National Drug Strategy
National Drug Strategy

The costs of tobacco, alcohol and illicit drug abuse to Australian Society in 2004/05

2.8 to 2.15

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2.8 Avoidable costs of drug abuse

Estimates of the aggregate costs of substance abuse do not indicate the potential returns to anti-abuse policies and programs. These potential returns are represented by avoidable costs.

It is accepted that the hypothetical alternative situation on which this paper’s calculations are based, of no past or present drug abuse, is not achievable under any circumstances. Estimates of the total costs of drug abuse comprise both avoidable and unavoidable costs. Unavoidable costs comprise the costs which are currently borne relating to past drug abuse, together with those resulting from the fact that some proportion of the population will continue to abuse drugs. Avoidable costs are those costs which are potentially amenable to public policy initiatives and behavioural changes.

Previous papers in this series have presented estimates of the avoidable costs of substance abuse in Australia. However, as indicated above, the present authors will, in a separate paper, estimate the avoidable costs of alcohol misuse in Australia. The present paper, unlike previous papers in this series, does not provide any estimates of the avoidable costs of substance abuse.

2.9 The incidence of abuse costs

This paper follows the recommendations of the International Guidelines for Estimating the Costs of Substance Abuse (Single et al., 2003) in attempting to identify the incidence of drug abuse costs; that is, who bears these costs. Abuse costs can be viewed as a form of tax imposed upon various sections of the community. Accordingly, the incidence of these costs can be analysed using the principles of tax incidence analysis developed in the public finance literature.

Tax analysis makes the distinction between legal incidence and effective (or economic) incidence. Legal incidence indicates which individuals or organisations are legally required to pay the tax to the revenue authorities. Economic incidence describes who ultimately bears the tax after all the economic adjustments resulting from the imposition of the tax have been worked through. For example, a manufacturer might be required to pay increased GST (legal incidence) but the tax might be passed on to the consumer in the form of higher prices (effective incidence). It is relatively easy to identify the legal incidence of a tax. Determination of effective incidence, on the other hand, will at best be very difficult.

Drug abuse costs are treated in this study, for the purposes of identifying their incidence, as a form of tax. We attempt to estimate here the impact incidence (the equivalent of the legal incidence) rather than the effective incidence, which would be an extremely complex process beyond the scope of the present study.

Social costs of drug abuse can bear upon one or more of four community groups (neither private costs nor private benefits being estimated in this study):
There are various mechanisms by which these groups could shift the abuse costs to other groups. Some of these mechanisms are indicated in Table 1.

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Table 1, Mechanisms of cost shifting

Cost initially borne by
Means by which cost is shifted
Cost shifted to
Drug users
Lower work productivity at existing wage rates
Other individuals
Lower work productivity at existing wage rates
Higher prices or Lower wages or Lower tax payments
Consumers or Employees or Government
Higher taxes or Lower expenditures
Taxpayers (private and business) or Beneficiaries of government expenditures (private and business)

Given that any costs imposed on business or government must eventually be shifted in some form, all costs must ultimately be borne by individuals.

This table demonstrates how difficult it would be to identify the nature and extent of these economic adjustments resulting from drug abuse. No attempt is made here to do so. The incidence identified here is the impact incidence upon the three major groups—households (consisting of ill-informed and/or addicted abusers and other individuals), business and government.

By their nature, intangible costs cannot be shifted. For example, there is no mechanism by which the costs of loss of life can be passed on to others. Thus individuals bear both the impact and the effective incidence of all intangible costs.

An interesting issue arises in relation to the impact incidence of the resources used in the abusive consumption of alcohol, tobacco and illicit drugs. As these resources would have been available for other uses had they not been utilised for this purpose, it needs to be determined which section of the community (households, business or government) would have benefited from the availability of these resources.

The approach of the present study is to assume that the productive resources released from the production and distribution of drugs would have become available for the production and distribution of other goods and services. Thus the impact incidence of the resources used as a result of drug abuse is assumed to be on businesses involved in these alternative activities.

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2.10 Active and involuntary smoking

This study disaggregates the costs of smoking into active and involuntary components. The more usual distinction is between active and passive smoking (sometimes called sidestream smoke or environmental tobacco smoke). However, all three phrases have their limitations in that they appear to indicate that the only mechanism by which smoking affects non-smokers is by the latter’s inhalation of tobacco smoke. There are, however, other mechanisms by which smoking can affect non-smokers. As an illustration, pregnant mothers who smoke are likely to impose adverse health effects on their unborn children (for example, through low birthweight or sudden infant death syndrome). While the term "involuntary smoking" is to be preferred and is adopted in this study, some of the epidemiological information (for example in Appendix C) still refers to "passive smoking".

