Sunday Science Lesson: Efforts to lower quality of tobacco products are poor substitutes for taxes

by Carl V Phillips

I am back from Italy and the GTNF2015, and mostly recovered. I have more to say about that meeting, particularly posting the content of my talk, and a backlog of a dozen unrelated or semi-related posts I want to write. Not knowing where to start, and it being Sunday, I will go for a science lesson. And, yes, I know I am in the middle of a science lesson series (and being a proper scholar, I am also in the middle of numerous other series) — next week, I hope.

I went to an interesting session about “plain products”, which was a cryptic way of referring to the intentional lowering of the quality of products, using anything from unattractive packaging, to limitations on flavoring, to lowering nicotine concentration. Interestingly, none of the presenters actually came out and said “lowering the quality of products” until I pushed them to adopt such plain language in the Q&A. I suppose their oft-repeated “affecting the value proposition” is the British synonym for that more pointed American phrase. But the former just does not seem to make it clear enough that these tactics are about lowering the benefits that are experienced by consumer — i.e., intentionally hurting consumers in order to manipulate their behavior.

The panelists’ discussion of the effects on the black market (which they predicted would be modest for fiddling with the appearance and huge for lowering the nicotine) brought to mind the basic economics of how to lower the net benefits of taking an action. There is often a legitimate reason for doing so, due to negative externalities (i.e., harms caused to people who are not party to a purchase or action, and thus cannot influence how much of it is done). Consuming fuel creates pollution and is sometimes the reason for military spending. Driving across a congested bridge or into a congested downtown slows everyone else caught in the congestion. We would like people to take the external costs into consideration when deciding whether to take the action, but they will not do so without some intervention that raises the cost they personally pay.

Economists generally favor lowering the attractiveness of the action by just enough that it internalizes the externality costs someone is imposing. To do so, economists basically always favor imposing taxes (as on gasoline) or user fees (such as road tolls). The reason for that is simple: Such transfers are not a net cost to the world; every loss to the party paying the penalty is captured by someone else. In theory, we could create right incentives by making drivers sit for a while in a penalty-box parking area, based on how much time they will cost other drivers by adding to the congestion, or smack someone in the face every time he fills his gas tank. But those are pure costs to the world that have no offsetting benefits.

So consider the case of tobacco products and other products that “public health” people want to discourage. Set aside the question of whether they have any right to do so, and just consider the methods for doing so. Imposing taxes has the advantage of being a transfer, whereas efforts to lower the quality of the product are pure costs with no offsetting benefits. If lowering the quality has any effect on consumption at all, it is because they harmed product users without benefiting anyone. (If they have no effect, then they probably did not really harm anyone, but they did not accomplish anything either.) So basically, at least as a first cut, raising taxes dominates all such alternatives — i.e., it is better in at least one way and no worse by any measure.

Now someone might reply that, in the jurisdictions where these measures are being considered, the taxes are already as high as they can be without tipping a large portion of consumers into the black market (which I use as a shorthand to also include grey markets, sales of products that would be legal but for the failure to pay taxes). But wait. Net benefits from a consumption choice are basically a scalar; everything can be converted into a one-dimensional measure of how good or bad the product is, on net. So lowering the quality in a particular way is functionally equivalent to raising taxes by some particular quantity. It is functionally equivalent in terms of punishing the consumers to manipulate them into reducing consumption. But it is also functionally equivalent in terms of pushing them into the black market. Thus, taxes are still a dominant strategy.

I posed this observation to the panel, who had gone into detail about multiple dimensions of the value proposition, and they basically agreed. There were a few thoughts offered about how there might be complications, making the reality a bit different from the equivalency I proposed, but we did not have time to delve into them. I will take a crack at it here, and then circle back to the question of why the dominated strategy is being attempted.

One possible justification for an alternative method of lowering net benefits might be that they lower the net benefits more for those consumers whose net benefits they are especially keen to lower (again, setting aside the question of justifying having such a goal). After all, the equivalency between X quantity of taxes and some other reduction in product quality is not going to be the same X for everyone, as the above simplification suggested. So in theory it might be possible to find a way to lower product quality to teenagers a lot more than it is lowered for adult consumers of the product. This, of course, is the excuse that is offered for banning attractive flavors.

