The Changing Political Environment for …ageconsearch.umn.edu/bitstream/15387/1/31020291.pdf · The Changing Political Environment for Tobacco—Implications for Southern Tobacco

Journal of Agricultural and Applied Economic.s, 31,2(August 1999):291–3080 1999 SouthernAgricultural Economics Association

The Changing Political Environment forTobacco—Implications for SouthernTobacco Farmers, Rural Economies,Taxpayers, and Consumers

A. Blake Brown, William M. Snell, and Kelly H. Tiller

ABSTRACT

The farm level economic implications of the political turmoil surrounding tobacco areexamined. Tobacco ranks first in crop receipts in the Southeastern United States. Freemarket advocates typically want to eliminate the tobacco program because of its cartel-like nature, Health advocates want to maintain the program because it limits tobacco pro-duction. Cigarette manufacturers tolerate the program because of the political support theyreceive from program stakeholders. The effects of cigarette price increases with and with-out a program are examined. Whether or not the program is maintained in the face ofdeclining tobacco demand has significant implications for Southern agriculture.

Key Words: cigarette price, health advocates, political, Southern agriculture, tobacco,tobacco program.

Since the early settlers discovered tobacco beingg-mownby native North Americans, tobacco hasbeen an important commodity in the south. Butit also been a very controversial one. The to-bacco debate has intensified during the 1990s.Existing and proposed regulations and restric-tions, excise tax increases, health issues, chang-ing social attitudes towards tobacco use, litiga-tion, and international competition have inducedmuch uncertainty regarding the future of the to-bacco program, tobacco farming, and manysouthern rural economies. All of these issues

A. Blake Brown is the Hugh C. Kiger associate pro-iessor, Department of Agricultural and Resource Eco-nomics, North Carolina State University, Raleigh,North Carolina; William M. Snell is associate exten-sion professor, Department of Agricultural Economics,University of Kentucky, Lexington, Kentucky; andKelly H. Tiller is assistant professor, Agricultural Pol-icy and Analysis Center, University of Tennessee,Knoxville, Tennessee.

were intensified and highlighted ckning lastyear’s lengthy debate over a national tobaccosettlement. The debate prompted visils to tobac-co-pr@ducing states by President Clinton andSecretmy of Agriculture Glicktnan and con-sumed an unprecedented three and a half weeksof debate on the U.S. Senate floor. Althoughnational tobacco settlement legislation nevermaterialized in 1998, the tobacco companies anclthe states’ attorneys general were successful indeveloping an agreement to settle existing stateMedicaid lawsuits in exchange for tobacco in-dustry agreement to change some of their mar-keting practices and payments in excess of $200billion over 25 years. While the growers werenot part of the settlement, the following state-ment was included in the agreement:

Whereas, the participating manufacturersrecognize the concern of the tobacco grower

292 Journal of Agricultural and Applied Economics, August 1999

16

14

12

Figure 1. Distribution of agricultural re-ceipts ] in sevenz Southern states, 1992–97

community that it may be adversely affectedby the potential reduction in tobacco con-sumption resulting from this settlement, (themanufacturers) reaffirm their commitment towork cooperatively to address concernsabout the potential adverse economic impacton such community.

Since the agreement, political leaders from to-bacco producing states and tobacco companyofficials have been meeting to discuss suchconcerns, termed “Phase II” of the settlement.To date, Phase II involves establishment of acompany-supported farm-level trust fund tocompensate tobacco farmers for reductions inquota and economic harm induced by Phase Iof the settlement.

Despite recent developments, the tobaccoindustry, tobacco farmers, and communitiesdependent on tobacco still face considerablepolitical, legal, and economic uncertainty,Flue-cured quotas will be reduced 17.5% in1999 (to the lowest level in history) and bur-ley quotas are expected to fall by a double-digit level as well. Potential future changes innational tobacco policy (e.g., elimination ofthe federal tobacco program, increase in thefederal excise tax on tobacco products, addi-tional regulation) and litigation facing the in-dustry will continue to affect the structure andlocation of tobacco farming, diversificationstrategies, and the distribution of farm income,agribusiness sales, and economic growth in to-bacco-dependent regions. Consequently, to-bacco farm organizations and policy makersfrom tobacco-producing states are continuallymonitoring the political environment to deter-mine the optimal strategy for tobacco farmers

50 ( :

40

30

I~

20

10

~

o

KY NC SC TN VA GA FL

■ ‘A of (lops “/. of Total

Figure 2. Tobacco receipts as a percent ofcrop and total agricultural receipts by state,1992–97

and their rural communities amidst a very un-certain and volatile tobacco outlook. The pur-pose of this paper is to present the economicfundamentals associated with domestic tobac-co production and the U.S. tobacco programand to discuss the implications of potentialchanges in U.S. tobacco policy at the farm andcommunity level.

Tobacco’s Economic Importance to theSouth

Tobacco is the nation’s sixth largest crop interms of cash receipts and is produced in 20states. While not considered a major U.S.crop—accounting for about two percent ofU.S. agricultural cash receipts in 1997—to-bacco is an integral crop in parts of the south.About 90 percent of the nation’s tobacco isgrown in seven states in the South, led byNorth Carolina and Kentucky, followed bySouth Carolina, Tennessee, Virginia, Georgia,and Florida. Within the seven major tobaccoproducing states in the Southern region, to-bacco ranked first in terms of total crop cashreceipts and second in terms of overall agri-cultural cash receipts during the 1992 – 1996period (Figures 1 and 2). The relative impor-tance of tobacco in the South is even morepronounced when net returns from tobacco areexamined as a share of net farm income. Fur-thermore, tobacco has trailed only cotton as

Brown, Snell, and Tiller: Implications for Southern Tobacco Farmers and Rural Economies 293

the South’s most important export commodity(Marchant and Ballenger).

According to the 1992 Census of Agricul-ture, tobacco is grown on 124,000 farms, withaverage tobacco acreage of 6.7 acres per farm(Grise). While some consolidation of tobaccoproduction is occurring, production in manyparts of the South remains concentrated on rel-atively small family farms. Average tobaccoacreage per farm varies tremendously by to-bacco type. Today, most flue-cured tobaccofarms (located primarily in the Carolinas, Vir-ginia, Georgia, and Florida) average around 35to 40 acres of tobacco, compared to burleytobacco farms (located primarily in Kentucky,Tennessee, and North Carolina) which gener-ally produce 10 acres of tobacco or less.