To clarify this distinction, medical conditions attributable to active smoking occur as a result of smokers inflicting adverse health effects on themselves. Conditions attributable to involuntary smoking occur when smokers inflict adverse health effects on others (including the unborn).

This study assumes that all smoking-attributable conditions suffered by people aged less than fifteen years reflect involuntary smoking. The grounds for this assumption are that juveniles under the age of 15 either will be non-smokers or will not have smoked for a period of time long enough to have acquired smoking-attributable medical conditions. At ages of 15 and above, only conditions specifically identified by Ridolfo and Stevenson (2001) or by Begg et al. (2007) as resulting from passive smoking are assumed to reflect involuntary smoking.

On current medical evidence, the overwhelming proportion of the morbidity attributable to involuntary smoking, as well as a high proportion of involuntary smoking mortality, is borne by the young.

Table 2 below lists the conditions assumed by this study to result from involuntary smoking.

Table 2, Involuntary smoking-attributable conditions

0–14 years of age
15 years of age and over
Tobacco abuse
Lung cancer (passive)
Lower respiratory tract infection
Ischaemic heart disease (passive)
Crohn’s disease
Ulcerative colitis
Antepartum haemorrhage
Low birthweight
Fire injuries
Otitis media
Source: Appendix C. Note that the Crohn’s disease attributable fractions for mortality are positive but for morbidity are negative.

It could be argued that alcohol consumption can have analogous involuntary effects in that people are killed or injured as collateral consequences of alcohol misuse. However, data deficiencies mean that we have been unable to produce this disaggregation.

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2.11 Valuation of life

Drug abuse causes premature deaths. When a life is lost prematurely the community bears two types of social costs—the loss of productive capacity (a tangible cost) and the psychological effects borne by the drug abuse victim and others (an intangible cost). How to value the costs to the community of these deaths is the subject of considerable debate in the economic literature.

Valuing the loss of productive capacity is known as the human capital approach. It involves estimating the loss of the future stream of productive capacity and expressing it as a present-day value by the application of an appropriate discount rate. The psychological costs of premature death are estimated using the willingness-to-pay approach, in which researchers identify how much people would be willing to pay to reduce the risk of death in a particular period of time (death not being permanently avoidable). Generally, intangible costs (in this case, willingness-to-pay) are more difficult to value than tangible costs, for which conventional markets (and so market prices) exist. However, the human capital approach has to confront the significant difficulty of choosing an appropriate discount rate. The two approaches are discussed in Bureau of Transport Economics (2000, chapter 3).

If the human capital approach is adopted, premature deaths of people of above workforce age are, by implication, considered to have no social cost since no productive capacity is
lost. Indeed some "benefits" could be considered to accrue to the community as a whole since the resources which would have been needed to supply the consumption needs of the deceased are saved. However, the community by many actions (including the allocation of substantial healthcare resources to the aged) demonstrates clearly that it believes the lives of people of beyond work force age are still of value. Thus, while it is important to value the loss of productive capacity, to ignore the psychological costs valued in a willingness-to-pay approach would produce a totally misleading estimate of the social cost of premature deaths.

The present study values the drug-attributable loss of productive capacity in the year under study (a tangible cost) together with the psychological costs of premature death. Consistent with the demographic approach adopted here, the study estimates the value of the loss of one year’s living, not the value of a lost life (which can involve the loss of many years of living).

The Bureau of Transport Economics (2000) refers to a range of international willingness-to-pay estimates of the value of life. It indicates that a reasonable valuation of a lost life in Australia in 1996 would be $2 million, which is at the low end of the range of international estimates. In this study this figure is adjusted to 2004/05 prices by the Australian National Accounts implicit price deflator for domestic final demand and converted to the value of a year’s living by reference to the average life expectancy of the Australian population (Australian Bureau of Statistics, Deaths 2000).

The average intangible value of the loss of one year’s living in 2004/05 prices was calculated to be $53,267.

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2.12 Pain and suffering

As reported in our previous studies, pain and suffering attributable to road accidents remains the single component of total drug-attributable pain and suffering to which we are able to assign a monetary value. This estimate is derived from the research reported in the Bureau of Transport Economics (BTE) (2000), but it does not appear possible to extend this estimate to other areas of drug abuse.

Easton (1997) in his New Zealand study has estimated that intangible morbidity costs are of similar order of magnitude to mortality costs. While data are not available to make similar calculations for Australia, it is recognised that the results presented here may well represent a considerable underestimate.

