The new economics of smoking.

• Author: Gruber, Jonathan
• Position: Research Summaries

The past six years have seen an enormous change in the treatment of smoking by both the public and policy makers. In 1995, federal and state excise taxes on cigarettes were one-third lower, in real terms, than their peak level of the mid-1960s. But taxes have risen by over 50 percent since then, and now stand at over one dollar per pack.

From the traditional economic perspective, this shift in government policy is unwarranted. The traditional economic model of smoking follows the standard approach to modeling any decision that involves tradeoffs over time (1). Fully informed, forward-looking, rational consumers make the decision of whether to smoke, weighing the benefits of doing so in terms of smoking enjoyment against the costs in terms of health and other risks. The only call for intervention in such a model is related to the externalities that smokers impose on others, such as increased medical costs for our public insurance programs. But such externalities are in fact fairly small by most measures, since these costs are offset by the savings from earlier mortality of smokers, who pay a lifetime of Social Securit3, taxes but often don't live long enough to collect their benefits. As a result, the traditional economic model would suggest that the "optimal" tax on cigarettes may be below even its 1995 level.

My recent work has questioned the validity of this traditional model. I have developed, in work with Botond Koszegi, an alternative model of the smoking decision which has radically different implications for government policy, rationalizing large taxes on cigarettes and other types of regulatory controls (2). In this article, I describe this "new economics of smoking."

The New Approach

The fundamental problem with the rational addiction model is that it does not account for the "self- control" problems faced by smokers. There is ample evidence that adults are unable to quit smoking even if they have a desire to do so. Eight in ten smokers in America express a desire to quit the habit, but many fewer than that actually do quit. According to one study, over 80 percent of smokers try to quit in a typical year, and the average smoker tries to quit every eight and half months. Fifty-four percent of serious quit attempts fail within one week.

These facts motivated Koszegi and me to develop an alternative formulation of the smoking decision which changes the traditional formulation in just one critical way: by allowing smokers to be time inconsistent. This approach, now widely used within the new field of "behavioral economics," is one where there is conflict between what the smoker would like for himself today and what he would like for himself tomorrow. Today's "self" is impatient. Faced with the tradeoff between the short- term pleasures of smoking and the long- term health damages of doing so, he will greatly discount the latter and decide to smoke. But tomorrow's "self" is much more patient. That more patient self would prefer to quit smoking. The problem, however, is that tomorrow never comes. The next day, the future self who was patient is now the current self who is impatient. So the smoking continues, to the long-term regret of the smoker. This is in contrast with the time consistent formulation that is assumed by the traditional economics model. In that formulation, today's self and all future selves are in agreement about the advisability of smoking, leading to no regret or inability to carry out plans to quit.

This formulation of preferences is one which is much more widely supported by the large literature on experimental evaluations of individual choice over time. Experiments consistently show that consumers are much more patient when making decisions about the future than when those same...