Given the uncertainty facing the tobaccoindustry, most tobacco farmers are attemptingto diversify their income base. However, fewalternative agricultural enterprises can consis-tently rival the $1000 (plus) net return per acreof tobacco. In many cases, net returns fromtobacco are used to finance diversification intoother agricultural enterprises. Despite these di-versification strategies, a large percentage offarms growing tobacco are still heavily depen-dent on returns from tobacco. Census data re-veal that 73 percent of tobacco farms deriveat least 50 percent of their total farm salesfrom tobacco. While tobacco remains a vitalcomponent of the enterprise mix on thesefarms, census data also reveal that over 60 per-cent of tobacco farm operators work off farmwith over 40 percent working off farm fulltime (Grise).

Although tobacco is an important compo-nent of agriculture in many parts of the South,an expanding non-agricultural economy hasdiminished tobacco’s (and thus agriculture’s)relative importance in many areas. A recentUSDA study revealed that real personal in-come in tobacco-producing counties has morethan doubled since 1970, while tobacco saleshave declined by about 50 percent. Further-more, the study discovered that tobacco salesaccount for less than one percent of total localpersonal income in nearly one half of tobacco-producing counties. In only 20 percent of themore than 400 tobacco producing counties

does tobacco directly account for more thanfive percent of local personal income (Gale,USDA). The more “tobacco-dependent”counties are located in regions which possesslimited off-farm employment opportunities,low educational attainment levels, and possesspersonal income growth well below the na-tional average, primarily Kentucky and Ap-palachian counties. Thus additional income-generating opportunities and educationalachievements are very important to the long-term growth of these economies. In the short-term, a significant down-turn in tobacco saleswill certainly have noticeable adverse effectson many of these “tobacco-dependent” localeconomies. Furthermore, given their coststructure, many of these tobacco-dependentcounties are very dependent on the continua-tion of the federal tobacco program.

The U.S. Tobacco Program

The structure of tobacco farming has been in-fluenced considerably by the federal tobaccoprogram. The tobacco program, along withsupply restriction programs for many other ag-ricultural commodities (most of which no lon-ger exist), was established under the Agricul-tural Adjustment Act of 1938 as a means toraise and stabilize tobacco prices and income.Under the program, tobacco farmers agreed torestrict supply via marketing/acreage allot-ments (or quotas) in exchange for minimumprice guarantees. If tobacco companies do notbid above the predetermined price support lev-el at regulated tobacco auctions, grower co-operatives purchase the surplus tobacco usingCommodity Credit Corporation (CCC) funds.Price support levels are determined by aweighted average of changes in productioncosts and lagged market prices. National mar-keting quotas are set each year based upon thedomestic purchase intentions, exports, andCCC loan stock levels. The inclusion of pro-duction costs and the fact that downwardmovement in market prices is limited by theprice support structure means that price sup-ports are not very responsive when demanddecreases. Thus, it is reasonable to describethe tobacco program as maintaining price by


shifting supply via the marketing quota. Al-lowing price to fall instead of quota can onlybe accomplished by lowering price supportsthrough legislative action.

The marketing quotas for U.S. tobaccowere initially divided among tobacco growersbased on production history. Over the yearsavailable quota has been dispersed amongheirs of tobacco farmers, non-producers whopurchased farms with tobacco quota, and, ofcourse, active tobacco farmers who inheritedor purchased quota, The quota can be rentedor sold under certain restrictions (Rucker,Thurman, and Sumner). Only individualsowning or renting quota can legally sell to-bacco through regulated auctions. Flue-cured

tobacco growers own about one-third of thenational flue-cured marketing quota (USDA–ERS); the remainder is owned by non-produc-ers who rent their quota to growers. While nohard evidence exists, burley tobacco growersare purported to own about 60 percent of theburley marketing quota.

In economic terms the demand curve forU.S. tobacco is downward sloping and U.S.tobacco producers exercise monopoly powerin the world tobacco market through the set-ting and enforcement of national quotas forU.S. tobacco sales. The downward sloping de-mand curve for tobacco is well documented(Rezitis, Brown, and Foster; Beghin andChang; Sumner and Alston). The elevation ofU.S. tobacco prices through enforcement ofnational supply restrictions grants cartel rentsto U.S. tobacco quota owners via the market-ing quotas. Since a farmer must own or rentquota in order to legally sell tobacco, quota isan asset with its own rental and sales market.The annual rental value of the quota is the

annual cartel rent accruing from the tobaccoprogram (Johnson, Johnson and Norton). Fig-ure 3 illustrates the supply and demand forU.S. tobacco at the farm level, as well as theannual marketing quota and the economicrents accruing to quota owners. In Figure 3, Pis the market price for tobacco, MC is the mar-ginal cost of production for tobacco, and QOisthe national marketing quota level. The rentalvalue per unit of quota, R, is a residual value

P

MC

D—Q“ Q

Figure 3. Supply, demand, quota, and quotarental rates under the tobacco program

and is determined by the difference betweenexpected price and marginal cost.

From the 1930s to 1980, the program un-derwent relatively few modifications. How-ever, since the early 1980s, political and eco-nomic pressures have induced several programchanges and have threatened the program’soverall existence. In 1982, the price supportprogram was mandated to operate at no netcost to the federal government or taxpayers.Costs that arise when tobacco put under loan(tobacco taken in by the coops) is later sold ata price lower than the loan principal plus in-terest are paid by an assessment on growersand buyers at the wholesale level. More re-cently, legislation has prohibited any federalexpenditures on tobacco export promotion orany research related to tobacco production,processing or marketing. Increasing interna-tional competition induced price support re-ductions in 1985 and major trade policychanges in the 1990s. The program was alsomodified several times in the 1980s and 1990sto allow for a more efficient transfer of mar-keting quotas, primarily within county bound-aries.

Pressures For and Against the FederalTobacco Program

In general, once government programs havebeen institutionalized, they are slow to recede


and seldom disappear. Despite this historicallyaccepted axiom of agricultural policy, the1990s have witnessed a reversal of many long-standing agricultural intervention policies,programs, and instruments. Despite the polit-ical climate, several characteristics of the to-bacco program have contributed to its survivalover the last 60 years and position it to con-tinue to have many supporters. The tobaccoprogram must be reauthorized by referenda ofquota owners every three years. These refer-enda have consistently approved maintenanceof the program by support of more than 90percent of quota owners. This outcome is notsurprising, considering the economic incen-tives the program provides to quota owners.Recall that quota is an asset with economicrents accruing to quota owners. Once quotaowners capitalize an investment in quota, theyhave little incentive to abandon the rents thatwill accrue to that asset. A quota owner’sspouse who depends upon income from quotarental to meet basic economic needs can be apersuasive political argument for maintainingthe value of the institutionalized program.

