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05/08/98 15:27 FAX 202 456 5557
DOMESTIC POLICY COUNCIL
5.
008
E
05/06/98 WED 14:28 FAX 202 6222633
Incidence Issues
There is по a-priori reason that the cigarette manufacturers would necessarily pass exactly
100 percent of the settlement cost through into the price of cigarettes. It is possible that part of
the payment might be passed backwards onto the owners of cigarette companies, or onto their
mine
workers or suppliers. In this case, the price might rise by less than implied had 100 percent of the
payment been passed through. Alternatively, the cigarette manufacturing industry might be able
postive
to use the payment as a focal point around which to coordinate a profit increasing price rise in
excess of that implied by a 100 percent pass through of the settlement payment.
These issues, which relate to the incidence of the payments, are difficult to resolve
definitively. They would complicate the analysis even if S. 1415 raised revenue through a
relatively simple excise tax. The actual structure of S. 1415, in which the payments are fixed to
the industry, but many vary across firms because allocated on the basis of market share, adds
additional complications.
We follow many other analysts. however, in assuming the tobacco manufacturers will pass
through into price 100 percent of the cost of the settlement. Indeed, the McCain legislation
explicitly requires manufacturers to pass on the settlement payments to prices.
Effect on Retail and Wholesaler Markups.
Our incidence assumption is that consumers bear the burden of the payments called for by S.
1415. This means that, in our model, retailers and wholesalers do not increase their margins in
response to S. 1415. The way that wholesalers and retailers set their markup is as an absolute
dollar amount above their costs of business. The competitive nature of the wholesale and retail
sectors make it impossible for these groups to increase this dollar amount when the prices of
cigarettes rise because of legislative action. In these competitive sectors, any retailer or
wholesaler that tried to increase their margins would soon be undercut by a neighboring store or
another wholesaler.
This view is shared widely. For example, the FTC, in their analysis of the original Attorney's
General settlement, assume in their "baseline", or central. calculation that there would not be any
mark-up at the wholesale or retail level of the payments made by manufacturers. This view also
is supported by virtually all of the relevant empirical evidence. A large number of economic
studies have examined the impact of cigarette tax increases on the retail price of cigarettes, and
4As the FTC states: "The gains or losses from a pass-through different from 100 percent
will accrue entirely to the manufacturing sector, so long as the wholesale and retail distribution of
cigarettes is competitive, with distributors obtaining по more than a competitive rate of return for
providing their services" (p. 26). Federal Trade Commission, Competition and the Financial
Impact of the Proposed Tobacco Industry Settlement. Washington, D.C.: Federal Trade
Commission, September 1997.
S
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"ocrText": "05/08/98 15:27 FAX 202 456 5557\nDOMESTIC POLICY COUNCIL\n5.\n008\nE\n05/06/98 WED 14:28 FAX 202 6222633\nIncidence Issues\nThere is по a-priori reason that the cigarette manufacturers would necessarily pass exactly\n100 percent of the settlement cost through into the price of cigarettes. It is possible that part of\nthe payment might be passed backwards onto the owners of cigarette companies, or onto their\nmine\nworkers or suppliers. In this case, the price might rise by less than implied had 100 percent of the\npayment been passed through. Alternatively, the cigarette manufacturing industry might be able\npostive\nto use the payment as a focal point around which to coordinate a profit increasing price rise in\nexcess of that implied by a 100 percent pass through of the settlement payment.\nThese issues, which relate to the incidence of the payments, are difficult to resolve\ndefinitively. They would complicate the analysis even if S. 1415 raised revenue through a\nrelatively simple excise tax. The actual structure of S. 1415, in which the payments are fixed to\nthe industry, but many vary across firms because allocated on the basis of market share, adds\nadditional complications.\nWe follow many other analysts. however, in assuming the tobacco manufacturers will pass\nthrough into price 100 percent of the cost of the settlement. Indeed, the McCain legislation\nexplicitly requires manufacturers to pass on the settlement payments to prices.\nEffect on Retail and Wholesaler Markups.\nOur incidence assumption is that consumers bear the burden of the payments called for by S.\n1415. This means that, in our model, retailers and wholesalers do not increase their margins in\nresponse to S. 1415. The way that wholesalers and retailers set their markup is as an absolute\ndollar amount above their costs of business. The competitive nature of the wholesale and retail\nsectors make it impossible for these groups to increase this dollar amount when the prices of\ncigarettes rise because of legislative action. In these competitive sectors, any retailer or\nwholesaler that tried to increase their margins would soon be undercut by a neighboring store or\nanother wholesaler.\nThis view is shared widely. For example, the FTC, in their analysis of the original Attorney's\nGeneral settlement, assume in their \"baseline\", or central. calculation that there would not be any\nmark-up at the wholesale or retail level of the payments made by manufacturers. This view also\nis supported by virtually all of the relevant empirical evidence. A large number of economic\nstudies have examined the impact of cigarette tax increases on the retail price of cigarettes, and\n4As the FTC states: \"The gains or losses from a pass-through different from 100 percent\nwill accrue entirely to the manufacturing sector, so long as the wholesale and retail distribution of\ncigarettes is competitive, with distributors obtaining по more than a competitive rate of return for\nproviding their services\" (p. 26). Federal Trade Commission, Competition and the Financial\nImpact of the Proposed Tobacco Industry Settlement. Washington, D.C.: Federal Trade\nCommission, September 1997.\nS"
}