Regulatory Proposal for Reducing Fire Risks from Cigarettes

Economic and Distributional Impacts of an Ignition Propensity Standard - Chapter 7

7.1 Introduction

The impacts of the proposed ignition propensity regulations would be felt primarily by the tobacco industry and its customers.  The discussion below identifies the most important of these potential effects.  Ideally, an analysis of this type would be based on a comprehensive model characterising the long-term ramifications of an increase in cigarette production costs for the tobacco products industry and related sectors of the Canadian economy.⁷⁴  An appropriate model, however, is not currently available, and the development of such a model is beyond the scope of this analysis. 

In the absence of such tools, the analysis provides a simplified screening assessment of the implications of an increase in cigarette production costs for both the industry and consumers.  It begins by describing the potential impact of increased operating costs on cigarette manufacturers' operating profits and on cigarette prices and sales.  It then describes the implications of these market impacts for various segments of the tobacco industry, including cigarette manufacturers, their suppliers, and distributors.  In addition, the discussion notes the potential implications of the standard for exports of tobacco products, government excise tax revenues, tobacco industry employment, and cigarette consumers.  It concludes by describing the characteristics of those who would benefit from the standard - i.e., segments of the population that might otherwise become victims of cigarette-ignited fires.

7.2 Impacts on Cigarette Manufacturers, Prices, and Sales

As Chapter 4 describes, the estimated cost of complying with the proposed ignition propensity regulations ranges from approximately $0.13 to $0.26 per carton.  If these costs were entirely absorbed by cigarette manufacturers, the companies' operating profits would be reduced by an estimated 2.9 to 5.9 percent.  Alternatively, cigarette manufacturers could raise prices to reflect their increased costs.  While some price increase is likely, the degree to which individual manufacturers would raise prices is uncertain, and would depend upon competitive forces within the tobacco products market.  Given the degree of competition in that market, it is unlikely that prices would rise by the full amount of the estimated cost increase (i.e., by 13 to 26 cents per carton).  Nonetheless, for purposes of bounding the potential economic impacts of the regulation, it is useful to consider this scenario.  The analysis that follows illustrates this case, assuming that manufacturers would raise cigarette prices by 13 to 26 cents per carton.  Given an average baseline retail price (including all taxes and duties) of $65.24 per carton, the addition of 13 to 26 cents would represent a retail price increase of 0.2 to 0.4 percent.⁷⁵

Numerous studies of the impact of cigarette prices on the consumption of cigarettes have been conducted.⁷⁶  These studies have found a statistically significant negative relationship between cigarette prices and consumer demand for cigarettes.  For adults, the estimated price elasticity of demand is approximately -0.4; i.e., a one percent increase in the price of cigarettes will yield a 0.4 percent decrease in the quantity sold.  Thus, a 0.2 to 0.4 percent increase in cigarette prices would be expected to result in a decline in demand of 0.08 to 0.16 percent.  Based on an initial domestic sales volume of 191.0 million cartons per year, this decline in demand would represent a reduction in annual sales of 152, 200 to 304, 500 cartons.⁷⁷

Exhibit 7-1 summarises the effects of this price increase and its estimated impact on manufacturers' annual revenues and operating profits.  As the exhibit indicates, a 13 to 26 cent increase in price per carton would increase annual revenues from cigarette sales by approximately $23.3 million to $46.5 million.  Due to the decline in cigarette demand, however, these additional revenues would not fully offset the anticipated increase in manufacturing costs.  As a result, manufacturers' annual operating profits would decline by approximately $0.7 million to $1.3 million (i.e., 0.08 to 0.16 percent).