Further, the tobacco program has sustaineda relatively large number of small familyfarms over the years and has been successfulin creating a structure that further supportscontinuation of the program. Barriers to quotamovement across county and state lines haveinhibited the transfer of quota to the lowestcost of production regions and thus preservedproduction areas where adoption of technolo-gies with economies of scale would have nototherwise been feasible. This has allowedcommunities to become more dependent upontobacco than they may have been otherwise.Termination of the program would likely shiftproduction to lower cost production regions,affecting many rural communities, with lim-ited economic opportunities, dependent upontobacco income. While this argument may nothold ground in a debate about economic effi-ciencies, it can have persuasive power in a po-litical debate.

Movement of the tobacco program to a no-net-cost program in 1982 strengthened supportfor program continuation. Further, as set forthin the Omnibus Budget Reconciliation Acts of

1990 and 1993, tobacco growers and manu-facturers are assessed one percent of the sup-port price on every pound of leaf tobacco mar-keted to be applied toward federal budgetdeficit reduction. On average, the deficit re-duction assessment generates about double thefederal cost of program administration (Wom-ach),

Support for the existing tobacco programhas also come from some unlikely sources, in-cluding some public health advocates. Whilethe tobacco program does indeed accrue rentsto producers, the supply restriction and result-ing higher price transfers rents from both con-sumer surplus and producer surplus to quotaowners in the form of monopoly or cartelrents. In some eyes the cost of the program,as measured by market inefficiencies, out-weighs the cost of program elimination, whichwould be lower input costs and higher manu-facturer profits which could then be passed onto consumers through lower tobacco productprices, leading to higher levels of tobaccoproduct consumption. Many free market ad-vocates have not pursued tobacco programelimination with the same fervor as other ag-ricultural commodities. This may be due inpart to the perceived ‘social cost’ of programelimination in terms of an economic windfallto an industry accused of deceiving the na-tion’s consumers and knowingly contributingto health degradation. Thus, the programserves to transfer economic benefits from anindustry with relatively little social standing tothe more socially palatable farming commu-nity.

Despite support of the program, politicalpressure to modify or end the tobacco programhas been gaining momentum over the past twodecades. Some members of Congress and op-ponents of the tobacco program question howthe federal government can support tobaccoproduction while it simultaneously supportsefforts to reduce tobacco consumption. Pro-gram opponents also argue that the existenceof USDA administrative costs and crop insur-ance subsidies—estimated to be about $14million and $48 million, respectively, in 1997(Womach)—prevent the tobacco programfrom being a true no-net-cost program. All of


these questions and concerns are being debat-ed in the wake of the Federal Agricultural Im-provement and Reform Act passed in 1996,which terminated supply control and price sta-bilizing programs for most all major crops,leaving only the tobacco, peanut, and sugarprograms intact. Collectively, these issueshave resulted in very intense political debateon the program in recent years. While the pro-gram has survived previous attacks, most ex-pect the political debate over the program toresurface once again this year.

In addition to political pressure from out-side grower circles, the tobacco program pre-sents some internal challenges and concernsfor growers. First, while the program does pro-vide price stability, it does not protect againstquota instability. In fact, the program operatesto stabilize price by destabilizing quota. Thiscan be especially problematic for large grow-ers who invest in achieving a productive ca-pacity that is then dependent upon being ableto secure sufficient quota. Once productive ca-pacity investments are made, large quotacuts—such as the 18-percent cut in flue-curedquota in 1998 followed by a 17.5-percent cutin 1999—increase the rental rate of quota, in-creasing variable costs and reducing net re-turns in the short run. In the long-run a per-manent quota decline forces some producersto exit production. Second, restricting quotatransfer across county boundaries induces ad-ditional inefficiencies as it does not allow pro-duction to move to the lowest cost areas. Also,the program has provided an economic price“umbrella” under which foreign competitionhas developed. As a result, the program’s ef-fectiveness has diminished in recent years asproduction increases and quality improve-ments overseas have weakened U.S. tobaccoprice competitiveness and thus market share.

Economic Fundamentals of TobaccoProduction

Complicating the set of pressures to maintain,change, or eliminate the federal tobacco pro-gram, differing demand elasticities acrosstypes of tobacco, differing production char-acteristics by region, and differing quota ar-

rangements may lead to differing desires re-garding program operation and continuation.Understanding the economic parameters as-sociated with U.S. tobacco production is keyto understanding or evaluating the potentialconsequences of changes in U.S. tobacco pol-icy. This section presents the economic fun-damentals of tobacco production which un-derscore differing incentives with regard toprogram changes or continuation across tobac-co types, regions, and ownership arrange-ments.

Differences Between Types of Tobacco

Understanding the differences in economicfundamentals between the two major types ofcigarette tobacco—flue-cured and burley—isuseful in analyzing differences in effects frompotential policy changes and, thus, differentstances that various farm groups may takeconcerning a particular policy. First, the de-mand for flue-cured tobacco is likely moreelastic than is the demand for burley tobacco.Beghin and Chang estimated the price elastic-ity of demand (output constant) of U.S. ciga-rette manufacturers to be about – 0.1 for U ,S.burley tobacco and about –0.9 for domesticflue-cured tobacco. The U.S. produces about30 percent of the world burley production ver-sus only nine percent of world flue-cured pro-duction (USDA–FAS). Further, foreign com-petitors in flue-cured production (mainlyBrazil and Zimbabwe) produce flue-cured to-bacco that is a much closer substitute for U.S.flue-cured than is foreign burley to U.S. bur-ley, While there are few estimates of the ex-port demand elasticity for flue-cured tobaccoand no estimates for the export demand elas-ticity for burley tobacco, the above factorsalso imply that export demand, and hence totaldemand, for burley tobacco is less elastic thanis demand for U.S. flue-cured tobacco.

While the tobacco program does not nec-essarily set the marketing quotas at the quan-tity that maximizes cartel rents, the fact thatburley demand is less elastic than flue-cureddemand implies that the rent maximizingquantity (at the intersection of the aggregatemarginal revenue and supply curves) is small-


er for burley than it is for flue-cured tobacco. 1Corroborating this insight is the fact that theburley marketing quotas have always been setat a lower quantity than the flue-cured mar-keting quotas. Despite lower marketing quo-tas, quota rental rates indicate that the margin-al cost of producing burley tobacco is higherthan that of flue-cured tobacco. 2 These eco-nomic fundamentals imply that burley farmgroups will lobby for a lower national quotathan will flue-cured farm groups. The lesselastic demand of burley implies that burleyquota owners have greater potential to extractcartel rents than do flue-cured quota owners.But this also implies that burley quota ownershave more to lose from deregulation of tobac-co than do flue-cured tobacco quota owners.As such, burley groups might be expected tooffer greater opposition to attempts to elimi-nate the tobacco program.