The problem with this is that there is simply no reason to believe that any of the quality-lowering interventions have this property. None. Curtailing flavors lowers the product quality for some teenager consumers and some adult consumers, and there is no reason to believe that the impact is greater for the former group. Plain packages might lower the welfare of both groups, but there is no reason to believe it would be greater for teenagers. Of course, the “public health” types consider all of those reductions in human welfare for any consumer to be good, but remember that we are looking for a reason why lowering product quality has an advantage over raising taxes, and it does not appear to exist here. Indeed, those who advocate for higher taxes are fond of claiming taxes will have a disproportionate effect on teenagers or would-be new consumers. It is not clear that this is true, but that is their claim, and so they are claiming that raising taxes is even more the dominant choice.

Another theoretical justification could be that some restrictions are harder to thwart via black markets. Once an untaxed cigarette is in the hands of a consumer, it is pretty much indistinguishable from a legal product. So I suppose if one of the new rules was that cigarette sticks had to all be some unattractive shade of green, you could spot someone who was circumventing that restriction at a glance. If this were used as an enforcement mechanism to catch black market consumers, then the black marketeers might have a harder time selling product that was diverted from a low-tax jurisdiction and might have to make their counterfeit product green too.

So if the green sticks really did discourage use (which is doubtful), that characteristic would still have to exist even when the taxes were not paid. If, of course, there was any enforcement at the consumer level, which has never been the case: Many black market products are sold in packs that do not mimic any legal product in the particular market (e.g., black market branded packs in Australia where plain packs are mandatory), and this does not seem to pose a problem for the black market. Moreover, the example that I came up with — ugly colored cigarettes — is really the only thing I can think of that even conceivably could have this property, of being difficult for even black marketeers to avoid.

The zombie idea of mandating lowered nicotine content is a bit of different story. Lowering nicotine content is a huge reduction in quality that unlike cosmetic changes — which are probably the equivalent of only a few cents of extra taxes — is equivalent to an enormous increase in taxes. Of course that means it is also an equally enormous incentive for shopping on the black market. The bigger the reduction, the bigger that incentive. Perhaps the 2% limit on e-cigarette liquid in the EU TPD is not enough to inspire a huge shift to the black market, though it will certainly cause some. Some consumers who want a higher concentration will just compensate by consuming more. Still, that option is enough more expensive — effectively an 80% tax on those who would prefer to use 3.6% nicotine liquid and so need to buy 80% more to compensate — that it will encourage a black market just as taxes at that level would.

The extreme versions of such proposals, which consist of lowering the nicotine content of legal cigarettes more and more, toward zero, are basically a prohibition. Take this far enough and it lowers the quality so much that it is difficult to claim that the real product consumers want is not banned; as one of the panelists pointed out, the legality of beer with 0.5% alcohol during Prohibition was never considered by anyone to mean that there was not a prohibition. Technically, a prohibition is basically the same as raising taxes on legal high-quality product to infinity, though this is fundamentally different from normal levels of taxation. The real issue is that such proposals are batshit crazy and so obviously counterproductive that they are unlikely to happen.

In short, I simply cannot think of any way in which lowering product quality — short of de facto prohibition — is not dominated by just raising taxes more. So why do such things get proposed? I can think of several reasons.

First, “public health” people are notoriously bad at understanding even basic economics. I have written about that many times (example). So they probably do not even understand that they are proposing dominated strategies. Second, whether or not they understand that, they can perhaps trick lawmakers into thinking these measures serve some purpose or have some potential that is absent for further tax increases. Perhaps they can convince them that this will not drain tax revenues (as they will, by encouraging the black market without even getting more taxes from those who remain in the legal market), and are more palatable than further taxation.

Then there are a few reasons that might not be based on innumeracy or pure politics. It is plausible that some particular quality reductions might not be as effective at driving consumers to the black market as equivalent losses via taxes are. The exact magnitude of price differentials is hard to fail to understand, whereas incremental degradation of quality might be a “boiling a frog” kind of thing. Black marketeers can easily demonstrate that their products are cheaper, but it might take a while for people to figure out when they are also higher quality. The bottom-feeders of the black market would still offer lower overall quality than the legal products, and other marketers might find it hard to distinguish themselves. Of course this is speculation. I am aware of no affirmative reason to believe this — and the frog thing is not actually true, of course.

Ultimately, though, I think it mostly comes down to two observations: “Public health” people have never met an anti-tobacco measure they did not like and they do not actually care about wasting resources and hurting people. This means they pursue every abuse they can think of, regardless of it being a terrible option (even if you stipulate that the goals are valid). They are ignoring the principles of good public policy because they do not care about good public policy. Despite their meetings and pronouncements, they are really a barbarian mob, not an army. But that should not stop us from using observations like the above when responding to them in contexts where someone else might care about good public policy.