The costs of cigarettes: the economic case for ex post incentive-based regulation.

• Author: Hanson, Jon D.

CONTENTS

1. INTRODUCTION: DEFINING THE PROBLEM

   1. A Brief History of Cigarette Regulation

   2. An Introduction to Incentive-Based Regulation and Enterprises

      Liability

   3. The Absence of Incentive-Based Regulation in the Proposed

      Settlement

   4. Overview II. THE FIRST SOURCE OF CONSUMER UNDETERRABILITY:

      IMPERFECT INFORMATION

   1. Current Views of Consumer Risk Perceptions

   2. A Critique of the Conventional Wisdom

      1. The Third-Person Effect

      2. The Problems of Imperfect Brand-Specific Information

      3. The Problem of Imperfect Relative-Risk Information

      4. The Potential Significance of Addiction and Other

      Related Sources of Imperfect Information

      a. The Industry's Claims

      b. Identifying the Relevant Margin: The Problem of Path

      Dependence

      c. Temporal Separation of Benefits and Costs:

      The Problem of Myopia

      d. Disaggregated Benefits and Pooled Costs:

      The Problem of Multiple Selves

      e. The Economists' Response

      i. The Premier Experiment

      ii. Evidence of Rational Decisionmaking

      iii. Summary

   3. The Informational Effect of Ex Post Incentive-Based

      Regulation Revisited III. THE SECOND SOURCE OF CONSUMER UNDETERRABILITY:

      NEGATIVE EXTERNALITIES

   1. Insurance Externalities

   2. Noninsurance Externalities

   3. A Review of, and Critical Response to, the Economists'

      Rebuttal

      1. Summary of the Economists' Cigarette Studies

      2. Critique of the Economists' Cigarette Studies

      a. A Closer Look at Negative Externalities:

      Incorporating the Imperfect Information Argument

      i. Costs to the Smoker's Family and Other Third

      Parties

      ii. Insurance Externalities

      iii. Costs to the Smoker

      iv. Additional Concerns

      b. A Closer Look at the Positive Externalities

      i. Assets Enjoyed (and Not Enjoyed) by Others

      ii. Do Smokers Really Externalize Forgone

      "Benefits"?

      iii. What About the Current Level of Excise Taxes?

      iv. Morality and Social Norms

   4. The Potential Internalizing Effects of Ex Post

      Incentive-Based Regulation

   5. Summary IV. CHOOSING AMONG REGULATORY APPROACHES

   1. The Disadvantages of Command-and-Control Regulation

   2. The Disadvantages of Performance-Based Regulation

   3. The Disadvantages of Ex Ante Incentive-Based Regulation

      1. The Informational Demands of an Ideal Pigouvian Tax

      2. Additional Deterrence Problems with Current Excise

      Taxes: The Unraveling Effect and Errors of Omission and

      Commission

   4. The Advantages of Ex Post Incentive-Based Regulation

      1. The Reduction of Information Problems

      2. The Reduction of Overdeterrence Problems When

         Information Varies Across Consumers

      3. The Prevention of Unraveling

   5. The Advantages of Victim-Initiated over State-Initiated

      Ex Post Incentive-Based Regulation

   6. Summary V. IMPLEMENTING A VICTIM INITIATED EX POST

      INCENTIVE-BASED SYSTEM

   1. Alternative Victim-Initiated Ex Post Incentive-Based Systems

      1. Enterprise Liability

      2. Smokers' Compensation a. Causation

         a. General Causation

         i. Specific Causation

         ii. Specific Causation

         b. The Cigarette Card

         c. Damages

      3. Summary

   2. What Might the Cigarette Market Look Like in a World with Ex

      Post Incentive-Based Regulation?

      1. Safer Cigarettes and Safer Smokers

      2. Black Market Cigarettes

   3. The Problem of Transition and the Case for Supplementary

      Ex Ante Regulation

      1. Making the Transition to Ex Post Incentive-Based

         Regulation: The Retroactivity Question

      2. The Judgment-Proof Problem

      3. Widely Dispersed Harm: Dealing with Public ETS

         Exposure

   4. Summary VI. AN ASSESSMENT OF THE PROPOSED NATIONAL TOBACCO

      SETTLEMENT

   1. The Complete Rejection of Ex Post Incentive-Based

      Regulation

      1. The Proposal's Civil Liability Provisions

      2. The Effect of Civil Liability Provisions

   2. The Proposal's Attempt To Inform Consumers

      1. Warning Requirements

         a. Summary of Provision

         b. Critique

      2. Marketing Restrictions and Antismoking Advertising

         a. Summary of Provisions

         b. Critique

      3. The "Look-Back" Provision

         a. Summary of Provision

         b. Critique

      4. The Proposal's General Price Effects: The Excise Tax

         Model

         a. Summary of Provision

         b. Critique

   3. The Proposal's Attempt To Reduce Noninsurance Externalities

   4. Specific Provisions Intended To Improve Manufacturer Care

      Levels

      1. Command-and-Control Regulations

      2. Performance-Based Regulations

   5. Transition Issues

      1. The Distinction Between Past and Future Harms:

         $368.5 Billion for What?