Exhibit 7-1 - Potential Impact of an Igntion Propensity Standard on Cigarette Prices and Cigarette Manufacturer Revenues, Operating Costs, and Operating Profits (2002 $CAD)

Scenario	Cartons Sold Annually (thousands)	Revenue Per Carton	Annual Revenues (millions)	Annual Operating Costs (millions)	Annual Operating Profits (millions)
Baseline:  No Price Change	191,015.0	$10.12	$1,933.6	$1,088.2	$845.4
Price Increase: $0.13 Per Carton	190,862.8	$10.25	$1,956.9	$1,112.2	$844.8
Price Increase:  $0.26 Per Carton	190,710.5	$10.38	$1,980.1	$1,136.1	$844.1

Given the relatively modest impacts described above, the introduction of an ignition propensity standard would be unlikely to have a significant adverse effect on employment at cigarette manufacturing facilities, most of which are located in Quebec or Ontario.⁷⁸  Cigarette manufacturers might experience some downward pressure on employment due to a potential increase in cigarette prices and resulting decrease in domestic cigarette sales.  The magnitude of such effects, however, is likely to be small.  Moreover, any reduction in employment as a result of decreased demand might be offset by additional hiring (e.g., to conduct toxicity testing) to ensure compliance with the standard.  Thus, any adverse impact on employment in cigarette manufacturing is likely to be minor.

7.3 Impacts on Cigarette Manufacturing Suppliers

7.3.1 Tobacco Growers

As described in Chapter 3, it is unlikely that cigarette manufacturers would attempt to comply with the proposed ignition propensity standard by changing the density or blend of tobacco their products employ.  The analysis of compliance costs assumes no change in the consumption of leaf tobacco per carton of cigarettes produced.  Thus, the standard is not expected to have a direct impact on Canadian tobacco growers, most of whom are located in Ontario, Quebec, or Prince Edward Island.  As noted above, however, an increase in cigarette prices as a result of the regulation could reduce the quantity of cigarettes sold annually by as much as 0.08 to 0.16 percent.  This would reduce demand for tobacco used in domestically manufactured cigarettes by a similar amount.

Data on Canadian tobacco growers' annual sales to domestic cigarette manufacturers are not available.  The model of Canadian cigarette manufacturing costs, however, assumes purchased leaf tobacco costs of $1.15 per carton.  Based on an initial domestic sales volume of 191.0 million cartons per year, this yields an estimated total of $220.0 million in purchased leaf tobacco costs.  Employing this figure as a rough estimate of tobacco sales attributable to the sale of domestically manufactured cigarettes, a decline in demand of 0.08 to 0.16 percent would translate to a reduction in tobacco sales of $175, 400 to $350, 800 per year.

7.3.2 Paper Suppliers

As discussed in Chapters 3 and 4, cigarette manufacturers are most likely to comply with a cigarette ignition propensity standard by modifying the paper their products employ.  The costs associated with the proposed standard are attributable in part to additional expenditures on paper.  This paper would be produced and sold to cigarette manufacturers by paper suppliers (e.g., Schweitzer-Mauduit) whose scope of operations is international.  As best can be determined on the basis of currently available information, all paper supplied to Canadian cigarette manufacturers is produced in mills outside Canada.  Implementation of the proposed ignition propensity standard is not expected to change reliance on foreign mills.  As a result, the direct impact of a standard on cigarette paper suppliers would be felt outside the Canadian economy.

As noted in Chapter 3, Schweitzer-Mauduit and others already have developed and patented modified paper technologies that are designed to reduce a cigarette's ignition propensity; thus, some of the research and development costs that otherwise could be attributed to implementation of the proposed standard have already been incurred.  Additional research and development might be required, however, to ensure that modified-paper products comply with the standard.  In addition, paper suppliers could face additional costs in scaling-up modified paper production to meet the demand of Canadian cigarette manufacturers.  Even when sufficient production capacity is in place, the cost of producing modified paper is likely to be higher than the cost of producing standard cigarette paper, since additional labour and materials per unit of output may be required.  It is expected, however, that such costs would be passed through to cigarette manufacturers in the prices charged for modified paper, or perhaps would be borne directly by cigarette manufacturers in the form of licensing fees or direct investment programs with paper suppliers.⁷⁹  In either case, Canadian cigarette manufacturers would bear the cost of converting production to employ modified paper.  To the extent available information allows, these costs are captured in the cost analysis presented in Chapter 4.

