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Regulatory Proposal for Reducing Fire Risks from Cigarettes
Costs of Compliance with the Proposed Cigarette Ignition Propensity Regulations - Chapter 4
4.1 Introduction
The proposed cigarette ignition propensity regulations would require cigarette manufacturers to alter their cigarette designs to comply with an ignition propensity standard. The regulations would also require manufacturers to perform prescribed toxicity tests and report the results to Health Canada on an annual basis. Based on the information summarised in Chapter 3, the cigarette manufacturing industry would likely implement some form of modified paper technology to comply with the ignition propensity standard, and would most likely adopt banded paper to replace traditional cigarette paper.
This chapter provides an analysis of the costs of adopting such a compliance approach. The analysis is presented in two parts. In the first part, the baseline cost model outlined in Chapter 2 is adjusted to reflect the results of a modelled paper-modification cost study. In the second part, the responses of Canadian cigarette manufacturers to an outreach questionnaire are analysed in summary form, yielding an estimate of the incremental cost of implementing the banded-paper technology. The results from both approaches are then presented on an annual cost and present value basis.
Both the modelled estimate of compliance costs and the estimate derived from responses to the industry outreach questionnaire attempt to capture the full range of costs that the Canadian tobacco products industry would incur in order to comply with the proposed cigarette ignition propensity standard. This includes the costs associated with purchasing and operating new equipment, changing production processes or inputs (such as paper), undertaking additional quality assurance checks, or conducting toxicity tests to ensure compliance with the standard. From the perspective of cost-benefit analysis, these costs represent real-resource compliance costs.
The cost estimates do not include other potential social costs, such as the cost to the public sector of administering and enforcing the new policy, social welfare losses that might be associated with an increase in consumer or producer prices, or transitional social costs, such as those that might be associated with an increase in unemployment. In the absence of additional information and models that characterise the long-term ramifications of an increase in cigarette production costs for the tobacco products industry and related sectors of the Canadian economy, a complete assessment of these costs is not feasible. In this case, however, the potential impact of the regulation with respect to prices or transitional social costs is not expected to be large; as a result, the evaluation of direct compliance costs should provide a reasonable approximation of the social costs of the regulation.34
4.2 Modelled Cost Estimate
Among the ignition propensity compliance options analysed by the U.S. Technical Study Group was the use of heavier paper (see Chapter 3). 35 Specifically, the study estimated the incremental costs of increasing the overall thickness of cigarette paper. Such a modification differs from the banded-paper approach likely to be implemented by cigarette manufacturers, as the paper's thickness in the study was assumed to be increased uniformly, instead of only in intermittent bands. The nature and magnitude of the general changes that would be required at the cigarette manufacturing level, however, are sufficiently similar between the two approaches to support using the study as a point of reference for estimating the costs of compliance with the proposed standard.
As shown in Exhibit 4-1, the total incremental cost of the paper modification studied, stated in 2002 dollars, is $0.126 per carton. The details for the underlying calculations are provided in Appendix C.
| Current Costs | Post-Compliance Costs | |
|---|---|---|
| Purchased Leaf Tobacco | 1.152 | 1.152 |
| Handling, Transport and Storage | 0.978 | 0.978 |
| Tobacco Processing | 0.223 | 0.230 |
| Plug Making | 0.419 | 0.428 |
| Cigarette Making | 0.451 | 0.535 |
| Packaging/Shipping | 0.766 | 0.766 |
| Business Expenses | 1.708 | 1.708 |
| Toxicity Testing (see Note) | n/a | 0.027 |
| TOTAL COSTS = | $5.697 | $5.823 |
Note: The costs in the Toxicity Testing line reflect only the additional tests required by the proposed regulations. Numbers may not add because of rounding.
4.3 Industry-based Cost Estimates
4.3.1 Industry Outreach Questionnaire
As part of the data gathering process, industry outreach questionnaires were developed and sent to more than 40 potentially affected parties, including cigarette manufacturers, importers, retailers, growers, and unions.
The questionnaires solicited information regarding the respondents' familiarity with the pending regulatory issue, and asked for the respondents' opinions regarding the impacts that the proposed regulations might have on their industries. In the case of the questionnaire tailored for cigarette manufacturers, the modelled baseline cigarette manufacturing cost structure was presented, as well as an estimate of the costs of compliance with the proposed regulations. The recipients were then asked a series of questions regarding whether those modelled estimates were representative of their current costs and anticipated compliance costs.
Copies of the questionnaires are presented in Appendix B.
4.3.2 Industry Responses
In total, nine responses to the questionnaire were received from cigarette manufacturers (3), importers (3), unions (2), and retailers (2).
The responses from cigarette manufacturers yielded a range of estimated incremental costs for compliance with the proposed standard. All of the responses that included cost estimates assumed that a banded-paper technology would be implemented. To make the estimates comparable, the reported figures were adjusted using estimates of the respondents' domestic sales volumes, to normalise the results to a unit basis (i.e., dollars per carton of 200 cigarettes).
Among the responses obtained from cigarette manufacturers, the most complete set of cost estimates yielded the highest incremental unit costs. Exhibit 4-2 summarises these figures, and shows that the incremental cost to implement a banded-paper technology based on cigarette manufacturers' reported cost estimates would be approximately $0.257 per carton.
| Incremental | |
|---|---|
| Purchased Leaf Tobacco | $ -- |
| Handling, Transport and Storage | $ -- |
| Tobacco Processing | $ -- |
| Plug Making | $0.011 |
| Cigarette Making | $0.166 |
| Packaging/Shipping | $0.007 |
| Business Expenses (Note 1) | $0.003 |
| Toxicity Testing | $0.069 |
| Total Incremental Costs = | $0.257 |
Note (1): Incremental investment in paper-supplier equipment, depreciated over a 20-year period.
4.4 Total Costs
4.4.1 Annual Costs
Exhibit 4-3 summarises the estimated annual costs of complying with the proposed standard. Using the modelled estimate of $0.126 per carton and current domestic cigarette-manufacturing industry production of 206.5 million cartons per year yields total annual costs of approximately $26 million. When the same calculation is performed employing the industry-based estimate of $0.257 per carton, the resulting annual cost figure is approximately $53 million.
| Modelled Estimate | Industry-Based Estimate | |
|---|---|---|
| Incremental cost ($ per carton) | $0.126 | $0.257 |
| Annual production (millions of cartons) | 206.5 | 206.5 |
| Total incremental annual costs = | $26.0 | $53.0 |
4.4.2 Present Value of Costs
The compliance cost figures provided in Exhibit 4-3 are presented on an annual basis. To calculate the present value of these costs, the analysis assumes that they would remain constant in perpetuity (i.e., over an infinite number of years). Using this assumption and applying a discount rate of three percent, the present value of estimated compliance costs ranges from approximately $867 million to $1.8 billion, in 2002 dollars.
Chapter 6 presents an analysis of the sensitivity of these figures to the discount rate employed, providing estimates of the present value of compliance costs using a range of alternate discount rates.
34 Chapter 7 provides a screening assessment of the potential economic impacts of the regulation, including potential impacts on cigarette prices and on various sectors of the tobacco products industry.
35 Sumner, et al., 1987, Economic Sector Data for Modeling the Impact of Less Ignition-Prone Cigarettes, Technical Study Group on Cigarette and Little Cigar Fire Safety, Center for Fire Research, National Bureau of Standards, 89-98.