      2. Barriers to Entry

   6. Assessing the Proposal from a Distance VII. CONCLUSION

      APPENDIX: A CLOSER LOOK AT VISCUSI'S SURVEY DATA

   1. A Questionable Reference Point

   2. Qualitative Versus Quantitative Data

1. INTRODUCTION: DEFINING THE PROBLEM

   1. 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,(1) 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 the staggering social costs imposed by cigarette smoking, an outside observer might find it odd that cigarette production and consumption in this country are, to a remarkable extent, unregulated. It is true that selling cigarettes to minors is illegal in every state.(5) It is also true that a number of states and municipalities have passed laws and ordinances restricting the right to smoke in various public domains--from government buildings and health facilities to, in some cases, private workplaces.(6) And if one compares these levels of regulation to the level of regulation imposed on, say, bubble gum consumption, cigarette smoking seems fairly heavily regulated.(7) If, however, one compares cigarettes with other products that are considered dangerous but are comparatively less costly to society, such as heroin or cocaine,(8) the level of cigarette regulation seems inadequate. After all, adult smoking is legal in all fifty states. Likewise, if one compares the hands-off approach to regulating cigarette companies with the hands-on approach to regulating, say, pharmaceutical companies (many of whose products treat or even cure, rather than cause, serious health problems), tobacco companies appear to be essentially unregulated. Of the tobacco regulations that do exist, many turn out to be industry-friendly.(9) On top of all this, until very recently it appeared that cigarette companies, unlike most product manufacturers, were effectively immune from regulation by tort law.(10)

      How can this be? A good case can be made that the cigarette industry owes its privileged, lightly regulated status largely to the perseverance and ingenuity of its lawyers and to an unprecedented level of industry cooperation and solidarity. By amassing an immense lobbying war chest,(11) by developing a uniquely aggressive public relations and advertising approach,(12) and by adopting a self-described "General Patton" litigation strategy,(13) the cigarette industry has gained a reputation as unbeatable both in the courtroom and in the public policy arena.

      Consider, for instance, the industry's extraordinary ability for many years to avoid paying a penny to any tort plaintiff. Until very recently, the vast majority of decided cases and other legal authorities were hostile to the notion of cigarette manufacturer liability. Cigarette companies had managed not to pay damages (or to settle for a substantial payment) in even a single case brought against them by smoking plaintiffs, notwithstanding two "waves" of tort suits during the fifty years that scholars refer to as the "products liability revolution."(14) Until very recently as well, cigarette plaintiffs could find little reason for hope in the more general trends in products liability law. Whereas the 1960s and 1970s were characterized by an extraordinary expansion of liability, reflecting the then-prominent theory of enterprise liability, that trend largely ended in the mid-1980s. Since then, there has been a substantial retreat from enterprise liability in the courts.(15) In addition, one of tobacco plaintiffs' most promising legal theories, generic product liability,(16) has lost viability. Courts that were moving toward generic product liability, condemning outright particular products as unreasonably dangerous (despite the best possible design, construction, and warnings) and therefore subjecting them to strict liability, have been repeatedly overridden by their state legislatures.(17) Moreover, the reporters for the Restatement (Third) of Torts(18) squarely rejected generic products liability.(19)

      Similarly, for most of this time, the Food and Drug Administration (FDA) avoided any challenge to the nonregulatory status quo. That decision was due, not to a perceived lack of jurisdiction, but to a bureaucratic instinct for self-preservation. In the words of former FDA Commissioner David Kessler: "There was a sense among many within the agency that you couldn't pull it off, and the last thing you wanted was to tackle something you couldn't pull off and have the agency get killed."(20)

      Because of the dominant public sentiment regarding smokers and cigarette manufacturers, the prospect of altering this essentially laissez-faire market has long seemed remote. Indeed, the inhospitable legal environment reflects--and is, to some extent, the product of--the traditional American values of self-reliance and individualism, as well as pervasive public hostility toward smokers (the usual plaintiffs).(21) For a long time, there has been a strong sense among many scholars, commentators, and members of the public that smokers who die prematurely get what they bargained for (and, perhaps, what they deserve) and should not be heard to complain, much...