Burning Issues in the Tobacco Settlement Payments: An Economic Perspective

The tobacco settlement does not appear to achieve the efficiency objectives of a liability suit, even though it derives from an agreement between the industry and plaintiffs. There is no change in the product, information on hazards is widely available, payments are not made in lump sums because of past behavior, and the financial claims made by the states for recovery of medicaid costs are not justified because additional medicaid costs of smokers are more than offset by savings due to their premature death. As a corrective tax, given the availability of information on hazards and the lack of net external effects on third parties in excess of taxes, the market failure justification rests on suboptimal teenage smoking decisions that do not account fully for the transaction costs of quitting. Recent evidence, however, suggests that teenage participation may be relatively insensitive to price. Moreover, there are costs of introducing a highly regressive tax and of disruption that should be considered as a matter of public policy.