Cost benefit analysis principles and applications

¶ … Benefit Analysis

Introduction and Analysis of the Project: Cost-Benefit Analysis of Proposed New Health Warnings on Tobacco Products (Report, 2003)

The new regulation introduced in July 2004 to be implemented for all the years till 2030, have significant cost impact on the economy. Certain benefits are also associated with it, the primary ones include health improvement, increased revenues for non-tobacco industry and the decreased healthcare expense. The major costs are related to enforcement of this system, printing health warnings, decreased sales for tobacco industry and decreased revenue to the government. The report highlights the costs and benefits keeping in view the different years after implementation of regulation (Report, 2003).

Usually, the discount rates of 5 and 7% are used to estimate the costs and benefits likely to occur in the future. In all other industries, the Australian government makes its calculations on 7% discount rates assuming it the most appropriate discount rate that can be experienced as rate of return if the capital is invested on other projects. However, the appropriateness of this discount rates is questionable in the present world economic conditions in general and health sector in particular. Health sector usually has lower discount rate as they have long-term implications (Report, 2003).

The project is described as efficient if its NPV is positive (Report, 2003). Positive NPV shows that the benefits are more than costs as it is the simple difference of benefits and cost. It is important to mention that while calculating NPV, both the cost and benefit figures must be discounted to present rate.

It is also possible that a policy returns negative NPV, but it is still considered favorable. It means that there is another variable to determine whether the policy is desired or not. This variable is distributional implication. The benefits and costs are evaluated in the perspective of their incidence. There is no direct relationship between efficiency of a policy and its distributional implications (Report, 2003).

This reports casts light on the cost and benefit impact of health warning system that is proposed in the perspective of various social groups (Report, 2003).

The Setup

Below is the outline of major steps taken during the analysis in the selected report. It starts with forecasting the impact of proposed health warning system on tobacco consumption and the revenues tobacco industry has. It is the major point in analysis of the new system. The report also calculates the expenses which are likely to occur to switch to the new system and the shift of revenues from tobacco industry to other industries (Report, 2003).

The following section casts light over the costs and benefits associated with proposed health warning systems. In also provides the risk analysis of the new system. The section gives an idea that what are the possible costs and benefits if the system is implemented and if it is not implemented. All the values used in the analysis are accumulated to total policy period and discounted to the present rate to get a fair idea. The calculations are based on different social groups and years (Report, 2003).

Main steps in the cost-benefit analysis

1. Difference of social groups must be considered (Report, 2003)

2. Possible uncertainty and risk must also be considered

3. Cost and benefit values must be aggregated to total policy years to calculate total net benefit that is expected

4. Household effects and other industry values must be considered in analysis

5. Calculate expected impact of policy on government

6. Calculate possible gains for tobacco users

7. Calculate cost to be incurred on implementation of system in the tobacco industry

8. Calculate relationship between policy enforcement and rate of tobacco consumption

There are several stages belonging to health warning review (CDHAC, 2001):

Stage 1: the company that is undertaking the research project must be independent (Elliott and Shanahan Research, 2000) so that effectiveness and usefulness of health warning can be accurately assessed.

Stage 2: for public awareness and feedback, the distribution of discussion paper related to health warnings.

Stage 3: comments by the public related to health warning need to be considered. In addition to this, other researches that have been conducted are considered relevant. Market testing, development, along with improvement in strategies for the purpose of change.

Stage 4: government regulatory procedure includes preparation of draft regulation along with a statement of regulation impact which needs to be consulted by the regulation review authority. For public feedback, these statements are distributed.

Stage 5: all the regulations are finalized and are then submitted to executive council. If the council approves the regulations they are processed further for publishing in Commonwealth of Australian Gazette.

Stage 6: period of implementation

Main Costs and Benefits

It is expected that the new health warning system has multiple stake holders including all players in tobacco industry. The four main identified groups are government, tobacco consumers, third parties and the tobacco industry on the whole. The tobacco industry has many players like retailers of tobacco products, importers, suppliers and manufacturers as well (Report, 2003).

Among all the stakeholders, the tobacco manufacturers are the most likely entity to suffer from the new health warning system. It is because the carry out the major portion of activities in tobacco industry. They purchase tobacco leaf, process it, manufacture the products, manage printing on packaging, control inventory and deliver the products to retailers (Report, 2003).

A table is given below to shows the impact of new system on all groups. As the new warning system is likely to reduce tobacco sales, it is argued that the cost incurred on printing the warnings on packages must be transferred to the final consumers instead of bearing by the manufacturers. Hence, two major cost heads are likely to change; the revenue generates from sales and the expenses occurred on production. It leads to reduced profits and the reduced amount of tax to be paid to government (Report, 2003).

