Is “sin” tax a good idea?

“The art of taxation consists of so plucking the goose as to obtain the most feathers with the least possible amount of hissing.”

—Jean-Baptiste Colbert 1

BY:

-Caini Hong

-Chiraag Samaddar

-Kentaro Maniwa

-Rinisha Dutt

Section 4

Section 1

Section 3

Section 2• Conceptual

framework on Sin Tax

• Model

• Evidence to show whether Sin Tax is a good idea.

Alternatives and Conclusion

STRUCTURE

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3

SECTION 1: SIN TAX

Definition:

A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. These type of taxes are levied by governments to discourage individuals from partaking in such activities without making the use of the products illegal. These taxes also provide a source of government revenue.

Features:

• Selective taxation;• an excise tax (per-unit tax);• on consumer or supplier.

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Goods Harmful to individual health

Alcohol Tobacco Candy bars Sugary soft drinks “Junk food”

Harmful to society Gasoline Mobile tires Bullets

Services Considered Immoral by society

Gambling Prostitution

GOODS AND SERVICES THAT ARE CONSIDERED ‘SINFUL’

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Criteria to define whether consuming a good is sinful: Personally harmful and Externally harmful

• The traditional Pigouvian justification applied to sin goods, such as alcohol and tobacco.

• However, the “sin good” label of some goods, such as automobile tires, candy, soft drinks, and fast food, is questionable.

IS CONSUMING THESE GOODS ‘SINFUL’?

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Alcohol: Drunk driving, bad behavior

Tobacco: Exposure to secondhand tobacco smoke

“Junk food”: Raising of public health expenditure

Gasoline and mobile tires: Traffic congestion

Bullets: Hidden danger

Gambling: Losing the family paycheck at the craps table

Prostitution: Major cause of human trafficking and abuse of minors

NEGATIVE EXTERNALITY

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1. Reduce sinful goods consumption

2. Correct externality

3. Raise tax revenue

4. Redistribute wealth

(O'Donoghue & Rabin, 2006; Richard & Katelyn, 2009)

MOTIVATIONS

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SECTION 2: MODEL

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Theory:Sin taxes are imposed on goods which are highly inelastic.(Lorenzi, 2004)

Empirical Evidence:Researchers have reported a wide range of price elasticities. (especially on alcohol consumption).

-Ornstein (1980) and Ornstein & Levy (1983) suggest price elasticities for beer, wine and spirits to be -0.30, -1.00 and -1.50, respectively.

-Manning et al. (1995) examine several aggregate-level studies on the effects of excise taxes on alcohol consumption, reporting that the price elasticity for overall alcohol consumption is between -0.50 and -1.6.

CANNOT be concluded!

INELASTIC OR NOT?

Model 1: Inelastic case

)(PD

2Q

MSC

1Q)( tPD

cP

sP*P

DWL

t

Effects of imposing sin tax:• Consumption falls from Q1 to Q2• Government raises revenue• Burden of tax mostly on consumer

E

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Change in consumption pattern

xt x x

y

• Assume x represents the ‘sinful’ good and y represents a composite bundle of all every goods.

• Price of sinful good increases due to taxation

• Equilibrium: X -> X’

• The consumer reduces consumption of other goods in order to satisfy his habit

• This results in an even greater negative impact on the welfare of the consumer

yyt 'X 1U

2U 11

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Model 2: Relatively elastic case

1Q 2Q

PS

Tax E

MSCCS

cP

*P

sP

Effects of imposing sin tax:• Fall in consumption is greater• Government raises less revenue• Burden of tax more evenly spread

between consumers and suppliers

)( tPD 13

Change in consumption pattern

xt x x

y

• Assume x represents the taxed ‘sinful’ good and y represents a close substitute

• Price of sinful good increases due to taxation

• Equilibrium: X -> X’

• The consumer reduces consumption of x and instead shifts his consumption towards y

• No real benefit as y is just as harmful to the consumer as x

y

yt 'X

1U

2U

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1. Does sin tax reduce the sinful consumption?

2. Does sin tax reduce the externalities caused by sinful consumption?

3. Does sin tax improve social welfare?

4. Would sin tax itself cause any undesirable cost?

SECTION 3: EFFECTS OF SIN TAX

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Evidence: (1)Amongst EU countries there is NO association between cigarette(inelastic demand) prices and smoking rates-No reduction in consumption! (Snowdon, 2012)

(2) In the United States, researchers suggest that soft drink taxation, as currently practiced, leads to a moderate reduction in soft drink(relatively elastic demand) consumption by children and adolescents. (Fletcher, Frisvold and Tefft, 2010)

Inference: It depends on the elasticities of these goods. However, the results are sensitive to the choice of functional form in the demand model specification. (Leung & Phelps, 1993)

1. DOES SIN TAX REDUCE SINFUL CONSUMPTION SIGNIFICANTLY?

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Evidence:1)Snowdon (2012) reports there is no relationship between alcohol prices and alcohol related harm in EU countries

2)Wagenaar, Salois and Komro (2009) state that “based on current evidence it is estimated that doubling the tax on alcohol would reduce alcohol-related mortality by about 35%, traffic deaths by 11%, and crime in general by 1.4%.”

3)Joyner and Warner (2013) consider whether a price-hike on sugar and harmful fats would affect consumption is debatable because there no evidence yet.

2. DOES SIN TAX SUCCESSFULLY REDUCE THE EXTERNALITIES CAUSED BY SINFUL

CONSUMPTION?

