Regulation Is the Taxation of Power
Smoking cigarettes is bad for one’s health. The U.S. healthcare system ends up holding the bag for the cost of dealing with its long-term effects. On the face of it, the acceleration of the decline in cigarette consumption is good news, but this is offset by the growth in alternative methods for ingesting nicotine such as vaping or chew. Here’s the Wall Street Journal:
“According to data from Marlboro maker Altria, cigarette’s share of the U.S. nicotine industry fell to 60% last year, down from 80% in 2018. Smokers are switching to smoke-free products such as vapes in higher numbers than expected. If the trend continues, it will only take another three years for cigarettes’ share to dip below 50%.
“In another bearish sign for cigarettes, British American Tobacco recently announced a £27.3 billion non-cash impairment of some of its U.S. tobacco brands, equivalent to $34.6 billion at current exchange rates. The move reduced the book value of brands such as Camel and Newport by a third, in an admission that their long-term prospects have deteriorated since BAT took control of their maker Reynolds American in 2017.”
This is remarkable given tobacco’s historical inelasticity of demand. Before the emergence of vaping and other smoke-free alternatives, cigarette manufacturers were able to raise prices even in the face of secular pressure on consumption from social and cultural trends.
“Cigarette companies’ defense against falling volumes has long been their amazing ability to raise prices. Between 2018 and 2023, Altria grew its operating profit by 27%, even as cigarette industry volumes in the US shrank by more than a fifty.” [emphasis added]
The growth of the alternatives has inflected higher.
“According to Philip Morris International Chief Executive Jacek Olczak, noncumbustible brands start to push out cigarettes at a faster rate once they reach around 7% of a country’s total nicotine market and become more visible in the street. In Japan, heated tobacco sticks – a technology pioneered by PMI that gives nicotine users a hit without the harmful smoke – now make up around 40% of the country’s total tobacco market.”
It’s not as if vaping is healthy.
“That report made clear: using e-cigarettes causes health risks. It concluded that e-cigarettes both contain and emit a number of potentially toxic substances. The Academies' report also states there is moderate evidence that youth who use e-cigarettes are at increased risk for cough and wheezing and an increase in asthma exacerbations.”
These products include acetaldehyde, acrolein, and formaldehyde. Acrolein is a herbicide. “It can cause acute lung injury and COPD and may cause asthma and lung cancer.”
Returning to cigarettes, all but four U.S. states signed a “Master Settlement Agreement” with cigarette manufacturers. The other four have their own, independent settlements.
“In 1998, 52 state and territory attorneys general signed the Master Settlement Agreement (MSA) with the four largest tobacco companies in the U.S. to settle dozens of state lawsuits brought to recover billions of dollars in health care costs associated with treating smoking-related illnesses.
“Eventually, more than 45 tobacco companies settled with the Settling States under the MSA. Although Florida, Minnesota, Mississippi, and Texas are not signatories to the MSA, they have their own individual tobacco settlements, which occurred prior to the MSA.”
This was real money.
“States were to receive over $206 billion over 25 years.”
The MSA wasn’t imposed by any legislature. There was no plebiscite backing its establishment. States dunned an entire industry. The interesting thing is that Big Tobacco was willing to accept this regulatory setup voluntarily.
Ostensibly, the purpose of the MSA was to reduce smoking by raising cigarette prices (to pay for the settlement), limiting marketing activities, restricting companies from misleading statements about the attendant health risks, etc. These moves were implemented with a mass tort settlement to ensure consistency on a national scale, possibly in the absence of the kind of consensus necessary for federal legislation of a private industry. The heroes of this story are the State Attorneys-General. It was as if they had undertaken a successful proxy fight for control of the cigarette companies in order to force change, in the same way that Engine No. 1 attempted to force Exxon to mend its environmental ways.
Vaping and other alternative products aren’t covered by the MSA.
There was a significant drop-off in cigarette use.
“Between 1998 and 2019, U.S. cigarette consumption dropped by more than 50%. During that same time period, regular smoking by high schoolers dropped from its near peak of 36.4% in 1997 to a low 6.0% in 2019.”