Differences Among Tobacco Production

Regions

The tobacco program also prevents the geo-graphic movement of tobacco production.With the exception of Tennessee, marketingquotas cannot be sold or rented across countylines. Thus, production has been fixed geo-graphically with the initial allocation of quotasin the 1930s, As production technologies haveevolved over time, particularly towards moremechanization, substantial differences in pro-duction costs among different regions haveemerged. For example, regions where the to-pography has favored adoption of mechanizedtransplanting and harvesting now have sub-stantially lower per-unit costs of production

] The exception to this generalization would be ifthe cost of producing burley is sufficiently lower (dueto the position of the supply curve) than that of pro-ducing flue-cured to cause the intersection of the mar-ginal revenue curve and the supply curve to be at aquantity greaterthanfor flue-cured. This does not seemto be the case.

2The implication of higher marginal cost of pro-duction for burley despite a lower total quantity sup-plied is that the supply curve for burley is positionedabove the supply curve for flue-cured tobacco. Thisconfirms thatthe cartel optimum for burley is at a low-er quantity than for flue-cured.

N’ro

Burley

$005-015 ‘035 Flue-cured

I (FL \Figure 4. 1997 quota rental rates in tobaccoproducing states

than regions where adoption of mechanizationhas been more costly. In economic terms, atthe start of the program marginal costs wouldhave been expected to be equal across pro-duction regions. However, as technologieshave emerged that favor one production regionover another the tobacco program preventedmovement of production that would havemaintained an equilibrium of marginal costsamong production regions. These differencesin marginal costs are reflected in differencesin quota rental values among counties. Themarginal cost of production for a county canbe found by subtracting the quota rental ratefrom the expected price per pound of tobacco.As such, each county is a separate quota rentalmarket.

Figure 4 shows current quota rental ratesfor various production regions. Since the mar-ginal cost of production is found by subtract-ing the quota rental rate for a county from themarket price of tobacco, higher quota rentalrates indicate lower marginal costs of produc-tion. Among the burley producing regions, theAppalachian region has the highest marginalcosts. The mountainous terrain of the Appa-lachian region makes mechanization and con-solidation of farms expensive. In many coun-

29$3 Journal of Agricultural and Applied Economics, August 1999

$

~NP

I D’ D“

I

QPI ~PO NPI

c! Q

Figure 5. Decline in demand with and with-out the tobacco program’

ties in this region, quota rental rates are near

zero and tobacco production is less than the

quota for the county, especially in Tennessee

where cross-county leasing is permitted withinthe state. The highest quota rental rates in bur-ley are in central and western Kentucky wheretopography makes consolidation of farmsmuch less expensive. Among the flue-curedproducing regions, central North Carolina andVirginia have the highest marginal costs.However, unlike the high cost regions of theburley producing area, quota rental rates aresubstantially greater than zero and the quota isfully utilized. Southern Georgia and the coast-al plains of North Carolina and South Carolinahave the lowest marginal costs in the flue-cured production area.

Dl~erences Among Quota Arrangements

Besides differences in economic fundamentalsamong regions and types of tobacco, there arealso differences in economic fundamentalsamong individual tobacco farmers within re-gions and types of tobacco. The primary dif-ference among tobacco farmers leading to dif-ferences in their desire to maintain oreliminate the tobacco program, as well as dif-fering desires for price and quota levels undera program, is the degree to which the farmer

shares in the cartel rents garnered by the pro-gram. Farmers who own quotas for everypound of tobacco they grow earn cartel rentsequivalent to the quota rental rate on everypound of tobacco they produce as well as anyeconomic rents from producer surplus.

All farmers, either owning or renting quota,give up some producer surplus, at least in theshort and intermediate term, due to supply re-strictions of the program. For farmers whoown quotas for all the tobacco they produce,cartel rents collected more than offset the sac-rifice in producer surplus. However, for farm-ers renting quotas for a large share of the to-bacco they produce, the cartel rents collectedon the small share of quotas they own maynot offset the potential short- and intermedi-ate-term gains in producer surplus that wouldresult if the program were eliminated. Thus, ata given point in time, producers owning quotafor only a small share of their tobacco pro-duction may be more willing to give up thetobacco program than farmers who own quotafor a large share of their production. Producerswho own quota for a small share of their pro-duction may also be more willing to allowprice to decline in order to maintain the na-tional marketing quota than to allow the na-tional marketing quota to decline (causingquota rental rates to increase) in order to main-tain price.

Tobacco Production Under AlternativePolicy and Program Arrangements

Some of the most notable proposals made dur-ing the recent U.S. Senate debate on the to-bacco settlement would have increased ciga-rette prices and either maintained oreliminated the tobacco program. Though theseproposals failed to materialize in 1998, legis-lators have indicated that these issues may re-surface in 1999. While the mechanism for acigarette price increase and the magnitude ofthe increase may change from the 1998 pro-posals, a substantial increase in cigarette pric-es via a tax or due to increased costs to cig-arette manufacturers seems likely. Based onlegislation enacted in 1997, the federal excisetax on cigarettes is already scheduled to in-


crease from $0.24 to $0.39 per pack by 2001.In addition, cigarette manufacturers boostedcigarette prices by over $0.45 per pack in cal-endar year 1998 to cover projected settlementcosts, Further, accompanying any tobacco leg-islation will likely be debate about whether ornot to continue or alter the U.S. tobacco pro-gram.

Examining the effects of an increase in cig-arette prices along with the effects of eithermaintaining or eliminating the tobacco pro-gram provides insights into the economic in-centives that drive the political positions ofhealth advocacy groups and farm groups onthe continuation of a tobacco program. Sum-ner and Wohlgenant (1985, 1983) developed amodel and examined the effects of an increasein the federal excise tax on cigarettes. Morerecently, Brown used a slight modification ofthis model to examine the farm-level effectsof increases in cigarette taxes and smoking re-strictions. The model presented in Brown isused to separately analyze the economic ef-fects of an increase in the price of cigaretteson burley and flue-cured tobacco producersand quota owners under two scenarios, one inwhich the tobacco program is maintained andone in which the tobacco program is elimi-nated. The model is presented in the Appen-dix. For purposes of this discussion, a $1. OO-per-pack (50-percent) increase in the price ofcigarettes is considered, which is smaller thanthe price increases proposed in 1998, but inline with many legislators’ speculations aboutincreases that might be proposed in the nextround of legislative debates.