7.4 Impacts on Distributors, Retailers, and Importers

Implementation of the proposed ignition propensity regulations is not expected to impose additional costs on the distribution or retail sale of domestic cigarettes. As noted above, however, the potential increase in cigarette prices as a result of the regulations could reduce the quantity of cigarettes sold annually by 0.08 to 0.16 percent.  If this were the case, revenues from the distribution and retail sale of domestic cigarettes throughout Canada would be expected to experience a similar decline.

In contrast to the relatively minor estimated impact on the distribution and sale of domestic cigarettes, promulgation of the standard could pose a significant impediment to the import, distribution, and sale of foreign cigarettes.  Unless Canadian sales represent a significant share of its total sales volume, a foreign manufacturer that is not subject to reduced ignition propensity regulations in other markets may be unwilling to incur the cost of modifying its products to comply with Canada's proposed standard.  Since the import and sale of non-compliant cigarettes would be prohibited, it is conceivable that foreign manufacturers would withdraw from the Canadian market.  This would in turn impose a loss of business on firms operating in Canada that import and distribute foreign cigarettes.  The potential magnitude of the impact on any individual firm would depend on how large a share of its business is accounted for by foreign cigarette sales, and how successful it is in replacing any sales that are lost with other sources of revenue (e.g., the sale of domestic cigarettes).  For a firm that focuses heavily or exclusively on imported cigarettes, the loss of business could be severe enough to raise the risk of employee layoffs or a complete shutdown. 

Although the withdrawal of one or more foreign manufacturers from the Canadian market could impose significant adverse effects on cigarette importers, the impact on the economy as a whole is not likely to be severe.  As noted in Chapter 2, imported cigarettes account for less than one percent of cigarette sales in Canada each year (i.e., annual sales of less than $22 million).  If foreign manufacturers were to withdraw from the Canadian market, individuals who currently smoke foreign cigarettes would likely switch to Canadian brands.  To the extent that this occurred, the sales and profits of manufacturers and distributors of Canadian cigarettes would increase.  From the standpoint of the general economy, this potential effect would at least partially offset adverse impacts on cigarette importers.⁸⁰

7.5 Impacts on Cigarette Exports

As noted in Chapter 2, exports and duty free sales of Canadian cigarettes account for approximately six percent of the revenues of Canadian cigarette manufacturers.  The proposed ignition propensity standard would apply to all cigarettes manufactured in Canada, including cigarettes manufactured for export.  Non-Canadian manufacturers serving markets outside Canada currently are not subject to similar cigarette ignition propensity regulations.  Thus, Canadian manufacturers are not likely to be able to raise their export prices to cover the costs of complying with Canada's standard.  Instead, these costs are likely to be absorbed by Canadian manufacturers in the form of reduced profits.

It is possible that the manufacturing of reduced ignition propensity cigarettes would offer Canadian producers a competitive advantage should political jurisdictions outside Canada introduce similar regulatory requirements.  For example, New York State has recently adopted a standard similar to that proposed by Health Canada.  The New York standard will come into effect on June 28, 2004.  

7.6 Impacts on Excise Tax Revenues

A 13- to 26-cents per carton increase in the price of cigarettes and resulting 0.08 to 0.16 percent decrease in sales volume would yield a proportional reduction in Federal and provincial excise tax revenues.  Exhibit 7-2 summarises the effect, based on a Federal excise tax of $10.35 per carton, a Federal excise duty of $5.50 per carton, and an average provincial tobacco tax of $27.04 per carton.  As the exhibit indicates, the reduction in Federal excise tax revenues is estimated to range from $1.6 million to $3.2 million per year, while the reduction in Federal excise duty revenues is estimated to range from $0.8 million to $1.7 million.  The estimated reduction in provincial tax revenues ranges from $4.1 million to $8.2 million.

