Cost Benefit Analysis Article Critique

Excerpt from Article Critique :

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…

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