Estimates of the retail price elasticity of de-mand for cigarettes range from – 0.28 to–0,80 (Wasserman et al.; Chaloupka, Batagiand Levin; Coate and Lewit; Jones; Becker,Grossman, and Murphy) with most ch.tsteringbetween –0.4 and –0.75. Chaloupka, using aneconomic model developed by Becker andMurphy, estimated the long-run price elasticityof demand to range from – 0.35 to –0.48.More recently, Becker, Grossman, and Mur-phy, using the same model but a different dataseries, estimated the long-run price elasticityof demand to be -0.75. The results presentedin this paper are based on simulations of a

cigarette price increase under two scenarios inwhich two cigarette price elasticity of de-

mands, – 0.4 (Chaloupka) and –0.75 (Becker,

Grossman, and Murphy), are used.Following Beghin and Chang, the domestic

price elasticity of demand for burley and flue-cured are assumed to be –O. 1 and – 0.9 re-

spectively.? The export price elasticity of de-mand is assumed to be – 1.5 for burley and–3.0 for flue-cured tobacco.4 The total price

elasticity of demand used for U.S. burley and

flue-cured are then –0.53 and – 1.75 respec-

tively. Following Goodwin and Sumner, theaggregate supply elasticity under the tobaccoprogram is assumed to be 4.0. Without a to-

bacco program, the aggregate long-run supplyelasticity is assumed to be perfectly elastic.Other parameters used in the simulations are

presented in the appendix.

Simulating a Cigarette Price Increase

In the simulations, the derived domestic de-mands for U.S. burley and flue-cured tobaccoshift back due to a movement back along thedemand curve for U.S. cigarettes as the price

increases. The cigarette price increase is dueeither to an increase in the cost of producing

cigarettes resulting from mandatory payments

f Sumner and Alston estimated the domestic de-mand elasticity for US tobacco (burley and flue-curedcombined) to be – 2. However, more recently Rezitis,Brown and Foster, using a dynamic model, estimatedthe long-run domestic demand elasticity for US tobac-co to be –0.4. Using a share weighted average of theBeghin and Chang parameters yields an estimate of–0.56. These latter results seem to support the ideathat the domestic demand for US tobacco is inelastic.

dNorton and Johnson estimated the export elastic-ity for US flue-cured tobacco to be – 2.33. However,since their work, US share of the world flue-curedtrade has diminished and competing countries havesucceeded in producing flue-cured tobacco that is acloser substitute to US Rue-cured. This situation im-pIies that export demand would have become moreelastic. There are no estimates of the export demandelasticity for US burley tobacco. However, the eco-nomic fundamentals outlined in the previous sectionindicate that burley export demand is less elastic thanUS flue-cured export demand.


to the government or to an increase in ciga-rette taxes. Under the tobacco program, thequota shifts back with demand to maintain thefarm price of tobacco. This is illustrated inFigure 3 where, under a program, as demandshifts back from D[) to D 1 the national mar-keting quota—initially set at QPO—declines toQ“ in order to maintain price Pro. As tobaccoproduction moves back and down along theupward sloping aggregate restricted supplycurve~, S>, marginal cost declines. The quota

rental rate rises as the difference between price

and marginal cost increases.

The simulation results indicate that under

the current tobacco program a $1.00-per-packincrease in cigarette prices could cause U.S.cigarette consumption to decline between 15and 38 percent in the long run. Using a do-mestic price elasticity of demand for U.S. cig-arette consumption of –0.4 and assuming aconstant elasticity of demand yields the lowerforecast (a 15-percent decline). The higherforecast (a 38-percent decline) is obtained byusing a price elasticity of – 0.75 and a linearapproximation to U.S. cigarette demand. Giv-en the range of elasticity estimates for ciga-rette demand, the large increase in cigaretteprices, and the lack of estimates for the priceelasticity of tobacco export demand, theseforecasts are speculative. However, the as-sumptions and price elasticities used may pro-vide reasonable bounds for the forecasts. Moreimportantly, considerable insight into the eco-nomic incentives for various interest groups isgained, despite the speculative nature of thesimulations.

The $1.00 tax increase with maintenance ofthe current tobacco program would cause a de-cline in the burley tobacco quota (the quantity

‘ If payments shift up the supply curve via shiftingup individual marginal cost curves, then the paymentsmust be per unit payments. Lump sum payments maybe viewed as sunk costs and would not affect the mar-ginal cost curve unless the government requires thatcigarette companies raise cigarette prices.

(,The supply curve is restricted in the sense thattobacco production is fixed geographically under theprogram. These restrictions cause it to be more inelas-tic than in the absence of a program, even in the longrun, See Goodwin and Sumner or Fulginiti and Perrin[or a more detailed discussion.

needed to maintain the current farm price) of7 to 17 percent in the long run (Table 1). Asthe quota declines, the difference between themarginal cost of producing burley tobacco andits price (which remains constant) increases sothat the quota rental rate increases by 10 to 22percent. This increase in quota rental rate morethan offsets the decline in quota so that totalquota rental income (i.e. cartel rents) actuallyincreases slightly for burley tobacco quotaowners. Similarly, a $1.00-per-pack increasein cigarette prices results in a 6- to 15-percentdecline in the national marketing quota forflue-cured tobacco in order to maintain thecurrent farm price (Table 1). Quota rental ratesin the flue-cured production areas rise on av-erage between 5 and 13 percent. Unlike bur-ley, total quota rental income for flue-curedquota owners declines. Neither exports of bur-ley or flue-cured tobacco change since farmprice is unaffected by declines in demand un-der the program.

Simulating a Cigarette Price Increase With

Program Elimination

When the tobacco program is eliminated, pricemoves down along the new demand curve, D‘(Figure 3), for U.S. tobacco (after the shiftback in demand due to increased cigaretteprice) to the intersection of demand with anunrestricted and perfectly elastic long-run ag-gregate supply curve, SNP. The unrestrictedsupply curve, SNP,will lie at or below the in-tersection of the restricted supply curve, S’,and the quota, QP(). The new price, PNP,willequal marginal cost and all cartel rents will betransferred to the purchasers of tobacco (i.e. toconsumer surplus). The quantity of tobaccoproduced will increase to QNP’.7

If, along with a $1.00-per-pack increase incigarette prices, the tobacco program is elim-inated, the change in U.S. burley tobacco pro-duction is expected to range from – 6 to +8percent over the burley production levels un-der the program and before the price increase

7If the shift back in demand were large enough,QN’” could be less than Q]”). This is not the case forthe level of cigarette price increase considered here.