Exhibit 7-2 - Potential Impact of a Cigarette Ignition Propensity Standard on Annual Excise Tax Revenues (2002 $CAD, millions)

Scenario	Cartons Sold Annually (thousands)	Federal Excise Tax Revenues	Federal Excise Duty Revenues	Provincial Tax Revenues
Baseline:  No Price Change	191,015.0	$1,977.0	$1,050.6	$5,165.4
Price Increase: $0.13 Per Carton	190,862.8	$1,975.4	$1,049.7	$5,161.3
Price Increase:  $0.26 Per Carton	190,710.5	$1,973.9	$1,048.9	$5,157.2

7.7 Impacts on Employment

In light of the relatively modest impacts described above, the proposed cigarette ignition propensity regulations would be unlikely to have a significant adverse effect on overall employment in the tobacco products industry.  As previously noted, there is a risk of job loss in the import sector if foreign cigarette manufacturers withdraw from the Canadian market.  The magnitude of the risk is unclear, however, and any job loss would be counterbalanced, at least in part, as consumers of imported cigarettes shifted their demand to domestic brands.  Beyond this, cigarette manufacturers, tobacco growers, and distributors or retailers might experience some downward pressure on employment due to a potential increase in cigarette prices and resulting decrease in domestic cigarette sales.  The magnitude of such effects, however, is likely to be small.  Moreover, any reduction in employment as a result of decreased demand might be offset by additional hiring (e.g., to conduct toxicity testing) to ensure compliance with the regulations.  Thus, from the perspective of the industry as a whole, any adverse impact on employment is likely to be minor.

7.8 Impacts on Consumer Expenditures

As previously noted, implementation of the ignition propensity regulations could result in an increase in the retail price of cigarettes and, in response, a reduction in consumer demand.  Despite the reduction in demand, the net effect of any price increase would be an increase in consumer expenditures on cigarettes.  Exhibit 7-3 illustrates this impact for price increases of 13 and 26 cents per carton.  As the exhibit indicates, the potential increase in consumer expenditures is estimated to range from $14.9 million to $29.7 million annually.  This represents a 0.12 to 0.24 percent increase in annual expenditures on cigarettes.

Exhibit 7-3 - Potential Impact of an Ignition Propensity Standard on Consumers' Cigarette Expenditures (2002 $CAD)

Scenario	Cartons Sold Annually (thousands)	Retail Price per Carton	Annual Expenditures (millions
Baseline:  No Price Change	191,015.0	$65.24	$12,462.6
Price Increase:  $0.13 Per Carton	190,862.8	$65.37	$12,477.5
Price Increase:  $0.26 Per Carton	190,710.5	$65.50	$12,492.3

Assuming a nationally uniform price change, the increase in costs to consumers would be distributed by province roughly in proportion to the geographic distribution of the nation's cigarette smokers.  Exhibit 7-4 presents this distribution and applies it to the changes in expenditures estimated above.⁸¹  As the exhibit indicates, smokers in Ontario and Quebec would account for the majority of the net increase in expenditures. Less populous provinces would bear a smaller share of these costs, in proportion to their share of the smoking population.

Exhibit 7-4 - Potential Annual Increase in Expenditures on Cigarettes by Province

Province	Share of Cigarette Smokers Nationally	Potential Annual Increase in Expenditures on Cigarettes (2002 $CAD, thousands)
		Price Increase: $0.13 per Carton	Price Increase: $0.26 per Carton
Newfoundland	2.1%	$310.2	$619.6
Prince Edward Island	0.5%	$78.0	$155.7
Nova Scotia	3.5%	$522.5	$1,043.7
New Brunswick	2.8%	$421.1	$841.0
Quebec	26.8%	$3,983.9	$7,957.2
Ontario	34.6%	$5,145.8	$10,277.9
Manitoba	4.3%	$639.4	$1,277.2
Saskatchewan	3.7%	$549.8	$1,098.1
Alberta	11.1%	$1,656.6	$3,308.9
British Columbia	10.3%	$1,531.0	$3,058.0
Other	0.3%	$48.0	$96.0
Total	100.0%	$14,879.4	$29,719.2

7.9 Distribution of Benefits

The proposed standard would directly benefit segments of the population that might otherwise become victims of cigarette-ignited fires.  This includes Canadians who smoke - an estimated 21 percent of the population age 15 and over and non-smokers who reside with them.⁸²  Studies of fire damages in other countries indicate that approximately 40 percent of the victims of cigarette-ignited fires are non-smokers.⁸³  According to the literature, victims tend to be those whose ability to respond to and escape from a fire is impaired.  This includes the elderly, the very young, individuals with mental or physical disabilities, and individuals who are sleeping and/or under the influence of drugs or alcohol.⁸⁴

