Government regulation and taxation of the tobacco industry

Tobacco industry has seen significant government intervention since at least the New Deal. Tobacco farmers have typically received subsidies for their crops and the benefits of marijuana prohibition but in more decent decades they have also faced increasingly strict controls on the sale of tobacco products. Prior to the era of restrictive cigarette sales, and buoyed by subsidies, tobacco was one of the more lucrative products to farm in the United States, a situation that has changed of late. The most recent move on the part of the government was the Transitional Tobacco Payment Program, which as the name implies was intended to provide incentive for farmers to transition to other crops (Mccord, 2014).

The moves on the part of government have reflected different roles that government has played. The subsidies reflected the role that government plays in promoting agriculture, not just promoting a farming lifestyle but ensuring a certain degree of security in the production of agricultural products. Taxation is more a reflection of fiscal policy, which typically views tobacco products as having a low price elasticity of demand, and therefore a lucrative target for taxation. The government's role in health policy is reflected in restrictions on the sale of tobacco, which have served to drive down demand for cigarettes in the past few decades.

This paper will examine the role that the federal government has played in the tobacco industry, beginning with the New Deal, and through the current situation where tobacco farmers have lost the subsidies that formerly protected their livelihoods.

II. Subsidies for the Tobacco Industry

Government intervention in the tobacco market began in 1933, in the midst of the Great Depression. At the time, major tobacco manufacturers held significant bargaining power over individual farmers, and over small farming groups that were seeking to market their product. As a result of this bargaining power, major manufacturers were able to negotiate prices that were in excess of the cost of production. In basic economics, the long-run effect of this would be to remove some farmers from the market, but of course many farmers felt that there were challenges with exiting the business. The process of reducing supply was going to happen anyway, but it was going to happen slowly and painfully.

Hahn (2011) notes that tobacco farmers were therefore willing to allow for some government intervention in the tobacco industry, in order to guarantee that they would be able to live from the proceeds of their farming (Hahn, 2011). Building on some pre-existing legal structures, the New Deal-era laws finally gave tobacco farmers the price controls they had been seeking since the end of World War One. Hahn (2011) notes that one of the issues farmers faced was the lengthy process of curing and warehousing for tobacco meant that manufacturers were able to insulate themselves somewhat from production variability, and could store product until needed, increasing their bargaining power. Producers, needing cash to live on and to pay for the next years' farming, had no such luxury.

So it was that the federal government became involved at the behest of the tobacco farmers. Tobacco was one of the crops in the Agricultural Adjustment Act, and the trade-off was that agricultural production of tobacco would be reduced, in exchange for subsidies that guaranteed a price floor for farmers. The quotas forced some farmers to exit the business, and the reduction in supply would have increased prices anyway, but the price floor offered a guarantee of a certain price to the farmer, regardless of production cost and regardless of bargaining power with the major cigarette manufacturers. It was this system that remained in place for decades.

The end of the subsidies came in 2004, though the Transitional Tobacco Payment Program offered funding for the next ten years thereafter to farmers who were exiting the tobacco business as the result of losing their subsidies. Despite the restrictions on tobacco sales and the high taxation, the business is still lucrative and major cigarette manufacturers still hold substantial bargaining power over tobacco farmers, so many have left the industry with the end of the subsidies, as other crops have proven to be more lucrative (Bomey, 2015).

The end of the subsidies meant the end of the price floor. This deregulation meant that in all likelihood there would be overcapacity in the marketplace. For decades, tobacco farming was incredibly lucrative because of the price floor. As production techniques improved, so did yields, and farmers could produce for a cost well under the floor, ensuring that any farmer in the market would yield a high profit, in particular on large corporate farms with lower marginal costs (Shillinger, 1995). With the end of the subsidies, the manufacturers would have their bargaining power restored, and this was inevitably going to drive down prices paid to farmers. As such, some of the farmers -- particularly those with high cost structures -- would be flushed from the market, able to make more money producing other crops, and that is exactly what has happened.

With no subsidies, the farmers face an uncertain environment where they do not know how much they will be paid for their production, and that uncertainty makes it difficult to plan production levels, investment in the industry, and it makes it difficult for farmers to know whether or not they will be able to earn a living -- many farmers have left the industry because of this uncertainty.

III. Taxing Tobacco

In the past few decades, there has been an increase on restrictions surrounding the sale of tobacco. Some of the restrictions have related to marketing tobacco products, but taxation policy has also played a key role. In general, tobacco is an addictive product, such that there is low price elasticity of demand. A tobacco consumer is likely still going to be a tobacco consumer even after a tax increase, and this encourages government to increase taxes on tobacco, especially when combined with a public health objective as well (remember that government pays Medicare, Medicaid and the VA, so pays for a lot of health care for smokers).