Table 1. Effects of a $1.00 per pack cigarette price increase under the current tobacco program

Total Farm Quota Rental QuotaTotal Sales Revenues Rate IncomeMillion Ibs Million $ Mb Million $

Burley Initial Level 605 1,107 0.30 181Change –43 to – 106 –78 to –193 +.03 to +.07 +2 to +3V. Change –7 to –17 –7 to –17 +10 to +22 +1 to +2

Flue-Cured Initial Level 904 1,582 0.40 362Change –55 to –136 –96 to –239 +.02 to +.05 –4 to –15~. Change –6 to –15 –6 to –15 +5 to +13 –lto–4

(Table 2). Comparing the production levels af-ter the price increase under the tobacco pro-gram versus with no program indicates that thequantity of burley tobacco produced would be13 to 16 percent greater without a program.The farm price of burley tobacco in the ab-sence of a program is expected to decline over20 percent from its program level. With theprice decline, exports of burley tobacco in-crease, partially or fully offsetting declines inuse of burley tobacco by U.S. cigarette man-ufacturers.

In the case of flue-cured tobacco, produc-tion of flue-cured tobacco after the price in-crease and with elimination of the programwould be expected to be 61 to 73 percentgreater than the quantity produced before thetax increase and under the tobacco program(Table 2). Comparing elimination of the to-bacco program and a $1.00-per-pack increasein cigarette prices with the same cigaretteprice increase under the program indicates thatflue-cured production would increase by 84 to89 percent in the absence of the tobacco pro-gram. The price of flue-cured tobacco is ex-

pected to decline by about 27 percent. Withthe flue-cured tobacco price decline, potentialgrowth in exports of U.S. flue-cured tobaccoranges from 80 to 155 percent. Recall thatboth domestic and export demand for U.S.flue-cured tobacco are thought to be muchmore elastic than demand for burley tobacco.

With the elimination of the tobacco pro-gram, income from quota is also eliminated.Because the long-run supply of tobacco is as-sumed to become almost perfectly elastic withderegulation of tobacco production, all annualcartel rents are transferred to consumer sur-plus.’ This represents a transfer of over $180million in annual income from burley tobaccoquota owners to cigarette manufacturers and/or smokers. Almost $350 million in annual in-come is expected to be transferred from flue-cured tobacco quota owners to cigarettemanufacturers and/or smokers.

RAll cartel rents are transferredto consumers’ sur-plus as long as the unrestricted (after program elimi-nation) perfectly elastic aggregate supply curve goesthrough a point representing current or lower marginalcost of production.

Table 2. Effects of a $1.00 per pack cigarette price increase and elimination of the tobaccoprogram

Total Farm DomesticRevenues Total Sales Use Exports PriceMillion $ Million lbs Million lbs Million lbs $/lb

Burley Initial Level 1,107 605 419 186 1.83Change –160 to –286 –39 to +48 –34 to –99 +60 to +82 1.45% Change –14 to –26 –6 to +8 –8 to –24 +32 to +44 –20

Flue-Cured Initial Level 1,582 904 550 354 1.75Change –106 to +415 +249 to +656 –36 to +106 +285 to +551 1.28% Change –7 to +26 +27 to i-72 –6 to +19 +80 to +155 –27


With elimination of the tobacco programtotal farm revenues from the sale of U.S. flue-cured tobacco are expected to increase be-tween 10 and 34 percent compared to a sce-nario which maintains the current tobaccoprogram and increases cigarette prices by$1.00 per pack. This represents between a – 7and +26 percent change in farm revenues overthe level before the price increase (Table 2).However, total farm revenues from the sale ofU.S. burley tobacco decline between eight and10 percent when the tobacco program is elim-inated compared to a scenario that maintainsthe tobacco program and increases cigaretteprices by $1.00 per pack.g This represents a14- to 26-percent decline in farm revenues af-ter the price increase and program eliminationcompared to farm revenues before the tax in-crease (Table 2).

Structural Implications for Price andProgram Changes

Major changes in the national tobacco policy(i.e., elimination of the tobacco program, a rel-atively large reduction in the average pricesupport level, or implementation of a relative-ly large excise tax increase) will have signif-icant structural effects on tobacco farmingcommunities. The differences in marginalcosts among regions are important in analyz-ing the potential structural changes that wouldresult from changes to the tobacco program. Ifthe quota system were eliminated, total tobac-co production would increase. However, pro-duction would decline in regions with thehighest marginal costs while it would increasein regions with the lowest marginal costs, i0

gThe lack of an export elasticityestimatefor bur-ley tobacco is problematic.However, given the do-mestic elasticityestimateof – 0.1, in order for farmrevenuesfrom burleytobacco to expandafterprogramelimination,the exportelasticitywould have to be – 5or greater(in absolutevalue). An export elasticityofthis magnitudeseemsunlikely.

10How much production increases or decreaseswithin a particular county depends on the slope of theaggregate supply curve for tobacco production in thecounty. For most counties, land for tobacco productionwould be the limiting factor of production that couldcause a long-run county supply curve to be upward

Rucker, Thurman, and Sumner analyzed po-tential changes in the location of productionand accompanying welfare effects under aprogram scenario which allowed cross-countyleasing in North Carolina but did not eliminatethe program. With the elimination of countybarriers to movement of production, theyfound that production would decline in thepiedmont of North Carolina and increase inthe coastal plain portion of the state. Since dif-ferences in marginal costs among regions aregreater in the burley production area than inthe flue-cured production area, it follows thatgreater structural change would be expected tooccur in the burley producing regions if thetobacco program were eliminated. The Appa-lachian region might cease to produce tobaccoentirely. Central and western regions in Ken-tucky and Tennessee likely would increaseproduction of burley tobacco after some ad-justment period.

Even though tobacco production evidentlywas not the most profitable use for land out-side the current tobacco producing regions six-ty years ago when the tobacco program estab-lished and froze the geographic location ofproduction, that might not be the case now.Thus, elimination of the tobacco programcould result in production of tobacco outsidethe current producing areas. The greateststructural change may ultimately occur inKentucky and the Appalachian region, whichpossesses over one-half of all the farms grow-ing tobacco in the United States and have thegreatest economic dependency on tobacco.The current program imposes significant trans-action costs for consolidation of farms becauseof the regulations governing consolidation of

sloping. In many counties, particularlythose in thecoastal plain areas of North and South Carolina, to-bacco productionoccupies only a smallpercentageoftotal cropland.In thesecounties, the long-run supplycurve, m the absence of a program, would be expectedto be close to perfectly elastic around the currentquan-tity of tobacco produced under the program. However,in some counties, such as those in the Appalachianregion or the piedmont of Virginia or North Carolina,tobacco production occupies a high percentage of thetillable cropland. In these counties the long-run supplycurve may be fairly inelastic around the current quan-tity of tobacco produced under the program.


quota and the marketing of tobacco. Elimina-tion of the program would then reduce the costof consolidation increasing economies of scaleassociated with tobacco production. These fac-tors point to a potentially large net exit of to-bacco farmers despite an overall expansion intobacco production.

