The Wages of Sin Taxes

I have a report out today with the Adam Smith Institute looking at sin taxes (The Wages of Sin Taxes). Here's the Executive Summary...

Governments have long relied on indirect taxes on consumer goods as a source of revenue. ‘Sinful’ items such as alcohol and tobacco have traditionally been taxed punitively and some have called for new taxes on fatty foods and sugary drinks, as well as a minimum price on a unit of alcohol.

Campaigners and politicians often cite astronomical figures as being the ‘cost to the taxpayer’ of certain products, but these statements have no foundation in economics. The studies which produce these figures are dominated by ‘costs’ which are neither financial nor borne by the taxpayer. They include hypothetical estimates of the value of a life year lost, earnings forgone due to premature mortality and expenditure by the consumer on the product itself. These figures are usually inflated, but even when they are plausible they cannot be used to justify sin taxes because these ‘costs’ affect only the individual; they are not paid by the taxpayer.

It is frequently claimed that consumers of ‘unhealthy’ products place an excessive burden on public services—healthcare, in particular—and that this justifies additional taxation in order to (a) reduce consumption of the sinful product, and (b) reimburse the state for the extra money it is forced to spend. This is not true. There is ample evidence that, on average, smokers and the obese are less of a ‘drain on public services’ than nonsmokers and the slim because they spend fewer years withdrawing pensions, prescriptions, nursing home provision and other benefits. Their lifetime healthcare costs are usually lower than those who lead ‘healthy lives’. If making consumers pay their way is truly the aim of public policy, the government would be more justified in placing a tax on fruit and vegetables.

The case of alcohol differs from that of tobacco and ‘unhealthy’ food in so far as there are additional externalities relating to violence, drink-driving and property damage. It is likely that drinking and drunkenness result in additional costs to the public purse which are not offset by savings and benefits, but these are covered by existing alcohol taxes with several billion pounds to spare. Just as smokers are subsidising nonsmokers, so drinkers are subsidising teetotallers.

As instruments of social engineering, sin taxes are blunt tools which are largely ignored by the target group while creating a range of unintended consequences which damage health, stoke criminality and, beyond a certain point, lead to the government receiving less tax revenue. They are a costly and inefficient means of attempting behavioural change.

Taxing goods which are price inelastic, especially those which are addictive, is far more likely to impoverish consumers than it is to turn them into abstainers. Alcoholics are rarely deterred from drinking by higher prices and there is evidence that tobacco taxes are now so high that further increases will yield diminishing returns. Many studies have concluded that ‘fat taxes’ and ‘soda taxes’ have little or no effect on rates of obesity. Such levies are better seen as stealth taxes than sin taxes.

Like virtually all indirect taxation, sin taxes hit the poor harder than the rich. Taxes on tobacco, sugar-sweetened drinks and ‘junk food’ are doubly regressive because they are disproportionally consumed by people on lower incomes. Placing a minimum price on alcohol would be extraordinarily regressive since it would deliberately target drinks which are consumed by the poor while leaving the drinks of the rich untouched.

This is a paper I've been working on since October, inspired by the Danish government's decision to bring in a 'fat tax', France's decision to introduce a 'soda tax' and Scotland's decision to bring in minimum pricing (a sin tax by any other name).

For me, the most interesting part was looking at the studies which estimate the 'cost to society' of various activities. It is clear that the politicians who cite these reports have never read them, or else they do not understand the difference between private costs and public costs. None of these studies support the view that slim, teetotal, nonsmoking taxpayers subsidise the habits of others. Existing taxes on these products far exceed the various public costs incurred. Indeed, with the possible exception of alcohol, there is no economic justification for taxing these products beyond the normal rate of sales tax at all.

I was also interested to see the lack of correlation between affordability and harm when I compared EU countries. It is, of course, a fundamental principle of economics that higher prices usually reduce consumption. This has traditionally been the case with alcohol and tobacco, but there is no longer any association between cigarette taxation and smoking prevalence. There are several possible explanations for this. It may be that the number of smokers has been reduced to such an extent over the last 40 years that those who remain have a very inelastic demand, and/or the black market has reduced the efficacy of these taxes. Sure enough, there is a correlation between cigarette affordability and illicit sales.

In the case of alcohol, higher prices reduce per capita consumption but do not reduce alcohol-related harm. This is an important finding, because temperance policies assume that reducing overall consumption is the key to reducing alcoholism, drink-driving and 'binge-drinking'.

In the case of food and drink, various studies have shown that sin taxes are hopelessly ineffective at reducing obesity. All of these sin taxes are, however, are very good at making the poor poorer. Economic theory might imply that the poor would be more responsive to sin taxes—this is certainly what campaigners claim—but we have decades of real life evidence telling us that this does not happen in practice (although moderate drinkers may be an exception).

The take-home message is that those who campaign for higher taxes on 'unhealthy' products should not use the argument that drinkers/smokers/fatties are a burden on public services because it has no basis in fact. The argument can only be made on the basis of pure paternalism or—as is usually the case—by admitting that the government needs more money.


Do go read the whole report here (PDF). I'd also like to thank Eric Crampton who has written much about this subject in the past and who offered many useful comments on the first draft.