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Equally "bad" substitutionso International Agency for Research on Cancer (IARC, 2011) concluded

that the availability of a variety of low-priced brands and products in some countries would allow tobacco users to switch down to cheaper alternatives

o In response to tax and price increases. Studies found that teenage “marijuana” consumption increased when states raised ”beer” taxes or increased the minimum drinking age. (Richard & Katelyn, 2009)

( for addicts, the good is inelastic, while for non-addicts, its relatively elastic)

Our intuition ! -addicts and non-addicts

Negative Externality

AddictNon-addict

The addicts have more difficulties in changing their behavior, which generally should take more responsibility for the externality caused.

INFERENCE

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Referring to our Model: it does improve social welfare! Caveat:

From the Public Finance side, whether the tax revenue generated can improve social welfare remains uncertain.

Evidence:o A coalition of California nonprofit anti-smoking organizations brazenly

sued Governor Pete Wilson for "illegally diverting" more than $165 million that supposedly should have been spent on "education" programs and instead was improperly used for health screening and immunization of poor children. (Richard & Katelyn, 2009)

Explanation: There is no guarantee that tax funds will be used as advertised, and there is very little public control. These funds usually go into the general fund or toward other politically favored causes.

3. DOES SIN TAX IMPROVE SOCIAL WELFARE?

Source: WHO Report on the Global Tobacco Epidemic (2008), Retrieved on Oct 3rd , 2013, fromhttp://www.who.int/tobacco/mpower/mpower_report_global_control_2008.pdf

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• Higher prices consumers switch to alternative products, licit and illicit (which are equally abused).

• Theft: Those who cannot meet the increased price contraband & counterfeit goods/ steal/ substitute substances.

• Smuggling and cross border traffic: Too high sin tax invite cross-border traffic from lower taxing neighboring countries.

• Lobby cost: People support taxes that benefit them directly; that is, they lobby for taxes to receive "rents.” (Richard & Katelyn, 2009)

• Declining Govt. Revenue: As the sin tax rises, so too does smuggling until the market goes beyond the peak of the Laffer Curve, moving either direction (higher or lower taxes) from that peak will lower tax revenue, despite the tax rate continuing to rise.

4. WOULD SIN TAX HAVE ANY UNINTENDED COSTS?

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Laffer Curve Diagram

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BENEFITS Consumption of targeted goods

Tax revenue

External ity ( through improving publ ic health and preventing both medical overuse/chronic disease, etc.)

Redistr ibute wealth (benefits poor)

Positive behavioral changes associated with these taxes d isproportionately benefit the poor improved health over time. more money to spend on other

things.

COSTS Impoverishes consumers rather

than turning them into abstainers- because the Tax is on goods which are price inelastic, especial ly those which are addictive.

Regressive - L ike a l l indirect taxation

Medics and campaigners c la im that s in taxes save the state money by reducing i l l health NOT TRUE!

Curb personal freedom-( behavioral economics)

Black market creation!

COST-BENEFIT ANALYSIS OF SIN TAX

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It is widely believed that they do, but a simple thought experiment shows this to be unlikely! Consider two scenarios- 1) the entire population dies at the age of 70. 2) The entire population dies at the age of 90. Assuming an average retirement age of 65, it should be obvious that the second scenario will cost the government more in pensions, prescriptions, long-term care, healthcare and benefits.

Inference:Although smokers require more healthcare expenditure during their working lives, nonsmokers require greater expenditure in pensions, nursing care and welfare payments!

Evidences:1)Leu and Schaub(1983 ) - lifetime expenditure higher for nonsmokers than for smokers.2)Barendregt et al. (1997) - a decline in smoking prevalence short term reduction in healthcare costs, but they would rise again after fifteen years when the erstwhile smokers began to age. 3) Lippiatt (1990) - every 1 per cent decline in US cigarette sales increased life expectancy by 1.45 million years.

Do sinners cost more to keep than saints?- NO!

SECTION 4: ALTERNATIVES

Prohibition on the ‘Sin tax products’Change consumer habits

(government campaigns, public service announcement on TV etc.)(+) saving public health cost; no bad-good substitution problem; (-) no tax revenue; no immediate outcome

SECTION 4: ALTERNATIVES

Prohibition on the ‘Sin tax products’Change consumer habits

(government campaigns, public service announcement on TV etc.)(+) saving public health cost; no bad-good substitution problem; (-) no tax revenue; no immediate outcome

Healthy incentivesSubsidize private company to produce healthier alternatives.(+) no disproportional treatment; no freedom issue; no black-market issue (-) increasing public expenditure; rent-seeking activities

Modernize dated laws on ‘sin tax products’

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Our intuition:“Sin Quota”:

Quota on producing Sin tax products.(+) reduce significant consumption(-) implement difficulties; black markets.

Establish ‘monitoring system’ for Fund ManagementDiscretion may be the excuse for politician to use the money in an inappropriate way.

SUGGESTIONS?

P2P1

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CONCLUSION

Sin taxes are an effective way of raising revenue, an unreliable way of cutting consumption, an inefficient way of reducing externality, an unreliable way of redistributing social wealth.

Sin tax may be good from economic models, not a good idea from empirical evidence. However politicians would like this idea.

The starting point of it is good, but whether it could end in a good place that successfully reaches its goal remains uncertain.

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Adam J. H., William F. S., and Michael D. T. (2013), SIN TAXES: Size, Growth, and Creation of the Sindustry, Mercatus Center of George Mason University Working Paper, No. 13 – 04

Snowdon, C. (2012) The Wages of Sin Taxes. Retrieved on 2 Oct, 2013 from

O'Donoghue, T., & Rabin, M. (2006). Optimal sin taxes. Journal of Public Economics , 90(10), 1825-1849.

Lorenzi, P. (2004). Sin taxes. Society , 41(3), 59-65.

REFERENCE:

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Q & A

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