Under the current structure of the tobaccoprogram, small-scale producers may havesome cost advantages over larger producersgiven their access to family labor and the useof depreciated assets. However, small-scaleproducers’ access to markets and credit andtheir ability to remain low-cost producers isquestionable under the structure of a freermarket environment. Contracts offered by to-bacco companies and dealers are the means ofmarketing tobacco in many countries. If a con-tract marketing system were to evolve, tobac-co companies (or their agents administeringthe contract system, which could include leafdealers or warehouse owners) would likelyinitially seek existing tobacco growers whohave access to large and productive tracts ofland. Given the current infrastructure avail-able, tobacco production may initially stay intraditional tobacco producing states in theshort-run. Given time, however, productioncould move into non-traditional areas based onproduction costs and quality considerations.

Southern Georgia and the coastal plains re-gions of North and South Carolina likelywould experience large increases in flue-curedtobacco production. Virginia and the centralpart of North Carolina, where flue-cured pro-duction costs are highest, would experiencedeclines in flue-cured tobacco production and,subsequently, farm income. These areas arethe least agriculturally diversified regionswithin the flue-cured producing area, Fewfarm alternatives with similar income produc-ing potential to tobacco exist in these hilly androlling regions, where tobacco occupies a high

percentage of tillable land. Given the mana-gerial expertise for growing tobacco in theseareas and the suitability of the soils for grow-ing burley tobacco, one possible alternativecrop to flue-cured tobacco for Virginia andcentral North Carolina might be the less mech-anized burley tobacco. For many farmers in

these regions, off-farm employment would bethe alternative of choice, as the region is high-ly industrialized with healthy growth in thissector projected. Production under the currenttobacco program will not be easy for the flue-cured region either. With reduced quotas andlarge production capacity, particularly in theflue-cured areas, many farmers may have dif-ficulty covering all of their fixed costs. Com-petition among farmers for available quota isintense in the flue-cured areas, This will ulti-mately lead to the exit of some farmers, al-though not as many as with the elimination ofthe tobacco program.

Policy Implications for Price and ProgramChanges

With the current political trend moving awayfrom farm programs, many farm groups in to-bacco-producing states fear that the tobaccoprogram will share a fate similar to other farmprograms. Even though the tobacco programis authorized by permanent legislation and nota part of the farm bill, Senator Richard Lugar(current Chair of the Senate Committee onAgriculture and a strong advocate of fleermarkets) has vowed to eliminate the tobaccoprogram. However, even Senator Lugar ac-knowledges that tobacco is different from oth-er agricultural commodities and that more to-bacco at a cheaper price may not be desirablefor society.

In the past, cigarette manufacturers havebeen strong supporters of the tobacco program—even though it can reduce the demand forcigarettes and/or increase their productioncosts—in return for political support fromfarmers and other quota owners. Manufactur-ers still value political support of the farmingcommunity, as evidenced by their recent ef-forts to voluntarily provide economic assis-tance to tobacco farmers negatively impactedby the settlement of state Medicaid lawsuits,but the political influence of the producercommunity may not carry the same weight inthe manufacturers’ eyes in the future. It ap-pears that the manufacturers achieved a higherlevel of political support from a $45-millionad campaign that appealed to smokers and tax-


payers during the Senate debate on the settle-ment last summer than they will likely be ableto achieve in the future from producers andquota owners. However, as long as cigarettemanufacturers are under the threat of legisla-tive action that could reduce the demand forcigarettes or increase their cost of operation,cigarette manufacturers may have an incentiveto continue support for maintenance of a to-bacco program in return for political supportfrom the farming community.

Health advocacy groups will likely contin-ue to debate the merits of supporting mainte-nance of a tobacco program that potentiallyincreases the political base of cigarette man-ufacturers but may reduce cigarette demandthrough higher costs of production and trans-fers some of the economic surplus from man-ufacturers to growers versus supporting elim-ination of the program resulting in lesspolitical support for cigarette manufacturersbut also resulting in a large economic windfallto cigarette manufacturers. Several of the ma-jor health advocacy groups have been workingwith tobacco farmers in recent years to under-stand the complexity of the tobacco issue froma production and rural community standpoint.In January 1998, a document which outlinesbroad points of agreement parties havereached a consensus on, including support ofa tobacco program, was prepared jointly by agroup of public health advocates and tobaccoproducers. The “Core Principles of Agree-ment Between the Public Health Communityand the Tobacco Producer Community” hassince been signed by nearly 100 public health,political, and farm organizations, including theAmerican Cancer Society, the American HeartAssociation, the American Public Health As-sociation, the Burley Stabilization Corpora-tion, the Burley Tobacco Growers Coopera-tive, Inc., and the Flue-Cured TobaccoStabilization Corporation. The current strategyof health advocacy groups supporting contin-uation of a tobacco program in return for po-litical support from farm groups for some anti-smoking initiatives, especially limiting youthaccess to tobacco products, will likely contin-ue.

Thus, in an ironic twist, the health-related

problems that plague tobacco may also be thebest defense for the continuation of a tobaccoprogram. Continuation of the current tobaccoprogram, if possible, will be with reduced lev-els of national quota due to declining domestic

demand for cigarettes and intense foreigncompetition. Most burley tobacco growers and

quota owners may find the status quo the most

desirable alternative, even at reduced quotalevels. Burley price and quota currently is setin the inelastic portion of the burley tobaccodemand curve. This indicates that burley to-bacco farm organizations may actually want toincrease price and reduce quota further. As aresult, farm organizations representing burley

tobacco growers and quota owners, from states

such as Kentucky and Tennessee, will likely

continue to lobby for the continuation of thecurrent tobacco program.

A consensus is much more difficult toreach among flue-cured tobacco growers andquota owners. Growers and quota owners incentral North Carolina and Virginia, whereproduction costs are highest, are likely toagree with most burley groups in their supportof tobacco program continuation, Flue-curedtobacco growers who own quota for most of

their tobacco production and non-producingquota owners are also likely to favor contin-uation of the current tobacco program, even inthe face of reduced quota levels, Flue-curedtobacco growers who rent quota for a substan-

tial portion of their production, particularlythose in the coastal plain of the Carolinas andin southern Georgia, are likely to be less sup-

portive of continuation of the current tobaccoprogram. In the face of declining quotas, many

of these growers may support allowing tobac-

co prices to decline in order to maintain quotalevels or even eliminating the program alto-

gether. While there may be fewer growers withthese circumstances than other types of tobac-co growers, they generally have larger farming

operations and grow the majority of the do-mestic flue-cured tobacco. Because of their fi-nancial stake in the longevity of tobacco in the

U.S. they tend to be vocal and very politicallyactive.