Fire data from the Ontario Office of the Fire Marshal support these findings.⁸⁵  As Exhibit 7-5 indicates, between 1995 and 2001, only 13 percent of individuals killed in fires caused by lit smoker's material were awake and in "normal" physical condition at the time of the fire.  Approximately 40 percent of those who died were under the influence of alcohol or drugs, 27 percent had a physical disability, 18 percent were asleep, one percent were infants, and one percent were physically restrained or detained.

Exhibit 7-5 - Physical Condition of Individuals Killed in Fires Caused by Lit Smoker's Material, Ontario, 1995 - 2001

Note:
This exhibit represents the physical condition of fire victims where the condition was known.  The records for approximately 22 percent of fatalities did not report the physical condition of the victim. Source:

Analysis of injury data from Office of the Fire Marshal, Ontario, "Ontario Civilian Fire Injuries: age, injury type and severity," April 23, 2003; received from Alison Wilson, Co-ordinator, Data Services, OFM, August 8, 2003.

With respect to age, the Ontario data indicate that the elderly are disproportionately likely to be killed in fires caused by lit smoker's materials.  Exhibit 7-6 shows the distribution of such fatalities by the victim's age.  More than 27 percent of the fatalities involved individuals over the age of 70, a group that represents only nine percent of the population nation-wide.  The data show victims of all ages, however; thus, the benefits of the ignition standard would extend to all age groups.

Exhibit 7-6 - Age of Individuals Killed in Fires Caused by Lit Smoker's Material, Ontario, 1995 - 2001

Source:
Analysis of injury data from Office of the Fire Marshal, Ontario, "Ontario Civilian Fire Injuries: age, injury type and severity," April 23, 2003; received from Alison Wilson, Co-ordinator, Data Services, OFM, August 8, 2003.

Data on the geographic distribution of cigarette-fire damages are unavailable.  It is reasonable to assume, however, that the benefits of the ignition propensity standard would be distributed by province roughly in proportion to the geographic distribution of the nation's cigarette smokers.  Exhibit 7-7 presents this distribution and applies it to the annual benefits estimates developed in Chapter 5.  As the exhibit indicates, approximately 61 percent of cigarette smokers reside in Ontario and Quebec.  Thus, the analysis assumes that a similar proportion of the benefits of the RIP standard would accrue to residents of these provinces.  Less populous provinces would enjoy a smaller share of total benefits, in proportion to their share of the smoking population.

Exhibit 7-7 - Estimated Distribution of Annual Benefits by Province

Province	Share of Cigarette Smokers Nationally	Estimated Annual Benefits of the Proposed RIP Standard (2002 $CAD, millions)
		Scenario 1	Scenario 2
Newfoundland	2.1%	$4.8	$2.4
Prince Edward Island	0.5%	$1.2	$0.6
Nova Scotia	3.5%	$8.0	$4.0
New Brunswick	2.8%	$6.5	$3.2
Quebec	26.8%	$61.1	$30.5
Ontario	34.6%		$39.5
Manitoba	4.3%	$9.8	$4.9
Saskatchewan	3.7%	$8.4	$4.2
Alberta	11.1%	$25.4	$12.7
British Columbia	10.3%	$23.5	$11.7
Other	0.3%	$0.7	$0.4
Total	100.0%	$228.1	$114.1

In stakeholder consultations with Health Canada, at least one tobacco industry member has raised concerns that lower income groups would benefit less than others from implementation of the proposed standard, since lower income groups are more likely than others to smoke tobacco sticks or hand-rolled cigarettes, which are not subject to the proposed regulation.  Further, this stakeholder has asserted that the vulnerability of lower income groups to cigarette fires would be exacerbated by promulgation of the standard if it caused more of these consumers to switch from manufactured cigarettes to other tobacco products (e.g., hand-rolled cigarettes).  This would be the case, however, only if the ignition propensity of such products is greater than that of conventionally manufactured cigarettes. 