Major impacts by social group (taken from Report, 2003)

Social group and impact

Notes on impacts

1. Tobacco industry costs

Tobacco growers

Loss of net income

Manufacturers of tobacco products

Loss of net income, compliance/printing costs

Importers of tobacco products

Loss of net income

Retailers of tobacco products

Loss of net income

2. Tobacco consumers' benefits

Longevity, health, productivity, quality of life benefits

3. Government costs and benefits

Public health information expenses Net loss of tax revenues Savings in health care expenditures

4. Third party impacts

Other industry

Gain of economic profit, labour productivity

Other third party effects

Reduction in passive smoking cost, better health conditions for babies and reduced risk of fires

Smoking is detrimental to health and can cause diseases like strokes, chronic obstructive pulmonary diseases, lung and other cancers. All these diseases can lead to death, 20,000 of them can be considered as premature deaths. All those individuals who quit smoking start living a life of improved quality. Quitting tobacco consumption is a great step and it is taken when smokers get to know about the diseases that are caused due to smoking. The diseases suffered by people who consume tobacco make their life before death quite miserable, and even reduce the life span from nine to ten years. It is therefore contingent that those people who divert their expenses are not trailing any customer leftover (Report, 2003).

This report does not discuss about the losses of customer surplus. The interest and tobacco consumption habit of some smokers remain unchanged. Many smokers left smoking due to the price of tobacco which was greater than its real worth; therefore they did not lose any consumer surplus. After quitting the consumption of tobacco these people have diverted their attention to substitute products and are quite happy with their use.

When individuals will switch to other products, the government would definitely lose some revenue but then would gain tax from other alternative sources. Government would lose the revenue it previously availed through custom duties, GST and excise tax. There are a small number of other products which attract custom duties or excise tax and as far as GST is concerned it is not to be paid on 40% of alternative purchases. Nevertheless, Government will somehow manage to collect GST from other expenditures. Tobacco manufacturing companies pay high corporation taxes; a downfall in the consumption of tobacco products would lower the Government's corporate taxation income. While income tax availed from individuals does not change due to switching of expenses (Report, 2003).

Indirect taxes are referred as transfer payments, and are not accounted for in cost benefit analysis. Excise tax is not payable by individuals who quit using Tobacco products; this therefore acts as a saving for them. Individuals are least bothered after switching from tobacco to non-tobacco product that the $x being utilized in purchasing the product is going to Government or to the suppliers. In the absence of excise, the $x paid for the product would have gone directly to the supplier and none would have gone in Government reserves, the result would have been a loss of producer surplus rather than a decline of excise income (Report, 2003).

Decline in tobacco linked morbidities would bring reduction in the health care expenditure, which was previously done for the betterment of the public at large. Reduction would be apparent in the hospital costs, in pharmaceuticals, in other medical services, in health consultations and in nursing homes. Third parties would be benefitted by the reduction in smoking, like for example many industries would earn more revenue when smokers will switch to non-tobacco products, while others would benefit by the productivity of the workforce. Tobacco industry losses are balanced by the net income generated from other products. With the reduction in smoking, the surrounding air would be clean; few people would become passive smokers, moreover, the parental heed required for low weight babies would be reduced (Report, 2003).

Methods

Methods that were used for the study were appropriate. The study used the counterfactual exposure distributions to anticipate future trends. Some of the methodological errors or improvements that would be suggested here however could include:

There were instances when costs and benefits were overlapped

There were instances when certain health benefits were overlooked

There were instances when specific health costs were overlooked

The analysis and anticipated results were restricted to gender analysis only as opposed to different health costs or hazards analysis -- this could potentially be a good technique for future studies even if the same methodological distribution technique is used

Estimations and anticipations recorded in the results (as also displayed in the graphics below) will need to recalculated and reassessed in future studies bearing in mind the aspects that this case study overlooked

If the researchers want the reliability and validity of this case study to stay intact, they will need to review the new health policies and the outlook of tobacco users towards the new health policies in order to have a complete and thorough as well as generalizable case study that can be applied by future practitioners as well.

Also, since the overall approach towards statistical comparisons will move beyond the gender variables, the statistical analysis and software might also have to be enhanced and the use of a likert scale or regression might come in handy

The Results

Market Testing of New Health Warnings

Smokers' attitudes towards the content of new health warnings

Smokers will be greatly attracted to health warnings due to two main reasons. As they are already familiar with the existing warnings and laws regarding health care they will immediately observe the introduction of new health warnings. The new content is discussed in the section. Another main reason is that smokers will definitely notice these new large size warnings with different layouts (Parr et al., 2011).

Several claims arose regarding the introduction of health warnings. It was believed that these warning may not create any impact on smokers. However, it was observed that smokers were greatly influenced by these new warning statements. It encouraged them to focus on their smoking habits. Besides they are few smokers who consider these warning very seriously, particularly if they are related to their medical problems. For instance, smokers who are above the age of 40 have chances of suffering from emphysema. Similarly, those people who had been suffering from any heart disease became very concerned regarding their smoking habits and started observing the consequences (ERG, 2000; Parr et al., 2011).

