Tobacco Lookbacks

Tobacco- Lookbacks May 14, 1998 MEMORANDUM FOR THE CHIEF OF STAFF FROM: Bruce Reed SUBJECT: Youth Lookbacks The other side has agreed to $1,000 per youth smoker on the company-by-company penalty if we agree to an industrywide cap of $4 billion. I believe this is a good deal for us. Here are the facts. Industrywide penalties are passed directly to price, and are designed to drive up the price to discourage teens from smoking. Company-specific penalties are designed not to drive up the price of cigarettes (as the industrywide penalties do), but to come straight out of the companies' bottom line if they sell to kids. Companies cannot pass company-specific penalties onto price, because any price differential between companies (even a few pennies) will wreak havoc on their share of the adult market. That is why these companies always increase their prices in lock-step, as they did earlier this week. So when some say our company-specific penalty is a fraction of a penny a point, that's the wrong measure. We've already got an industrywide penalty that gets up to at least 35 cents a pack [$4 billion non-deductible = nearly $6 billion pre-tax, divided by our estimated volume of 17 billion packs in 2003 = about 35 cents a pack. If CBO estimates volume at 12 billion packs, our industrywide penalty could reach 50 cents a pack.] The purpose of a company-specific penalty is to change company behavior by imposing a serious disincentive. Here are a few ways to make our proposal more easily understood: 1. Without a company-specific penalty, any company can still make a profit by selling to kids. At $1,000 per youth smoker, our proposal will force a company to surrender twice the lifetime profits it makes from addicting a teen in the first place. (It's really more than twice, when you count the $150-250 in lost profits from the industrywide penalty.) 2. The companies sell 500 million packs a year to teenagers. A 12-point miss would cost the companies $500 million that they can't pass on to price -- that's $1 a pack for every pack they sell to teenagers. A 25-point miss would cost $1 billion -- or $2 a pack for every pack they sell to teenagers. To put it another way, that's 8 cents a pack for every percentage point miss. 3. This penalty is uncapped, and comes straight out of after-tax profits. The total after- tax profits of the domestic tobacco industry are $5 billion ($7.5 billion pre-tax). Treasury