The Economics of a Soda Tax


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This slideshow uses the concepts of supply, demand, elasticity, and consumer and producer surplus, and deadweight loss to explain the economics of a soda tax

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The Economics of a Soda Tax

  1. Economics Issues from Ed Dolan’s Econ Blog The Economics of a Soda Tax Updated March 23, 2016 Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.
  2. Tax Flavor of the Year: A Soda Tax  In 2014, Berkeley, California became the first city in the US to institute a tax on sugar-sweetened beverages (SSBs), popularly known as a “soda tax”  The popularity of a Soda tax is driven by two factors  The need for additional tax revenue at all levels of government  Increased concern about obesity and its associated health-care costs  In 2016 the UK announced that it would introduce a soda tax.  Hungary, Denmark, and Mexico have taxes on various kinds of “junk food” Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  3. Elasticity of Demand for Soda (1)  The effectiveness of a tax depends, in part, on how sensitive soda consumption is to a change in price  In economic terminology, the percentage decrease in consumption resulting from a 1 percent increase in price is known as the elasticity of demand If a given increase in price produces a large change in consumption, demand is “more elastic” If the increase in price is smaller, demand is “less elastic” Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  4. Elasticity of Demand for Soda (2)  The effectiveness of a tax depends, in part, on elasticity of demand The more elastic demand, the greater the reduction in consumption The less elastic demand, the greater the revenue raised by a given tax  A recent review of the literature by Lisa M. Powell and others found: Elasticity of demand for soft drinks as a whole was about 0.86 Elasticity for regular SSBs was greater, about 1.25, since a tax on SSBs would cause some to switch to diet drinks Source: Lisa M. Powell et. al, “Assessing the Effectiveness of Food and Beverage Taxes,” Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  5. Effect of a Tax on Prices A soda tax has three main effects  It raises the price paid by consumers from P0 to P1  It lowers the price received by producers from P0 to P2  It reduces the quantity sold from Q0 to Q1 Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  6. Tax Revenue  The tax revenue received by the government is equal to the amount of the tax multiplied by the after-tax quantity (Q2)  Other things being equal, less elastic demand or less elastic supply will increase the tax revenue because there will be less change in quantity sold Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  7. Deadweight Loss A tax also produces a deadweight loss, shown by the triangle  Part of the deadweight loss represents lost consumer surplus because consumers enjoy fewer units of the product after the tax  Part of the deadweight loss represents lost profit opportunities because producers sell less after the tax (lost producer surplus)  Note: Follow this link for a review of the concepts of consumer and producer surplus Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  8. Negative Externalities and Social Cost  If consumption of a good harms other people, it is said to have a negative externality , popularly called a “social cost” or “spillover effect”  If social cost were included along with private cost of production, the supply curve for the good would shift upward  Many observers think consuming soda has a negative externality because it contributes to obesity, which in turn raises health insurance costs for everyone Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  9. Offsetting social cost with a “sin tax”  A tax on a good that has harmful social costs is often called a “sin tax”  If the tax is equal to the negative externality, the deadweight loss of the tax would be offset by the reduced burden of social cost, so that the tax would actually improve efficiency  Revenue from a “sin tax” on soda could go to any useful purpose . . . Reduction of budget deficit Targeted spending for reducing public health costs associated with obesity Updated Mar. 23, 2016 Ed Dolan’s Econ Blog
  10. Are Soda Taxes Good Public Policy? Even if soda taxes work, are they good public policy? According to a thorough study by Donald Marron and others at the Tax Policy Center:  Well-designed taxes can encourage people to make healthier eating and drinking choices and can encourage businesses to develop and market healthier products.  However, soda taxes are regressive—they place a relatively greater burden on people with lower incomes  Unlike smoking, many people consume moderate amounts of SSBs without harm to their health  The bottom line: Taxes are an imperfect instrument for addressing nutrition and health concerns, but they may make sense as part of larger policy efforts related to obesity and excess sugar consumption Updated Mar. 23, 2016 Ed Dolan’s Econ Blog Donald Marron et al., “Should We Tax Unhealthy Food and Drinks?” Tax Policy Center Dec. 2015
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