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The Economics of a Soda Tax

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Many cities and countries tax sugary drinks, but soda taxes are an imperfect instrument of public policy

Published in: Economy & Finance
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The Economics of a Soda Tax

  1. Economic Issues For your Classroom The Economics of a Soda Tax Updated October 11, 2017 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. Ed Dolan is a Senior Fellow at the Niskanen Center and the author of Ed Dolan’s Econ Blog
  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”  Philadelphia, Seattle, Chicago, and other cities followed. France, Denmark, and Mexico also have soda taxes.  The popularity of a Soda tax is due to:  The need for additional tax revenue at all levels of government  Increased concern about obesity and its associated health-care costs  But soda taxes face fierce opposition. Chicago’s was repealed in Oct. 2017 Updated Oct. 11, 2017 Ed Dolan’s Econ Blog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 Oct. 11, 2017 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,” http://www.ncbi.nlm.nih.gov/pmc/articles/PMC3556391/ Updated Oct. 11, 2017 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 Oct. 11, 2017 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 Oct. 11, 2017 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 Oct. 11, 2017 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 Oct. 11, 2017 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 Oct. 11, 2017 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 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, who consumer relatively more soda  Other critics say it is bad policy to tie support of schools, healthcare, or another worthy cause to a dedicated tax rather than to general revenue  But still others say soda taxes don’t go far enough—we should tax all sugar  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 Oct. 11, 2017 Ed Dolan’s Econ Blog *Donald Marron et al., “Should We Tax Unhealthy Food and Drinks?” Tax Policy Center Dec. 2015
  11. Click on the image to learn more about Ed Dolan’s Econ texts or visit www.bvtpublishing.com For more posts and slideshows, Follow Ed Dolan’s Econ Blog Follow @DolanEcon on Twitter

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