Conclusions

Should national legislation concerning smok-ing and tobacco resurface in the near future,are there reasonable compromises concerningthe U.S. tobacco program that could satisfy allthe stakeholders in the program? A phase-outof the tobacco program with quota owners re-ceiving compensation for their quota has thepotential (given high enough compensationlevels) to find the support of most tobaccogrowers and quota owners. If the quota com-pensation were funded by increased cigarettetaxes or from payments from cigarette manu-facturers, then health groups would likely beagreeable in that cigarette manufacturerswould be denied a large economic windfallfrom elimination of the tobacco program andthe farm level political base of cigarette man-ufacturers would be reduced. Of course, an un-desirable effect of this strategy from a publichealth standpoint would be that the U.S.would grow and export more tobacco at muchlower prices, potentially raising new worldhealth concerns. Cigarette manufacturersmight oppose such efforts since they wouldlose much of their farm level political supportand be denied economic gains from elimina-tion of the tobacco program.

A more palatable compromise for most in-volved might be continuation of the currenttobacco program with no changes for burleytobacco but with a lowering of price support,with compensation to quota owners in theflue-cured tobacco producing areas. Brownand Martin explored the trade-off (withoutcompensation) between reduced price and re-duced quota for flue-cured tobacco growers,non-producing quota owners, and rural econ-omies. With compensation for allowing mar-ket price to fall by lowering support prices,flue-cured quota owners (both growers andnon-growers) could be made indifferent to thechange in price. Flue-cured growers who rentmost of their quota might support the changesince they would experience smaller declinesin national quotas (or even an increase de-pending on the magnitude of the price de-cline). With reduced price, quota rental rateswould decline. The painful structural change

and geographic changes in production associ-ated with ending the program would be avoid-ed. While flue-cured production would not de-cline as much (or could even increase) asunder the current program, health groupsmight be satisfied with a program that heldproduction below and prices above free mar-ket levels. Further, cigarette manufacturerscould be denied economic gains from lowerprices if compensation were financed from in-creased cigarette taxes or payments from cig-arette manufacturers, making the plan morepalatable to health groups. Cigarette manufac-turers might be indifferent to the plan if theywere forced to pay compensation for the low-ering of flue-cured tobacco prices.

On the other hand, promoters of free mar-kets, such as Senator Lugar, might feel lessthan victorious with a plan that leaves the to-bacco program intact, even if price and pro-duction were allowed to move closer to freemarket levels for flue-cured tobacco. With theexception of administrative costs, the tobaccoprogram operates at no cost to the federal gov-ernment, The administrative costs could alsobe shifted to fees or assessments paid by to-bacco farmers and purchasers of tobacco.Even with no cost to the government the main-tenance of a tobacco program and its politicalbase of growers and quota owners ensures thattobacco state legislators would have to contin-ue to deal with the controversy surroundingthe tobacco program.

A solution that pleases all parties involvedwill be difficult if not impossible to find andimplement. Given the mixed incentives forkeeping versus eliminating the tobacco pro-gram, the controversy is likely to continue.Predictions that the end of the tobacco pro-gram is near have been rampant since the firstSurgeon General’s report that implicatedsmoking as harmful to health. The programwas pronounced dead in the mid- 1980s amidskyrocketing program costs, increasing inter-national competition, and increased concernsabout smoking, only to be revived as a no-net-cost program (Rucker). The program has alsoexperienced major challenges during the1990s, with the most serious challenges aris-ing during the national tobacco settlement de-


bate in 1997. Despite all the problems sur-rounding the tobacco program, it has survivedfor over 50 years. While future survival re-mains highly uncertain, the ultimate irony isthat the program’s salvation may be the veryissue once thought to be the cause of its de-mise.

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Appendix

To simulate the effects of an increase in cigarettetaxes under the current tobacco program equations1–9 are solved as given in Brown and in Sumnerand Wohlgenant (1983, 1985). Definitions of vari-ables and parameter values are given in appendixTables 1 and 2. The proportionate change in a var-iable is indicated by the operator E. For an in-depthtreatment of the model and its use see Brown orSumner and Wohlgenant (1983, 1985).

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(lo)

(11)

(12)

EQC~= –VC~EP.,l

EQCC= –VCCEPC.

EQC = ~C,EQC, + (1 – ~C,)EQC.

EPC~= aC~EP,~+ a~ET

EPC. = [1/(1 – a~)](EPcd – LITET)

EQ,~ = a,~(J~~EP,Cl+ EQC

EQ,. = – q &ptd

EQ, = fl,~EQ,~ + (1 – (3,~)EQt.

EQr = ~EP,~

ER, = EP,, + EQ,

EL, = (1/@

EPt~– ((1 – CIL)kIL)@Q,


Table Al. Definitions of endogenous and exogenous variables

Symbol Definition Value

Exogenous Variable

T

Endogenous Variables

Q.,Pcd

Q..P,,

Q.P,,,

Q,,Q,,Q,R,L,

Federal excise tax per pack of cigarettes. $0.74

Quantity of cigarettes sold in U.S. by U.S. manufacturers.U.S. wholesale price of cigarettes.Quantity of cigarettes exported by U.S. manufacturers.Rice of U.S, manufacturedcigarettes for export.Total quantity of cigarettes produced by U.S. manufacturers.Farm sales price of U.S. tobaccoQuantity of U.S. tobacco purchased by U.S. manufacturers.Quantity of U.S. unmanufacturedtobacco exportsTotal quantity of domestically produced tobacco.Total domestic tobacco revenue.Market rental rate for tobacco quota.

Table A2. Parameter definitions and values

Parameters Burley Flue-cured

Domestic wholesale price elasticity of demand for cigarettes.Export wholesale price elasticity of demand for cigarettes.Quantity share of U.S. cigarettes sold in the U.S. market.U.S. tobacco share of domestic wholesale cigarette costs.Tax share of domestic wholesale cigarette costs.Own-elasticity of substitution for domestic tobaccoU.S. export price elasticity of demand for domestic tobacco.Quantity share of domestic tobacco used in U.S. cigarettesDomestic tobacco output response elasticity.Average cost share of quota rent in tobacco production.Elasticity of marginal cost of tobacco production

0.4, 0.750.80.670.0160.186.171.50.69

cc

0.160.25

0.4, 0.750.80.670.0190.18

46.593.00.60

m

0.230,25

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