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

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 advocate replacing the approach used in most of this literature, which first calculates health gains associated with regulation and then “offsets” them by some factor reflecting consumer surplus losses, with a more general behavioral public finance framework for welfare analysis. This framework applies standard tools of welfare analysis to consumer demand that may be “biased” (that is, not necessarily rational and fully informed) without requiring specific assumptions about the reason for the bias. This framework would require estimates of both biased and unbiased consumer demand; we sketch an agenda to help develop these in the context of smoking. The use of this framework would substantially reduce the confusion currently surrounding welfare analysis of tobacco regulation.