The graph drawn above indicates the most serious cases which are particularly noticeable among the smokers. A few were the ones who tried to get away from imagery (ERG, 2000; Parr et al., 2011).

Most of the health care warnings such as baby and Zita turned out to be very effective and influential in cases of extreme shame, embarrassment, and guilt. Images and other testimonials are the proofs that what physical and emotional impacts smokers have on themselves and the people around them. Medical researchers also come up with different factors of having kidney and bladder cancer and many of those factors are associated with the smoking. In the same way, there is different news about warning the people from the effects of smoking in the new way, such as the picture of Bryan concerning the lung cancer (ERG, 2000; Parr et al., 2011).

The purpose of such new and fabricated health warning campaigns have various points that can impact the smokers and the quitters in various ways. It is also to be noted that its content, message and way of conveying message is a little different what it the current scenario because of:

• A broader range of topic areas;

• A mix of different styles of images;

• A greater emphasis on morbidity, rather than mortality; and • A strong emotional component (Jarvis et al., 2001; Parr et al., 2011).

Broader range of topic areas:

Addressing those facts in conveying the message which has nothing to do with the health actually increase the effectiveness of this whole campaign. Smokers, which ae showing deflective behaviour in terms of realizing the effects of smoking in terms of financially, the severe health risk like lung cancer to the other people around him or her. Many smokers are very conscious about the increasing price of cigarettes. In the same way, many face rejection and criticism from their friends and family, hence smoking may affect the relationship between them and the smoker (Jarvis et al., 2001; Parr et al., 2011).

Mix of different styles of images:

The new strategy used in these warning campaigns was to employ various images to make it attractive and visible to the people. These images were used not only to show the extreme cases of body infections but also to highlight the familiarity creeps in:

"It shows just another damaged inside bit of the body."

"I can't tell the difference between a cow's insides and my own, so it doesn't matter to me." (Parr et al., 2011)

Many images which are used in such campaign were very effective in delivering the message and getting attentions of the people. For instance, the association of the Bryan with the lung cancer actually increased its message impact on the viewers. In the same way, the image showing blood of a person in the toilet resulting due to kidney cancer makes the smokers to imagine what would happen if they go through similar situation (Jarvis et al., 2001; Parr et al., 2011)

Greater emphasis on morbidity, rather than mortality:

This new warning campaign was aimed on the unhealthy aspects of smoking rather than showing the mortality facts. This is an effective way to inform the smokers about health issues caused by this smoking than only death itself. This highlighted the deteriorating health condition like stroke warning and potential loss of your loved one, friend or family and enabling of taking bathing and eating (McNeil, 2000; Parr et al., 2011).

Those warnings were shown as the act of smokers a very shameful and embarrassing for the people around them. The throat cancer and dental diseases were shown fully associated with the consequences of smoking not the other medical facts. In the same way, these healthcare warning campaigns also blamed the smokers of not quitting the smoking as it is under the control of the users either to keep using it or quit it forever (Parr et al., 2011).

Use of life histories:

As we have already discussed in the last section, the case studies play a pivotal role to influence smokers emotionally to quit the smoking. The name, age and time increase the authenticity of the message which these warning campaigns are showing to the smokers. In the same way, the disclosure of ages and names of Bryan and Zita but not showing that they are the famous actors and everyone should follow them. So, the names definitely help the viewers to memorize this healthcare warning message and correlate the relevance and condition of oneself with that particular case which is being shown. Such testimonial approaches foster the process of emotional involvement of people to the underlying situation (McNeil, 2000; Parr et al., 2011).

Estimated Benefits of Health Improvements

Health benefits of individuals are dependent on the quality and on the length of the lives. An epidemiological forecast in given in chapter five related to the deaths and the DALYs averted because of the consumption of tobacco. Valuation parameters are provided by this section (Report, 2003).

The fundamental assessment needs the significance of a life year. As was discussed earlier in the report that immature deaths lead to a decline in the average number of years of life. The lost years cost is further increased by the low quality life that is experienced before early deaths (Report, 2003).

This study discusses the economic literature on deriving the value of a healthy year from the value of life. The literature on valuing life years and life was reviewed in depth by Tolley et al. (1994) and they declared the range of U.S.$70,000 to U.S.$175,000 per life year to be a reasonable one. Cutler and Richardson (1997) in their study on valuing U.S. population health adopted an average value of U.S.$100,000 for a healthy year in 1990. The concept of valuing health year could be understood by the example where the value of a healthy year is found to be $118,000, if the estimated value of life is $2.0 million discounted at 5%/annum with average loss of healthy life being a period of 40 years.