2.13 Welfare

Drug abuse can cause increased reliance on social services of various kinds. These may be physical support services, such as the provision of supported accommodation, or income support, such as unemployment or disability benefits. Evaluation of the social costs of these services must avoid the inclusion of pecuniary costs.

The distinction between real and pecuniary costs as applied to the analysis of welfare is expounded in some detail in Collins and Lapsley (1991, pp. 56–8). It can be broadly summarised as follows. Where service provision involves the use of resources which would otherwise have been available to the community as a whole for other uses (for example, accommodation costs or the administrative costs of the support system), the resources used are real. These costs should be included in social cost estimates. Income support, on the other hand, usually represents a pecuniary transfer from one section of the community to another—that is simply a different distribution of the available resources. The resources available to the community as a whole (as opposed to the taxpaying community) do not change as a result of the process of income support, although they may result in very different types of expenditures and savings. Consequently, these costs do not constitute a valid component of social cost estimates, though they certainly can represent an important budgetary cost to government.

Collins and Lapsley (2002, p. 27) concluded that it was not possible to estimate welfare costs, either real or budgetary, causally attributable to the consumption of each of the three drug categories studied (alcohol, tobacco and illicits). The same conclusion was reached in the preparation of the present study.

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2.14 Revenue impacts of drug abuse

It is often asserted that, even if the social costs of abuse of tobacco and alcohol are high, the revenues derived by governments from taxing these drugs more than cover the costs imposed on governments. This argument cannot be made for illicit drugs, which yield no tax revenues, and which may indeed lead to a net revenue loss as a result of tax evasion and money laundering.

This apparently straightforward revenue/expenditure comparison, when subject to careful analysis, is far more complex. This can be best illustrated by taking the example of tobacco which, in terms of estimated social costs, is by far the most serious problem drug in Australia.

At the outset it should be conceded that, as will be seen later in this report, tobacco tax revenue does in fact exceed by a considerable margin the tobacco-attributable costs borne by the government sector. This fact is often interpreted to mean that "smokers pay their way".

However, smokers themselves bear a significant proportion of the social costs of smoking, for the reasons discussed above. It is, to a very large extent, the tobacco industry which imposes the social costs, not the smokers. The question "Do smokers pay their way?" is, in fact, the wrong question. The correct question is "Does the tobacco industry pay its way?" This question is easily answered in the negative.

There is a great deal of persuasive evidence that the demand for tobacco is relatively unresponsive to changes in tobacco prices. Using economic terminology, the demand for cigarettes is price-inelastic. Tax analysis shows that in these circumstances a high proportion of the tax is borne by the buyer not the seller. This implies that the industry which is responsible for the imposition of high social costs pays only a small proportion of the tobacco tax revenue.

Estimation of the budgetary impact of smoking indicates whether tobacco tax revenue compensates governments for the revenue and expenditure impacts of smoking (that is, whether smoking reduces budget deficits). It gives no indication of whether the sector that imposes the social costs compensates those sections of the community which bear the costs. These costs are borne by smokers, other individuals and the business sector. Governments merely pass on the costs borne by the public sector to the general community, by taxation or other means.

The same argument holds for alcohol, the other drug whose use is able to be directly taxed. If drug-producing industries are to compensate the rest of the community fully for the negative externalities which they generate, drug tax revenues should substantially exceed drug-related public expenditures.

In examining the budgetary impact of drug abuse, the obvious comparison is between expenditures undertaken and revenue generated. It should, however, also be recognised that drug abuse reduces revenue from some types of taxes. Abuse-induced mortality and morbidity will reduce income tax revenue as a result of a reduction in the size of the employed workforce. Indirect tax revenues will also be reduced as a result of the effect of mortality in reducing consumption expenditure levels. There would be other, relatively minor, effects on the revenue from such taxes as fringe benefits tax, payroll tax and company income tax. However, as explained below, the revenue from these latter types of taxes should be excluded from the analysis because they do not discriminate against the alcohol or tobacco industry in any way. All industries must bear these taxes at the same rates and they can, at least partially, be viewed as benefit taxes which finance services provided by government to industry generally. They are, accordingly, not incorporated in the budgetary analysis of this study.

Indirect taxes (which are calculated net of subsidies) are taxes which are assessed on producers in respect of the production, sale, purchase or use of goods and services and which are charged to the expenses of production. Examples are the GST, customs duties and excise taxes. Revenue from indirect taxes declines as a result of drug abuse because premature mortality reduces consumption levels and so reduces tax revenue raised from that consumption expenditure.

Indirect tax revenue losses (net of subsidy gains) are estimated by applying the ratio of indirect taxes to private final consumption expenditure to the estimated consumption reduction resulting from premature mortality. Indirect tax data are derived from Australian National Accounts:National Income and Expenditure.

