Smoke-Free Laws: Economic Issues Michael R. Pakko, Ph.D.* Federal Reserve Bank of St. Louis * The views presented here are my own, and do not represent official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System

Smoke-Free Laws: An Economist’s Perspective Michael R. Pakko, Ph.D.* Federal Reserve Bank of St. Louis * The views presented here are my own, and do not represent official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System (or anyone else, for that matter)

Prevalence of Smoke-free Laws Source: Americans for Nonsmokers’ Rights No smoke-free ordinances existed in the United States before As of November 2006, 2,344 municipalities in the United States have local laws in effect that restrict where smoking is allowed. Seventeen states and 519 municipalities have ordinances that require completely smoke-free workplaces, restaurants, and/or bars (but not all three). Six states and 162 municipalities require completely smoke-free workplaces, restaurants, and bars.

Today’s Topic: A (Critical) Review of The Literature Economic Theory and Policy The Role of Government The Market Works! An Economic Analysis of Smoke-free Laws

A Review of The Literature The Main Issue: Public Health vs. Economic Impact Primary battleground: Restaurants and Bars (bingo halls, billiard parlors, and bowling alleys … plus hotels and casinos too)

A Review of The Literature 1.Use of objective data 2.Inclusion of continuous data before and after ban 3.Statistical methods to control for trends and random fluctuations 4.Appropriate control for economic trends Siegel’s Criteria

Economic Impact Studies (I) (1) Was the study funded by a source clearly independent of the tobacco industry? (2) Did the study objectively measure what actually happened, or was it based on subjective predictions or assessments? (3) Was it published in a peer reviewed journal? Scollo, Lal et al (2005) “Review of the quality of studies on the economic effects of smoke-free policies on the hospitality industry” Studies Considered: 97 Economics Journals: 1

Economic Impact Studies (I) Research result: no statistically significant evidence from aggregate data. Conclusion: No effect = No cost. Example: ”This study provides further evidence that workers can be protected from the hazards of ETS exposure without adverse consequences for bar and restaurant business.” Interpretation error: failure to reject the null hypothesis is presented as conclusive evidence. General Findings and Critiques

Economic Impact Studies (I) Analyses ignore economic theory. Early studies utilize limited data sets. Evidence of local (and firm-specific) effects not considered. Full costs (e.g. welfare effects, impact on profits) not measured. Specification Errors … Other considerations

Economic Impact Studies (I) Common Specification errors: Omitted variable bias Small sample bias Sample selection bias Out-of-sample extrapolation errors Other considerations

Case Study: Maryville, MO June 9, 2003: Maryville Clean Indoor Air Act “the first such ordinance in Missouri to completely prohibit smoking in all restaurants.” - Cowen et al. (2004)

Maryville: Cowan et al. (2004) “no detrimental changes in revenues for eating and drinking places occurred after the ordinance took effect... In fact … the ordinance may have been beneficial for this area of business.”

The “Applebee’s Effect” February 2004: Applebee’s comes to town… “Things have gone exceptionally well in Maryville. Maryville has been one of the busiest stores in the country since its opening. We call it our crown jewel.” - Robert Marshall, VP of Operations, Concorde Neighborhood Group (Quoted in the Maryville Daily Forum, February 8, 2005)

The “Applebee’s Effect”

Maryville, MO: Conclusions Smoking ban had no significant effect on total bar and restaurant sales in Maryville. Sales increase in 2004 more closely corresponds to the opening of the new Applebee’s in town. The Maryville experience is inapplicable to many recent and prospective smoke-free laws.

Maryville, MO: Conclusions Small sample: 26 observations. Bars exempted (60% rule). Seven establishments exempted by name (including 3 restaurants). 70% of restaurants were smoke-free already (<10 establishments affected). Smoking prevalence: Maryville: 16.8% Missouri: 26.4% “the first such ordinance in Missouri to completely prohibit smoking in all restaurants.”

Economic Impact Studies (II) Pakko (forthcoming, Applied Economics): “No Smoking at the Slot Machines…” Adams and Cotti (2007, The B.E. Journal of Economic Analysis and Policy): “The Effect of Smoking Bans on Bars and Restaurants: An Analysis of Changes in Employment…” Fleck and Hanssen (forthcoming, Economic Inquiry): “Why Understanding Smoking Bans is Important for Estimating Their Effects…”

Economic Impact Studies (II) Pakko (forthcoming, Applied Economics): “No Smoking at the Slot Machines…” [See also, Thalheimer and Ali (2006)] Mandel, Alamar and Glantz (2005, Tobacco Control): “Smoke-free law did not effect revenue from gaming in Delaware” Pakko (2006, Tobacco Control): “Smoke-free law did effect revenue from gaming in Delaware” Alamar and Glantz (2006, Tobacco Control): “Authors’ response to M. R. Pakko” Background:

