Tobacco Regulation and Cost-Benefit Analysis: How Should We Value Foregone Consumer Surplus?

51 Pages Posted: 1 Aug 2016

See all articles by Helen Levy

Helen Levy

University of Michigan at Ann Arbor - Institute for Social Research (ISR); National Bureau of Economic Research (NBER)

Edward C. Norton

University of Michigan at Ann Arbor

Jeffrey A. Smith

University of Wisconsin - Madison; National Bureau of Economic Research (NBER); Institute for the Study of Labor (IZA)

Date Written: July 2016

Abstract

Recent tobacco regulations proposed by the Food and Drug Administration have raised a thorny question: how should the cost-benefit analysis accompanying such policies value foregone consumer surplus associated with regulation-induced reductions in smoking? In a model with rational and fully informed consumers, this question is straightforward. There is disagreement, however, about whether consumers are rational and fully informed, and the literature offers little practical guidance about what approach the FDA should use if they are not. In this paper, we outline the history of the FDA’s recent attempts to regulate cigarettes and other tobacco products and how they have valued foregone consumer surplus in cost-benefit analyses. We discuss the evidence on whether consumers are fully informed about the risks of smoking and whether their choices are rational, reviewing the competing arguments made by different authors about these questions. We describe the appropriate approach to welfare analysis under different assumptions about consumer information and rationality. Based on our reading of the theoretical and empirical literatures, we advocate using a behavioral public finance framework borrowed from the literature on environmental regulation. This approach applies standard tools of welfare analysis while allowing consumer behavior to deviate from rationality and full information without requiring specific assumptions about the reason for the deviation. The use of this approach would substantially reduce the confusion currently surrounding welfare analysis of tobacco regulation.

Suggested Citation

Levy, Helen and Norton, Edward C. and Smith, Jeffrey Andrew, Tobacco Regulation and Cost-Benefit Analysis: How Should We Value Foregone Consumer Surplus? (July 2016). NBER Working Paper No. w22471, Available at SSRN: https://ssrn.com/abstract=2816745

Helen Levy (Contact Author)

University of Michigan at Ann Arbor - Institute for Social Research (ISR) ( email )

Ann Arbor, MI 48106-1248
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Edward C. Norton

University of Michigan at Ann Arbor ( email )

500 S. State Street
Ann Arbor, MI 48109
United States

Jeffrey Andrew Smith

University of Wisconsin - Madison

716 Langdon Street
Madison, WI 53706-1481
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Institute for the Study of Labor (IZA)

P.O. Box 7240
Bonn, D-53072
Germany

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