As previously noted, the literature suggests that the opposite is true.  Thus, the fire risks faced by those who switched from manufactured cigarettes to hand-rolled cigarettes would be no greater than they are at present.  In addition, Health Canada has already begun research on the ignition propensity of other tobacco products and plans to propose ignition propensity standards for such products at a later date.  Thus, the promulgation of an ignition propensity standard for manufactured cigarettes should not have an adverse effect on the fire risks faced by lower income groups.  While the distribution of benefits across income groups is uncertain, the vulnerability of all income groups to cigarette fires should be reduced.

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⁷⁴ Models of this type are typically referred to as general equilibrium models.

⁷⁵ Data on retail prices were obtained from the Canadian Council for Tobacco Control, National Clearinghouse on Tobacco and Health, accessed online at http://www.ncth.ca/NCTHweb.nsf.

⁷⁶ For a summary of the literature, see James M. Nonnemaker et al., A Review of Economics as Used in Tobacco Control: Final Report, Prepared for Health Canada, August, 2002.

⁷⁷ Although a reduction in the demand for cigarettes would represent a loss of business for cigarette manufacturers, it also would be expected to reduce the losses attributable to cigarette-related fires, and to lead to a decrease in other adverse health effects associated with smoking. As noted in Chapter 5, these impacts have not been incorporated into the benefits assessment.

⁷⁸ Both Imperial Tobacco and Rothmans, Benson & Hedges operate plants in Quebec and Ontario. JTI-MacDonald maintains a plant in Saskatchewan, while Grand River Enterprises operates a facility in Ontario. Both Tabac ADL Tobacco and Bastos du Canada operate facilities in Quebec.

⁷⁹ In response to Health Canada 's outreach questionnaire, at least one respondent indicated that a paper supplier had requested cigarette manufacturers to provide capital to finance the development of banded paper production capacity.

⁸⁰ This potential effect has not been taken into account in evaluating the impact of an ignition propensity standard on manufacturers or distributors of Canadian cigarettes.

⁸¹ The distribution is based on data obtained from the 2001 Canadian Tobacco Use Monitoring Survey (CTUMS), which was designed to be representative of all persons aged 15 and older living in Canada, excluding residents of Yukon, Nunavut, and the Northwest Territories. As a default value, the analysis assumes that 21.7 percent of the residents of Yukon, Nunavut, and the Northwest Territories smoke; this percentage reflects the population-weighted average of the provinces surveyed.

⁸² For data on the percentage of Canadians who smoke, see: Table 1, "Smoking status and average number of cigarettes smoked per day, by age group and sex, age 15+, Canada 2002," Tobacco Control Programme, Health Canada Supplementary Tables, CTUMS Annual 2002, Canadian Tobacco Use Monitoring Survey.

⁸³ B.N. Leistikow, 2000, "The human and financial costs of smoking," Clinics in Chest Medicine 21(1), 191; F. Turnbull, J. Fowles 2001, The Health Implications of Fire-Safe Cigarettes in New Zealand: A Report to the Ministry of Health as Part of a Contract for Scientific Services, unpublished report, p. 2.

⁸⁴ J.J. Sacks, D.E. Nelson, 1994, "Smoking and injuries: an overview," Preventative Medicine 23, 515; J.R. Hall, 2003, The Smoking Material Fire Problem, Fire Analysis and Research Division, National Fire Protection Association, 39, 52; D.J. Barillo, R. Goode, 1996, "Fire fatality study: demographics of fire victims," Burns 22(2), 86; M. Wijayasinghe, 2000, "Where there's smoking... there's fire!" Alberta Fire News 21(1), 10; F. Turnbull, J. Fowles 2001, The Health Implications of Fire-Safe Cigarettes in New Zealand: A Report to the Ministry of Health as Part of a Contract for Scientific Services, unpublished report, pp. 2 and 5.

⁸⁵ Analysis of injury data from Office of the Fire Marshal, Ontario, "Ontario Civilian Fire Injuries: age, injury type and severity," April 23, 2003 ; received from Alison Wilson, Co-ordinator, Data Services, OFM, August 8, 2003.