Would that decline have happened without the MSA? Would cultural change in the wake of growing public awareness of the costs of cigarette consumption have led to a similar improvement without the MSA?
A study that appeared in the Journal of Economics, Business and Management suggests that the MSA had minimal impact.
“MSA was a historical monument for the promotion of US consumer health. However, MSA’s direct impacts on cigarette consumption were not high enough due to two reasons. The first is due to low budget allocations on tobacco prevention program which were out of MAS revenue. The second is due to a low-price elasticity and a high discount rate which makes increased cigarette pricing to compensate for paid MAS funds quite useless. The reduced and condensed smokers are not very sensitive to a price increase nowadays as they would have been to decades ago. These results are contrary to findings from [3] which showed a 5% reduction at age 21 to 64. Our findings concluded only around 0.07%. However, whereas our findings are only direct impacts of MSA funds, Sloan and Trogdon’s findings were indirect impacts. Based on the findings of this paper, I would like to leave a further analysis of the MSA’s indirect impacts by the increased cigarette prices using the rational addiction model.”
So, if the MSA wasn’t successful, why did it come up short against its stated aims?
Well, for one thing, the states didn’t use the funds the way they claimed they would.
“While at the time of the MSA, many states did establish tobacco prevention and education programs - very few states have funded them at Centers for Disease Control and Prevention (CDC)-recommended levels over the last 25 years. And only two states funded these programs at CDC-recommended levels in fiscal year 2023, according to the “State of Tobacco Control” report. In fiscal year 2023, the states collected an estimated $26.7 billion from tobacco settlement payments and taxes. But they will spend less than 3 percent of it – $733.5 million – on programs to prevent kids from smoking and help individuals who use tobacco to quit.”
Instead, they used the proceeds for general-purpose funding.
“The $246 billion was used to fill budget gaps, build roads, and for other purposes; only very rarely was it used for any form of public health, let alone reducing tobacco use, treating those who were addicted, and protecting kids from becoming smokers. It’s become a notorious example of collecting a lot of funds through litigation, but not getting those funds to those who most need or deserve them.”
When we look back at the behavior of the states, it appears as if the state Attorneys-General saw an opportunity too good to decline: the ability to seize some of the power of a massive industry. Here, the power they seized was economic (share of revenue) and political (appearing to put a big, bad company in its place).
Keep in mind the historical context of 1998. Unlike the current moment of prodigal fiscal profligacy, governments then faced a binding budget constraint. The power of money was significant.
The AGs made a Faustian pact with the tobacco companies, trading the moral superiority of their position for money and influence.
“Another big problem was that the tobacco settlement arrangements were such that states’ funding from the companies was tied to the companies’ profits. So, the states went from being adversaries to being business partners with the companies. In a sense, the states disincentivized the tobacco companies from acting better because they realized the amount of money they would get would depend on the tobacco companies’ profits. Also, to access some of the money coming in from Big Tobacco right away, the states sold bonds for the funds that would come in later in a process known as securitization. By some estimates only about 2.5 percent of the monies that were collected, and are being collected now, went or are going to tobacco control.”
The cigarette merchants raised cigarette prices to reflect the vigorish their new partners demanded. They raised prices more than what was necessary to cover the AG’s required juice. And why not? Part of the deal was immunity from prosecution.
“Brent Stafford of Regulator Watch told us:
“‘Fundamentally what you have is a protection racket, where tobacco companies are allowed to sell lethal products without fear of prosecution in return for forking over cash to governments.’” [emphasis added]
Not only did the structure of the deal preserve the business, it improved the business.
“A tax on profit would have harmed tobacco companies.
“However, funds were paid not on profit but on number of cigarettes sold. Smokers smoke whatever the price, so cigarette companies could simply up the price.
“That’s exactly what they did - and more. The 1999 Master Settlement added a 40 cent levy to cigarettes. But tobacco companies increased prices by 79 cents.”
It is not an exaggeration to say that the states became partners in this unsavory enterprise.
“Meanwhile, US states faced a perverse incentive. By keeping cigarettes legal, they would get more money. If they were ineffective at reducing smoking rates, they would get more money. If they stopped competition from reduced harm alternatives, they would get more money.
