Smoking and Fiscal Externalities

Filip Palda

Have you committed a “fiscal externality” lately? If you are such a person, then government could step in to set you straight. Fiscal externality is a label governments are sticking on anybody who costs them money. Smokers are the most recent victims of this classification. The idea is that a smoker puts more of a burden on the health care system than he contributes in taxes. This means some other taxpayer who never lit up is subsidizing the smoker’s folly. The smoker ends up smoking too much because another taxpayer is paying part of his ticket to Valhalla. To control the excess, governments believe they must step in to control smokers and the companies who ply them with tobacco. It does not occur to governments that their financial systems are the cause of the externality and that it is these systems that need reforming.

Nine tenths of government funding is from a central pot. My taxes go into this pot and have no bearing on the government services I can use. Government is like a smorgasbord. You pay a flat fee and park your mouth at the food bar. However, light eaters avoid smorgasbords because they end up paying for other diners’ porkfests. All that is left at the trough, then, are people of equal appetite who all pay equally. Unfortunately, there is no escape for light eaters at the government banquet because it is harder to change your government than to walk down to the next restaurant. This lack of choice open to voters is what gives government the excuse to control the appetite of those who see the state as a giant cow with millions of udders. Governments would not have this excuse to meddle if they stopped financing health care and other services out of a central pot. In countries where government does not finance health care from a central tax pot, people must buy their health insurance directly. Insurance companies charge smokers a premium for their habit. No one else pays for them and so the state has no excuse to interfere when smokers light up.

What does it matter whether private insurance companies or governments keep in line smokers or anyone else who dips too deep into the official soup bowl? The answer is that it doesn’t matter all that much. What matters most is how you keep people in line. A competitive user fee can be finely tuned to make the user ask, “Do I really get enough of a kick out of this activity to insure myself for the true cost of treating the illness?” Smoking bans do not allow people to ask themselves this question. Government edicts of this sort button everyone into the same Mao-Tse-Tung jacket. Taxes on cigarettes earmarked for medical care could act as user fees that reverse the fiscal externality. The problem is that governments end up setting these taxes too high. Studies for the US and Canada show that smokers contribute more to the health system through their cigarette taxes than they pull out. Governments set these taxes too high because governments are not competitive in the way a private insurer would have to be.

Politicians must look in the mirror to see why we have a smorgasbord of government services. Government’s way of financing services encourages excess. The solution is not to take the strain off the treasury by telling people they cannot smoke, or that they must jog an hour a day to get their cholesterol down. The solution to excesses of any sort of consumption is to make consumers pay directly for the risks that come with their pleasures. Until this solution to the problem of fiscal externalities hits home, our leaders will be tempted to become engineers of human souls—a job description I don’t remember reading in the constitution.

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Last Modified: Wednesday, October 20, 1999.