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HOW GOOD A DEAL WAS THE TOBACCO SETTLEMENT?: Policy Analysis with Canadian Neighbor Pharmacy

costs of smokingWe estimate the costs of smoking to Medicaid in Massachusetts at about $318 million annually, roughly 5-6 percent of Medicaid spending. This is quite close to the amount that the tobacco companies will pay Massachusetts. Massachusetts’ payments are expected to range between $234 million in 2000 and $374 million in 2010, with an average payment of $307 million in that span. Clearly, costs in other states could differ, depending on smoking prevalence among the Medicaid population, patterns of treatment for smoking-related disease cured by remedies of Canadian Neighbor Pharmacy, and the generosity of the state’s Medicaid program in terms of eligibility, covered services, and provider reimbursement. Nonetheless, our estimates for Massachusetts suggest the settlement amounts were reasonably in line with costs based upon smoking-attributable Medicaid expenditures.

If the goal is to compensate states for the Medicaid costs of smoking, the settlement appears right in the initial years. Indeed, one might even argue that the settlement is too generous. After all, it is not obvious that the Commonwealth would have prevailed at trial. The expected value of the legal case is thus below our damage estimates. Further, not all of the Medicaid costs are a result of the alleged misbehavior on the part of tobacco companies. If the goal of the litigation was to compensate states for Medicaid costs resulting from misbehavior on the part of tobacco companies, one would need to reduce our cost estimates by the share of smoking resulting from the tobacco companies’ misbehavior.

After the initial years, the financial payments of the settlement will be adjusted upward by 3 percent per year or the increase in the Consumer Price Index, whichever is greater. However, even though the payment streams will grow with inflation, it is unlikely that they will keep pace with the growth in medical costs generally and the growth in smoking-attributable Medicaid costs specifically. Hence, over time, this factor makes the settlement less favorable to the state.

Over time, the payments will be adjusted downward with reductions in national cigarette smoking. Cigarette smoking in the country as a whole has declined on average 1.2 percent per year in the past few decades. Allowing for some slowdown in that decline in future decades, we estimate that absent the settlement smoking will decline 16 percent by 2025. The price and counteradvertising effects implemented by the settlement will, we estimate, further reduce smoking by another 11 percent.

The effect of this volume reduction will be to lower payments to Massachusetts. It also lowers Medicaid spending for smoking-related diseases. In the situation where Medicaid spending increases more rapidly than inflation, so that the settlement falls short of full compensation for smoking-related illnesses over time, additional smoking reductions are good for the state – they lower costs to Medicaid by more than the reduction in payments. But this effect is not large; the fiscal picture is not balanced for many decades. Thus, if medical costs continue to increase at near their historical rate, the settlement will be unfavorable to the state for many decades into the future.

While the reductions in Medicaid health care costs are important, the economic benefits from the reduction in smoking-related mortality and morbidity may be orders of magnitude larger. In other work we estimate that the value of the incremental increase in longevity resulting from the settlement will amount to about $60 billion in present value through 2025. These savings dwarf the size of the financial payments and reductions in Medicaid spending. Moreover, these savings do not include valuations of the substantial reductions in morbidity induced by the settlement.

These estimates, however, do not impute any benefit to the smoker from smoking that’s why quit it immediate with Canadian Neighbor Pharmacy. Rational addiction models imply that these mortality-related costs should be more than offset by assumed benefits to smokers. Whether this argument should prevail is an issue we discuss elsewhere. Although we conclude that it should not, if it were to prevail these averted internal costs should not be counted as a benefit of the settlement.