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Incentives in "Thank You For Smoking"
by Dirk Mateer `

We know that smoking leads to an increased incidence of lung cancer and emphysema in individuals who smoke. Smoking also creates two negative externalities: an increased demand for medical services, since smokers are generally not as healthy as non-smokers, and secondhand smoke, which can affect those who are exposed. Thank You for Smoking follows the career of Nick Naylor, the chief spokesman for the Academy of Tobacco Studies, a lobbying organization. As the public face of tobacco manufacturers, Nick has a very difficult job. He spends his time defending the suspect “research” of the Academy of Tobacco Studies in the media and defending the rights smokers to choose for themselves. When increasing political pressure prompts lawmakers to introduce legislation that will replace the Surgeon General’s warning with a skull and crossbones on all cigarette packaging, Nick suggests paying Hollywood celebrities to smoke on screen to increase the visibility and glamour of cigarettes. He hopes that making cigarette smoking “sexy” will increase demand for cigarettes despite the new warnings. The film is study in market inefficiency. Since cigarettes create negative externalities, tobacco companies have an incentive to try to downplay the harm caused to others. At the same time, when externalities are significant – as they are with smoking – the government’s role is to try to restore the social optimum. The film nicely illustrates how stronger packaging regulations, like the skull and crossbones discussed in the film, will curb demand. The government also restricts production by taxing cigarette sellers. As of 2009, the federal tax on a pack of cigarettes is 39 cents. Individual state cigarette taxes vary, but average over $1.00 per pack. While the taxes are significant, cigarettes taxes in the United States are small compared to the European Union, where they range from $2.00 to as much as $10.00 per pack. Curbing demand and restricting supply both accomplish the same objective, lowering sales. Recall that when negative externalities exist that the private market equilibrium occurs at a higher output level because produces and consumers of cigarettes both ignore the social costs of their actions. In order to restore the social optimum, the government must discourage consumption of cigarettes. If the government can accurately measure the external damage done to society by the negative externalities associated with cigarette use, it can restore the socially optimal level of cigarette use. Determining the exact level requires a cost-benefit analysis of all of the factors that go into the production and use of cigarettes to determine the optimal amount of regulation and taxation. This calculation is not simple and there is wide disagreement about the optimal tax size, as evidenced by the large differences in tax rate on cigarettes in the United States and Europe. In addition, there is an inherent conflict of interest since the government collects tax revenues. The government can set tax rates to the level it believes will minimize the externalities involved (by invoking high tax rates that discouraging most consumption) or the government can set the tax rate to the level where it maximizes the revenue that is collected. In a world where government revenue sources are hard to come by it is worth noting that governments may use cigarette (and other sin taxes) primarily as a revenue source and not as a means to fight externalities.

This Commentary is related to the following Clips:
Incentives in "Thank You For Smoking" by Director: Jason Reitman, Producers: David O. Sacks and Edward R. Pressman (2005) Nick Naylor proposes a way to combat the anti-smoking campaign.