Smoke Got in Their Eyes
There's No Economic Logic in the Tobacco Settlement
MARCH 01, 1999 by SHELDON RICHMAN
Economics pervades life. Many people (not Freeman readers) will misinterpret that remark to mean that money is all that’s important. That common misinterpretation testifies to the dearth of economic education in America.
To say economics pervades life is the same as saying that choice pervades life. Everything we do volitionally requires that we choose one thing and forgo another. This is inescapable in a world where everything of value, including time, is limited.
We all understand this implicitly about our own actions. If you explain it to a child of, say, 10, he will know what you’re talking about right away. He makes choices all the time.
But because economics, in this broad sense, is not taught early on to most children, and surely is not taught in schools and universities, people have a hard time applying it to most abstract matters, such as government policy. When they focus on that realm, suddenly there are no choices, and resources at any moment are limitless. Policymakers are the worst offenders.
No better example exists than the recent settlement between the tobacco companies and 46 state attorneys general. Economics was almost completely missing from the analysis of the settlement.
To recap, the tobacco companies, under the threat of pending liability suits and new government regulation, agreed to pay the states $206 billion over the next 25 years to “reimburse” them for medical expenses paid on behalf of residents with smoking-related illnesses. At first, state officials were licking their chops over what they will be able to do when the money starts rolling in. Now it is dawning on them that there might not be as much money as they thought.
The state of Arkansas is a case in point. “Is Windfall for State All Smoke, No Cigar?” asked a headline in the Arkansas Democrat-Gazette. The state was expecting a $20 million check from the tobacco companies by the end of 1998. But to pay that bill, the tobacco companies raised the price of cigarettes by 60 cents. The state’s Department of Finance estimated that because of the price hike, cigarette sales would drop 11 percent, reducing tax revenues by $10 million in 1999. Easy come, easy go.
With the price increase comes an increase in the amount of tax smokers will pay on each pack, 2.8 cents to be exact. That led some people to believe that even if sales drop 11 percent, the state will still come out about $7 million ahead in tax revenues. Not so fast. Remember the broken-window fallacy.
At this point I must acknowledge, reluctantly, that Arkansas has a director of economic analysis and tax research who understands Bastiat’s broken-window principle. “With people having to spend more for cigarettes, that money has to come from somewhere, so we look at that as a wash in sales tax,” Joe LaFace said.
Good point. If smokers reduce other purchases to keep smoking as much as before, they will simply shift from one taxed item to another. There won’t be an increase in tax revenue.
Aside: That, of course, is a good thing. I never regard it as meritorious that a policy, even the repeal of a bad policy, produces more tax revenue. What’s good about government’s having even more money with which to commit mischief?
Well now. The windfall won’t be as large as the states anticipated. And the reason is that the tobacco companies raised prices, presumably dampening demand for cigarettes. Surely no one is surprised that the tobacco companies will pay the states from money obtained from customers. Do the companies have some other source of money? Moreover, since smokers are disproportionately low-income people, we have the Alice-in-Wonderlandish spectacle of smokers’ indirectly reimbursing the states for the medical services the state ostensibly pays for on their behalf.
To truly appreciate this, let’s walk through it step by step. The states, through Medicaid, pay for the treatment of low-income people with smoking-related illnesses. The states demand that the tobacco companies, which made the product that produced the illnesses, pay the states the money spent on treating their customers. The tobacco companies raise their prices in order to have the money to pay to the states for the treatment.
Wouldn’t it be more efficient—not to mention honest—to cut out the middle man? But doing so would give the game away. It would be equivalent to telling low-income people that smoking disqualifies them from Medicaid. How ominous would that be? The government would be announcing that personal habits will determine eligibility for government benefits. Precedent is powerful. If that policy is adopted for Medicaid, surely Medicare is next. And as the government slowly absorbs the medical industry (the attempted quick absorption came a cropper in 1993), it will have set the stage for the general denial of medical care on the basis of personal habits. Government will be in the triage business.
So, if you have clogged arteries and a life of ham and eggs behind you, perhaps Medicare won’t pay for your coronary bypass operation. If you have a cyrrhotic liver and a boozy past, you might be turned down for treatment.
But that won’t be the end of it. If you’re an octogenarian needing a new hip, well, maybe those resources would be better devoted to a younger person with productive years still ahead.
That’s the risk we run when we let government pay medical bills.
To cover all bases, we have to entertain the possibility that higher prices won’t reduce the demand for cigarettes. There were early indications of that. We can’t predict how people will act in the face of new alternatives. Let’s assume demand falls not at all. What happens? As we’ve already seen, there will be no new revenue for the states. Furthermore, since smokers don’t suddenly have additional income with which to pay the higher price, they will reduce other purchases. The falling demand for other products could result in cutbacks and layoffs in those industries. Let’s assume all the people laid off are nonsmokers. That leaves us with an odd outcome. People who don’t smoke will be made to suffer so that people who do smoke can have their medical expenses paid for. Not exactly justice, is it?
I think we can conclude that this tobacco deal is a fiasco. It’s a mass of fallacy, confusion, and dishonesty.
But it didn’t begin with the states’ lawsuits. It’s been going on for years. When the Clinton administration came in it spoke of raising the federal cigarette tax to, first, discourage smoking and, second, pay for health care and anti-smoking campaigns. Now I’m no Rhodes scholar, but isn’t there a conflict between those two objectives? If you have plans for the revenue from the cigarette tax, you’d better hope people keep smoking. That would help save Social Security too.
They never learn. President Clinton wants the states to use their tobacco windfalls for anti-smoking programs. (Some states are resisting.)
I have an idea: the government shouldn’t pay for anyone’s medical care or tax our habits or lecture us on how to live.