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OCR Page 1 of 7405/08/98 FRI 09:19 FAX 202 6222633
003
Comparison of Price Estimates in 2003: Treasury vs. Wall Street Analyses
A review of various private analysts' price projections under S. 1415 shows a range of values
distributed around an average nominal retail price of about $5.00 for cigarettes in 2003 compared to Treasury's
estimate of $3.57. Our analysis indicates that about one-fourth of that difference results from differences in
baseline prices in 2003 and the remainder three-fourths of the difference -- results from differences in the
interpretation of costs associated with the legislation.
A number of factors make it difficult to compare the analysts' estimates with Treasury's: incomplete
information about the analysts' estimates; differences in the functional forms for the demand for cigarettes;
different assumptions about the baseline price levels that would exist in the absence of any new legislation; the
extent to which companies will have to internalize company-specific costs; and different assumptions about the
effectiveness of various provisions, including the youth lookback and counter-smuggling provisions.
Recognizing these difficulties, we attempt to analyze the key differences below.
Absolute Prices vs. Price Differentials-Differences in the Baseline.
The Wall Street analysts report estimates of the absolute level of the price under the McCain bill in, say
2003, and the change in this price from the current price of cigarettes. This method is likely to overstate the
pure price effect of the McCain bill, however, because part of the price increase between now and 2003 has
nothing to do with the McCain bill.
The analysts assume that the baseline price -- the price of a pack of cigarettes that would emerge in the
absence of S. 1415 -- would be higher than that estimated by Treasury. Our review indicates that for 2003, on
average, the nominal baseline price difference by itself accounts for about $0.21, or 15 percent, of the total
difference between the Treasury and analysts' post-legislation price estimate. But that 15 percent by itself does
not measure the full effect of the baseline price difference on the estimate of the price of cigarettes under S.
1415. In addition to what might be called the independent effect, the higher baseline price also causes an
indirect, or feedback, effect which further raises the analysts' per-pack price. The feedback effect occurs
because, all else equal, a higher baseline price implies lower baseline cigarette sales, as well as lower cigarette
sales under S.1415. Consequently, a higher baseline price implies a higher per-unit payment under S. 1415,
because the total payments specified by S. 1415 have to be spread over a smaller number of units with a higher
price than with a lower price. In total, we estimate that about $0.32, or 23 percent, of the difference between
Treasury and the Wall Street estimates is due to differences in the baseline price.
A number of factors contribute to the higher baseline price level for the analysts compared to the
Treasury:
State excise tax increases: The analysts typically assume continued increases in real state excise taxes,
yielding about $0.15 more on average in the price in 2003 than Treasury. These analysts are
extrapolating a short-run trend increase in state excise taxes, while Treasury's model, which assumes
fixed nominal state taxes, is based on longer-run state behavior.
Manufacturer price: The analysts typically assume real growth in the manufacturer price, yielding about
$0.15 per pack more on average than Treasury. Treasury assumes a smaller increase in the manufacturer
take. In either case, increases of this nature go directly to the companies' profits and shouldn't be
considered a "cost" to the industry.
Per Pack Costs Beyond the Baseline
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