The present study presents estimates of the budgetary impacts at federal and state levels of tobacco, alcohol and illicit drug use, incorporating the revenue-contraction, as well as the revenue-generation, effects. It should be noted that the budgetary impact of abusive consumption is estimated, not the impact of total consumption (although these amounts are the same in relation to tobacco and illicit drugs).

There is a fundamental flaw in analyses often presented by the tobacco and alcohol industries on the revenue and expenditure effects of their industries. To include in the analysis all revenues attributable to the particular drug implies that the industry, in the absence of taxes targeted specifically at it, would be required to pay no taxes at all. It is quite wrong to attribute all tax revenue from alcohol or tobacco to be raised as compensation for the abuse-related externalities, rather than attributing some to the tax burden that is inevitably borne by all industries, whether they impose negative externalities or not. If there were no externalities, alcohol and tobacco would still bear sales or other consumption taxes consistent with the tax burden borne by other commodities.

This point can be illustrated clearly in relation to the current Goods and Services Tax (GST) regime. Virtually all goods and services are subject to GST at a rate of ten per cent. Thus the tax is almost completely non-discriminatory between products and between industries. In considering the tax contributions of the tobacco and alcohol industries, GST revenue should, in principle, be excluded, since only taxes which specifically discriminate against these drugs are relevant to the revenue/expenditure comparison.

There is, however, a complication in the Australian context in that the GST which is now applied to alcohol and tobacco was applied to these goods for the purposes of administrative simplicity. An-across-the-board GST at a single rate is much simpler, and accordingly much less costly to implement than one in which there are substantial exemptions (in the tax jargon, zero rating). As explained below, when the Australian GST was implemented, excise duties on alcohol and tobacco were simultaneously reduced, so that the overall tax burdens remained broadly the same. In acknowledging this history, the present study includes GST revenue on alcohol and tobacco for the purposes of the budgetary analysis.

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2.15 Research, education and drug program costs

The International Guidelines for Estimating the Costs of Substance Abuse (Single et al., 2003) argue that public expenditure on areas such as drug-related education programs or research projects represents the effects of public decisions to reduce abuse rather than the direct effects of abuse and, accordingly, should be excluded from abuse cost estimates. The guidelines recommend that these costs, although considered relevant to a study of drug abuse costs, should be presented separately as policy costs rather than incorporated in the abuse cost estimates. The present study follows Collins and Lapsley (2002) in adopting the criterion that expenditures on prevention of drug abuse and on research concerning appropriate interventions can be seen as discretionary, but that expenditures on the interventions themselves should not treated as discretionary.

At the time of the production of Collins and Lapsley (1996), the second in this series of estimates of the social costs of drug abuse, it was possible to obtain information on drug-related research and education costs from Commonwealth Department of Health internal records. The Commonwealth made payments to the states and territories through cost-sharing arrangements, and internal processes within the department separately identified different allocations.

Since that time the ability to estimate these expenditures has declined as the Commonwealth now has different arrangements for making payments to states and territories. These arrangements no longer separate funding for drug strategy activities from other public health activities. The Commonwealth requires outcome-based reports for this funding rather than information on acquittal of funds. In addition, accounting changes within the Australian Government Department of Health and Ageing mean that it no longer separates the funding stream in the previous manner, with consequent
difficulties for the attribution of funds to different activities. However, the Commonwealth through the Pharmaceutical Benefits Scheme (PBS) provides the following subsidies for pharmaceuticals prescribed for preventive purposes:

Table 3, PBS subsidies and patient contributions for prescribed preventive pharmaceuticals, 2004/05

Benefit paid by PBS $
Patient contribution $
Total cost $
Acamprosate calcium
Naltrexone hydrochloride
Bupropion hydrochloride (Zyban)

Source: Australian Government Department of Health and Ageing.

In principle, it would be desirable to estimate expenditures on drug-related research and education by the law enforcement, customs and education sectors. It seems likely that the effort from these agencies is increasing but the information necessary to estimate drug-related expenditures by these bodies is not published, and probably not collected.

The Australian Bureau of Statistics, in its publication on sources of Australian data on illicit drug use, acknowledged the difficulty of obtaining data on drugs research and education expenditures. It refers to the only published source of such data—a survey of government expenditure on drug programs and services by the Alcohol and Other Drugs Council of Australia (Crosbie and McNiven, 1999) and comments:
As a result of these problems it has once again not proved possible, for the purposes of the present study, to provide sufficiently comprehensive estimates of public expenditures on drug-related research and education, and on drug programs.

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