However, if the tax increases are high enough, people will stop smoking. This is particularly true of people who wish to stop smoking, and need incentive to do so. Further, tax increases can price cigarettes out of reach of young people, so that they never take up smoking in the first place. A study by the World Health Organization estimated that in developed countries the price elasticity of demand for cigarettes was -0.4, meaning that for every 1% increase in the price of cigarettes, demand would fall 0.4% (Perucic, 2012). This is a win for government coffers, but a loss for the tobacco industry, including the farmers because they lose volume with every tax increase.

Thus, taxation has served as a means both to raise state revenues, and as a means to curb its use. The case for the latter is clear -- government has a mandate to contribute to the betterment of public health. Moreover, government typically is a major payer in health care, even in the U.S. where government pays for Medicaid, Medicare and the VA. As such, there is strong incentive for government to balance out the revenue effects of tobacco with the health costs of its use. For most Western governments, this has led to severe restrictions on the sale of tobacco, which in many jurisdictions might be the most-regulated legal product.

Policies to discourage tobacco use come in many forms. These include restrictions on the marketing of tobacco products, but most studies have shown that taxation to increase the cost of using tobacco products is one of the most important means by which the health care costs of tobacco usage can be addressed (Cummings, 2002). Because tobacco is addictive, daily use is costly. Moreover, even a small increase in the cost of tobacco products per pack adds up to a substantial increase over the course of a month or a year. As such taxes on tobacco have been increased considerably in order to reduce demand, in particular among young people -- reducing the number of future addicts has helped diminish tobacco usage considerably and will have a long run impact on overall health.

Conclusions

It is not a question of whether government intervention in the market is good or bad. Any intervention -- or indeed any choice not to intervene and thus create a pure market economy for that good -- is a choice that has winners and losers. One's view of the value of that intervention surely is determined by whether they win or lose. For tobacco farmers, the intervention to create the subsidies was clearly something positive, because the artificial market for tobacco products was profitable. Tobacco manufacturers lost on that deal, but ultimately were also highly profitable because of the lack of regulation surrounding their products for so long. So market intervention was at worst neutral for them, and consumers ultimately paid a higher price in dollar terms for cigarettes than they otherwise would have.

The end to tobacco subsidies essentially brought the tobacco industry closer to a market economy, but of course the sale of cigarettes bears nothing no resemblance whatsoever to a free market. The problem there is that the government intervention was necessary from the government's point-of-view. Even without a public health mandate, the fact that the government is a payer, and that the negative health effects of tobacco products costs the government billions of dollars every year, puts the government at odds with the entire tobacco industry. Where in the 1930s there might have been a case that maintaining farms meant maintaining employment at a time when employment was scarce, the reality is that today government no longer cares that much about tobacco farming, at least not at the federal level. Government's interest in the tobacco industry is much more about balancing its ability to tax the products and the need to reduce health-related costs.

There is certainly moral hazard in that the same government with the power to tax and to regulate is the same government with an interest in reducing health care costs associated with tobacco use. But that just puts the tobacco business in an awkward position -- Medicare is never going to be on the table for any politician with an interest in re-election, and the tobacco industry is basically sitting opposite of that. Government intervention, therefore, is inevitable, and indeed the U.S. can look to other Western countries and see the future -- even more restrictions on the sale of tobacco and higher taxes than Americans face today.

The question of the morality of markets -- and by extension government intervention therein -- can drift into a philosophical rabbit hole, especially the quagmire of weighing deontological versus consequential perspectives (Herzog, 2013). Ultimately the question is moot -- government will intervene in the tobacco market, and whatever choice government makes is going to have winners and losers. There is no inherent right to grow tobacco, in so much as there is no inherent right to grow marijuana. Nor is there an inherent right to market either plant. Ultimately, government intervention should only exist to the extent that the government is fulfilling a public health mandate, and that should mean the continued end of subsidies for producers, but it is actually difficult to distinguish where government's interest in protecting public health ends and where its interest in reducing its own healthcare obligations begins. There is no easy answer -- and government intervention is neither good nor bad -- only that it creates winner and losers.

References

Bomey, N. (2015). Thousands of farmers stopped growing tobacco after deregulation payouts. USA Today. Retrieved October 17, 2016 from http://www.usatoday.com/story/money/2015/09/02/thousands-farmers-stopped-growing-tobacco-after-deregulation-payouts/32115163/

Cummings, K. (2002). Programs and policies to discourage the use of tobacco products. Oncogene. Vol 21 (48) 7349-7364.

Hahn, B. (2011) Making Tobacco Bright. Johns Hopkin University Press: Baltimore.

Herzog, L. (2013) Markets. Stanford Encyclopedia of Philosophy. Retrieved October 17, 2016 from http://plato.stanford.edu/entries/markets/#Jusmar

McCord, E. (2014) Tobacco farmers lose longtime safety net. NPR. Retrieved October 17, 2016 from http://www.npr.org/2014/10/24/357947259/tobacco-farmers-lose-longtime-safety-net

Perucic, A. (2012). The demand for cigarettes and other tobacco products. World Health Organization. Retrieved October 17, 2016 from http://www.who.int/tobacco/economics/meetings/dublin_demand_for_tob_feb2012.pdf