“Perhaps that’s why, after the Tobacco Master Settlement:
tobacco profits immediately increased
tobacco companies performed 47% better in the post MSA period than similar companies”
Why do you rob banks? Because that’s where the money is.
There is a historical sense of using taxation as an instrument of regulation. The MSA may have appeared to be an example of this at the time of its negotiation.
“But taxation has a third goal, which has not been noticed as widely: a regulatory goal. In most developed countries governments use the tax system to change the behavior of actors in the private sector, by incentivizing (subsidizing) activities they wish to promote and by disincentivizing (penalizing) activities they wish to discourage. This is the point of the second quotation above.
“This regulatory function of the tax system is quite well established. Indeed, it can be argued that some types of taxes, such as Pigouvian taxes (designed to deter certain activities by forcing private actors to internalize their social costs), are entirely regulatory in nature. In other cases, such as the corporate income tax, much of the complexity of the current tax structure stems from the government’s attempting to use it to achieve regulatory aims. If the US income tax was purely a revenue raising and redistributive tax, most of the complexity of the current tax code could be eliminated.
“Precisely for this reason, most commentators have decried the use of taxation for regulatory purposes. Regulation, they argue, should either be done directly, or if it is desirable that it be done via subsidies or penalties, those should be delivered directly as well by other government agencies. The IRS should be left to its proper role of collecting revenues, with a possible side role in achieving redistribution.”
According to the theory of taxation as an instrument of regulation, the concomitant increase in cigarette prices in response to the MSA was something that should have curbed consumption. Perhaps the Attorneys-General underestimated the inelasticity of demand for such a highly addictive product. It’s difficult to believe that all fifty states could have been so coincidentally naïve.
It is not irrational to believe that the true purpose of the MSA was what they obtained in fact: a transfer of economic and political power from large companies to public officials.
Now consider this passage from the FT’s Lunch with the FT interview of the Chair of the U.S. Federal Trade Commission, Lina Khan.
Shot:
“’At a basic level, I’m interested in imbalances in market power and how they manifest. That’s something you can see not just in tech but across many industries,’ says Khan, who has written sharp pieces on monopoly power in areas as diverse as airlines and agriculture. ‘A lot of people talk about markets as these forces that are the product of globalisation and technology and these things that are totally unrooted, that are totally separate from laws and legal institutions.’”
Chaser:
“Khan, like many in her cohort, believes otherwise. ‘If markets are leading us in directions that we, as a democratic society, decide are not compatible with our vision of liberty or democracy, it is incumbent upon government to do something.’”
I’m not sure how many people believe that markets are “totally separate from laws and legal institutions.” But her targets are “imbalances” of power: an allocation that she deems unjust or unfair, not necessarily because of consumer harm. Her characterization in the Chaser doesn’t refer to economic distortions. Talking about “liberty or democracy” suggests imbalances in political power. Big tech companies are powerful and influential. The competition here is between the government and private actors, in this view.
The New Brandeis movement (or “hipster antitrust” as Orrin Hatch dubbed it) of which Khan is an intellectual leader has a broader vision.
“The New Brandeis or neo-Brandeis movement is an antitrust academic and political movement in the United States which argues that excessively centralized private power is dangerous for economical, political and social reasons.”
It’s not obvious that government action is either necessary or sufficient.
For example, during the Pandemic, the government was engaged in dictating censorship rules to Twitter, silencing voices that turned out to be, in many cases, correct. The governing party did not and could not legislate this attack on liberty. Instead, they employed what is euphemistically described as “moral suasion” to use the influence of a private player for its political benefit, while obscuring its actions.
It would be a shame if something happened to your little tech company.
It doesn’t appear as if the government faced much internal pushback from Twitter employees, either.
It was a private actor in Elon Musk who exposed this anti-democratic perfidy and unwound it, at great personal cost. He did so, he claims, out of adherence to the constitution’s protection of free speech. Where is the arrogant indifference to the law that Khan alleges? At least in this example, it’s not to be found in the “markets,” made up of agents who benefit from the American rule of law and liberal protection of rights including especially property rights.