Economic Impact Studies (II) Pakko (forthcoming, Applied Economics): “No Smoking at the Slot Machines…” Seasonally Adjusted Net Proceeds at Delaware “Racinos” Smoke Free Law

Economic Impact Studies (II) Pakko (forthcoming, Applied Economics): “No Smoking at the Slot Machines…” Revenue losses totaled 15%, ranging from 9% to 16% at individual racinos. Profit losses likely exceeded revenue declines. Pattern of losses corresponded to regional competition. Annual revenue losses of $94 million dollars correspond to state revenue losses of $33 million per year. Conclusions:

Economic Impact Studies (II) Adams and Cotti (2007, BE Journal of Economic Analysis and Policy): “The Effect of Smoking Bans on Bars and Restaurants …” [See also, Phelps (2006) “The Economic Impact of 100% Smoking Bans”] Analysis of nationwide, county-level employment data for restaurants and bars. Employment at bars: statistically significant decline Larger effects in communities with high smoking prevalence Employment at restaurants: no significant effect overall Results differ geographically – smoking prevalence and weather

Economic Impact Studies (II) Fleck and Hanssen (forthcoming, Economic Inquiry): “Why Understanding Smoking Bans is Important for Estimating Their Effects…” Municipal sales tax revenues for California restaurants. Impact of “Any” ban: significant revenue decline Impact of “City” ban: no significant change Impact of “State” ban: significant revenue decline BUT - Evidence suggests an “endogeneity” problem: “restaurant sales growth … appears to cause restaurant [smoking] bans, not vice versa.”

Economic Theory Analyzing Risk: Increasing marginal costs and diminishing marginal benefits Revealed Preference: Market outcomes reflect consumer/worker preferences Market Failure? Externalities Imperfect information Coordination failure Government Intervention?

Economic Theory Analyzing Risk Increasing Marginal Cost and Diminishing Marginal Benefit

Economic Theory Revealed Preference Market outcome reflects consumer/worker preferences. If going smoke-free presented potential profits, restaurants and bars would do so without regulations. A regulation that restricts owners’ operating choices would at best have no effect on profitability. BUT - This outcome assumes market efficiency.

Economic Theory Is there Market Failure? Externalities (Spillover Effects) Imperfect information Coordination failure

Economic Theory Externalities (Spillover Effects) Definition: cost or benefit that is borne or received by third parties. Market Failure: Externalities only imply market failure when they are not reflected in prices/costs. Market Structure — Monopolistic Competition: Bar and restaurant owners compete based on quality — differences in attributes like name, location, food, and ambiance. This is the source of their profits (rents). Proposition: When property rights are clearly defined, profit maximization leads bar and restaurant owners to internalize the externalities of secondhand smoke.

Economic Theory Externalities (Spillover Effects) Customers who do not want to be around secondhand smoke will tend not to patronize places that allow smoking. Workers who do not want to work around secondhand smoke will tend to seek employment elsewhere. Business owners will be driven by the profit motive to accommodate their customers and compensate their employees. Profits, prices and wages reflect the costs of externalities. The market provides a menu of opportunities. How the Market Works

Economic Theory Imperfect Information Two potential problems: Consumers/workers underestimate risks Businesses incorrectly assess costs/benefits Policy Solution: Provide Information Coordination Failure: Competition prevents coordinated action. Profit opportunities (and public benefits) go unexploited.

Government’s Role What Government Action? Market Solution: Protect Property Rights Some Government Intervention: Provide Information 100% Ban: Enforce prohibitions

Government’s Role Do 100% Smoking Bans Go Too Far? Non-smoking Hotel Rooms – the devil is in the details. Prohibition of Smoking Lounges – is this necessary or desirable? Restrictions on Restaurants, Bars, Private Clubs, etc. (privately owned) The property-rights issue again …

Government’s Role “Hypothetical” Case:

Government’s Role “Hypothetical” Case:

Government’s Role “Hypothetical” Case:

The Market Works! As more people become concerned about secondhand smoke, the market is working to provide smoke-free environments. Government intervention is unnecessary. It represents a superfluous and costly restriction on consumer choice and private property rights. Smoking bans restrict business owners’ freedom to choose whether to allow smoking and limit their ability to find a market niche.

The Market Works! Nearly 300 eating establishments in Erie County have gone smoke-free. That's four times the number since "These places stay in business by meeting the needs of their customers," said Patrick Conway, chief executive of the Pennsylvania Restaurant Association. "More and more, people don't like smoke, and the restaurants have responded." May 14, 2007