services [USDHHS] 1992) and in important economic policy in the campaign to reduce several sources cited herein. Tobacco-related supply- tobacco use—higher cigarette excise taxes. This sec­ side policies are reviewed in more detail. In particular, tion reviews the alternative rationales for imposing the tobacco support program is closely examined, and cigarette and other tobacco taxes, including a histori­ its economic implications are discussed. That section cal or comparative approach, one based on the eco­ is followed by a discussion of the impact of tobacco nomic costs of cigarette smoking, one focused on the taxes and other prevention policies on prices in the health benefits of higher taxes, and one based on the highly concentrated U.S. cigarette markets. U.S. trade revenue potential of the taxes. Discussion of the ap­ policy relating to tobacco and tobacco products is re­ propriate level of the taxes suggested by each approach viewed, followed by a discussion of the domestic and follows its review. international impact of these policies. Finally, the Supply of Tobacco and Tobacco Products Tobacco is a truly American plant. The first commodity exported from the colonies to England known evidence of tobacco use is depicted in carvings (Johnson 1984). Indeed, tobacco was so important in on a Mayan temple in Chiapas, Mexico, that date from some colonies that it was sometimes used as the unit A.D. 600–900 (Wagner 1971). Europeans were first in­ of account (Johnson 1984). troduced to tobacco in 1492 when American Indians The high tariffs imposed by England on tobacco presented gifts of the substance to Christopher Colum­ and other imports from the colonies contributed to the bus. On Columbus’ return home, tobacco was intro­ start of the Revolutionary War. In the newly formed duced to Spain and throughout Europe. Tobacco was United States, tobacco soon became the leading agri­ widely grown by early English settlers in America and cultural export commodity. The tobacco industry was exported from the colonies to England, where it played a significant part in the U.S. economy of the was reexported to many other destinations. Colonial 19th and early 20th centuries. Although tobacco con­ tobacco exports to England grew from 100,000 pounds sumption has declined in recent years, it is still eco­ in 1620 to 100 million pounds just before the Revolu­ nomically important in major tobacco-producing states. tionary War, making tobacco the single most important Economic Approaches 295 Surgeon General's Report In many ways, tobacco is an ideal crop to grow. dark cigars; and other types used for cigar leaf (Johnson It grows under a variety of soil and climatic condi­ 1984). tions and thrives under specific but fairly common cir­ In 1992, the United States had about 124,000 cumstances. The tobacco plant has prodigious leaf farms producing tobacco, down sharply from 330,000 growth yet takes up relatively little field space, and in 1964 (U.S. Department of Agriculture [USDA] the financial return for tobacco is both absolutely and 1998a). Tobacco was grown on an estimated 644,000 relatively high compared with other agricultural com­ acres in 1999, down sharply from its recent peak of modities (Goodman 1993). For example, in 1993, the 836,000 acres in 1997. In 1998, tobacco farms produced per acre value of tobacco in the United States, $3,780, almost 1.5 billion pounds of tobacco at a total value of was well above the values for other crops (Grise 1995). approximately $2.7 billion. After inflation is accounted Because of these factors, tobacco is grown in more than for, however, the value of domestically grown tobacco 120 countries and thus is the most widely grown non­ has fallen since 1980. More than 1.4 billion pounds of food crop in the world (cotton acreage substantially domestically grown tobacco were used in 1998, with exceeds that of tobacco, but tobacco is grown in about less than two-thirds of this used domestically, while twice as many countries as cotton is). In the United the remainder was exported (Table 6.3). States, tobacco is a highly profitable crop for other rea­ Domestic consumption of domestically grown, sons, including agricultural price supports that guar­ unmanufactured tobacco fell steadily from the 1950s antee relatively high prices; the availability of loans through the early 1990s, from a peak of almost 1.6 bil­ from government, or tobacco companies, or both; the lion pounds in 1952 to about 900 million pounds in provision of seed, fertilizer, and other agricultural in­ 1993 (Table 6.3). After rising for a few years, domestic put from external sources; and export subsidies (Food consumption of domestically grown tobacco fell to just and Agriculture Organization of the United Nations over 900 million pounds in 1998. Declining prevalence 1990). Counter to these profitable arrangements, to­ of tobacco use is not the only—or even the main— bacco growing is relatively labor-intensive, demands factor behind the long-term decrease; domestically pro­ heavy use of fertilizers and pesticides, and often re­ duced cigarettes contain about 35 percent less tobacco quires the use of fuel for tobacco curing. than they did 40 years ago (Womach 1994b). Further­ Tobacco is a storable product, and its quality ini­ more, the use of imported tobacco in domestically pro­ tially improves with age. After being harvested, tobacco duced cigarettes has greatly increased in recent years. goes through several steps in a processing course, in­ In 1950, the imported tobacco content of domestically cluding sorting and grading (according to type and produced cigarettes was approximately 6 percent. By quality) and curing and drying by various techniques 1993, this proportion had risen to about 40 percent. (including flue, fire, sun, and air curing). Most of this The increased use of foreign tobacco is partly due processing is done on the tobacco farm before the prod­ to improvements in the quality of this tobacco, its rela­ uct is sold to the producers of cigarettes and other to­ tively low price, reduced barriers to trade in tobacco, bacco products. and the increased market penetration of lower-quality Several types of tobacco are grown in the United generic cigarettes, which include a higher share of im­ States and throughout the world. Burley and flue- ported tobacco. cured tobacco, the primary ingredients in cigarettes, The decline in the domestic use of tobacco grown are the most important of the domestically grown types in the United States has been offset somewhat by in­ of tobacco; they account for about 93 percent of total creased exports of domestically grown tobacco. How­ production (Tables 6.1 and 6.2). Most burley tobacco ever, unmanufactured exports peaked at 765 million is grown in Kentucky and flue-cured tobacco is grown pounds in 1978 and have fallen fairly steadily since; in primarily in North Carolina.