It’s no wonder Musk is himself now a target of the anti-trust authorities.
One interpretation of the Chaser comment above is that government officials (“we”) see themselves as having the right to “do something” about anyone who gets in their way (because that’s the only reasonable definition of “our vision”).
In the 1990s, the most valuable currency for the bureaucrat was money. Money was scarce. Today, it is status and control of the narrative that is tight. The government targets social media companies and others with large-scale cultural influence, especially those with fealty to the notion that there should be limits regarding the political power of the State over the individual.
The political class isn’t going after Cisco.
Of course, this is not something one observes only in the public sector context.
It is easy to imagine an internal bureaucracy at a private company exerting its influence over line functions, transferring the budget and influence of the people who actually do things to people who write policy statements and push paper. This happens all the time. It is a kind of a large company sclerosis, a thickening of the arteries of commerce. The more successful the company, the more vulnerable they are to this kind of buildup of fatty tissue.
Returning to Twitter, Musk fired thousands upon his arrival. The site kept working. With a fraction of its prior employee base, the company not only kept the lights on, it now “pushes code” into production with a faster cadence than it did in the pre-Musk period. This mass firing provoked a maelstrom of stories of his meanness, his sensitivity, and his ineluctable failure. Yet, Twitter continues to float above it all without getting sucked down into the abyss his critics are so confident will claim it.
One way to avoid the aggression of the regulator may be to appease him.
Peter Turchin talks about “elite overproduction:” the notion of a polity that produces more candidates for the elite than its ability to absorb them. Appeasement for the Big Tech companies may be a willingness to hire these people, sopping up the excess supply, employing what Richard Posner calls an “internal subsidy” in his paper on taxation by regulation. Big Tech hires elite people into lucrative, unproductive roles who would not be able to get jobs commensurate with their own ambitions and sense of self otherwise, enhancing the status of the overall elite in the process. Even better, to the extent that these people can advocate for the interests of the political class inside these private organizations, it’s a win for the regulator. He gets to control the machine by proxy. These elites sport the labels of their employers with pride, even after leaving for greener pastures, unaware of the signal they may be sending as to their true nature.
What else could explain Google AI’s Gemini image brouhaha if not “Googlers” run amok?
What did all these people whom Musk fired do? It appears as if they didn’t do much that helped the Twitter site function technically. They were the apparent beneficiaries of an internal subsidy from their more productive brethren. Large tech companies seem chock-a-block with such internal subsidies. Perhaps that’s why they are such an inviting target for regulators.
Given the company’s newfound debt burden tied to his acquisition of it, Musk appears to have decided that this was an internal subsidy Twitter could no longer afford.
Nobody is going after Big Tobacco today. They have nothing to offer that is in short supply. Today, the industry with a hard target is the one that shapes the message, especially in an era in which Big Media is dying.
In some cases, regulation may be nothing more than a transfer of power from people who acquire it organically to those who make the rules, all operating under the perception of a benign dictatorship of virtue. Such behavior free rides on the reputation generated by the positive impact prior rules have had for the organization’s welfare. One way of predicting the targets for such power grabs is to look for industries that generate tremendous amounts of the contemporary scarce political currency, be it money in the 1990s or narrative control and cultural influence today.
How do you, as a manager at a target company, hold the predatory regulator at bay?
One, you can take steps to hurt individual companies that the regulator has in their sights. Apple’s changes to its privacy rules damaged the social media companies like Facebook in this way. I don’t have to run faster than the bear. I just have to run faster than you.
Two, you absorb the excess elite production and give them make-work projects and cushy lifestyles that dilute their ambition so that they don’t interfere with your real work. Recall the cringey product manager videos from the height of the tech bubble. Just make sure that they don’t touch anything live or mission-critical. This is a tax you may be willing to pay rather than the more onerous burden the regulator may impose upon you.
Three, you can fold and give into their moral suasion, but you risk being discovered by earnest third parties with the consequent embarrassment and loss of influence. Instead, you may want to expose the regulators who would control you by confronting them in public. To do this you need deep pockets and public support. This is remarkably difficult. It is dangerous.
The price of liberty is eternal vigilance.