Special communication The case for OFSMOKE: how tobacco price regulation is needed to promote the health of markets, government revenue and the public Anna B Gilmore,1,2,3 J Robert Branston,4 David Sweanor5 1School for Health, University of Bath, Bath, UK 2UK Centre for Tobacco Control Studies, UK 3London School of Hygiene and Tropical Medicine, UK 4Centre for Governance and Regulation, School of Management, University of Bath, Bath, UK 5Faculty of Law, University of Ottawa, Ottawa, Ontario, Canada Correspondence to Dr Anna Gilmore, Department for Health, University of Bath, Claverton Down, Bath BA2 7AY, UK; a.gilmore@bath.ac.uk Received 20 October 2009 Accepted 9 July 2010 This paper is freely available online under the BMJ Journals unlocked scheme, see http:// tobaccocontrol.bmj.com/site/ about/unlocked.xhtml Tobacco Control 2010;19:423e430. doi:10.1136/tc.2009.034470 ABSTRACT Mainstream economic theory outlines four main causes of market failure and it is already well established that two of these (information failure and externalities) exist in a tobacco market. A third cause of market failure, market power, is also a serious problem in many tobacco markets. Market powerdcombined with unintended and often overlooked consequences of tobacco tax policies, notably that gradual increases in speciﬁc taxes may allow the industry to disguise signiﬁcant price increasesdhas, at least in high income countries, given cigarette manufacturers considerable pricing power and proﬁts. This paper examines ways this market failure could be addressed and proposes as a solution a system of price cap regulation wherein a cap is placed on the pre-tax cigarette manufacturers’ price but not on the retail price that consumers face. Well established in the utilities industry, price cap regulation would set a maximum price that cigarette companies can charge for their product based on an assessment of the genuine costs each ﬁrm faces in its operations and an assumption about the efﬁciency savings it would be expected to make. Such a system would achieve three main beneﬁts. First, it would address the problem of market failure and excess proﬁts while simultaneously allowing current tobacco control policies, including tax and price increases, to expanddthus tax increases would remain a central tenet of tobacco control policies and retail prices could continue to increase. Second, it would increase government revenue by transferring the excess proﬁts from the industry to the government purse. Third, it would bring numerous public health beneﬁts. In addition to addressing market power, while simultaneously allowing tobacco control policies to expand, it could offer a means of preventing down- trading to cheaper products and controlling unwanted industry practices such as cigarette smuggling, price ﬁxing and marketing to the young. The paper outlines in some detail how such a system might be developed in the UK, while brieﬂy exploring how it could be applied elsewhere, including in markets with state monopolies. INTRODUCTION This paper makes a radical proposal for the regu- lation of tobacco markets which are over- whelmingly dominated by cigarettes. It shows how market failure, in the form of market power, combined with well intentioned and necessary tobacco control policies, including taxation and marketing restrictions, have had the unintended consequence of giving cigarette manufacturers considerable pricing power and proﬁts. In so doing, it outlines an overlooked issue in tobacco control: gradual increases in speciﬁc taxes beneﬁt cigarette manufacturers by enabling them to increase prices and thus proﬁts, an issue which explains why industry proﬁts continue to increase despite falling cigarette sales. It then explores ways of addressing this problem, proposing as a solution a system of price cap regulation which, by capping cigarette manufacturers’ prices but not the price that consumers face at retail outlets, would allow governments to maintain and expand their tobacco control policies while mitigating their unintended consequences. In other words, this proposal would allow tax increases to remain a central tenet of tobacco control policy, but would do so while simultaneously preventing the high manufacturer proﬁts and market distortions. To explore how this might work in practice this paper uses the UK as an example, outlining how such an approach would not only address market failure and capture the rent currently accruing to the tobacco industry for the public purse, but also bring numerous public health advantages. Finally, the paper suggests that such a system could be applied to most markets, including those with state monopolies, by adapting it as necessary to the national context. PROBLEMS WITH THE CURRENT TOBACCO MARKET AND THE TOBACCO PRICING SYSTEM Market failure Mainstream economic theory outlines four main causes of market failure: information failure or asymmetry, externalities such as the external costs imposed on others through the manufacture and use of tobacco, the provision of public goods and market power.1 That two of these (information failure and externalities) exist in a tobacco market has already been clearly outlined2 and is not dwelt on further here. Instead, we outline how market power also exists. The number of major tobacco transnationals has been declining following numerous mergers and acquisitions such that there are now only four dominating the global tobacco market outside China: Philip Morris International, British American Tobacco, Japan Tobacco International and Imperial Tobacco.3 Consequently, the cigarette trade is dominated in virtually all major markets by a very small, and declining, number of cigarette manufacturing companies (table 1). In 2008, for example, notwithstanding the publicly owned Chinese National Tobacco Company which has a 98% share of the Chinese market, the leading 423