Tuesday, April 11, 2006

Sin Taxes

An ec 10 student asks me via email about an argument that Nicholas Kristof makes in today's NY Times. After noting that Americans drink too much soda, Kristof says:

we should impose a tax on sugary drinks -- 5 cents per fluid ounce. One of the most successful health measures this country has ever taken was the cigarette tax, and we should apply the same approach to beverages. All sweetened nondiet drinks would be targeted: soft drinks, iced tea, fruit punch, sports drinks and other concoctions like the 240-calorie Starbucks Caffe Mocha (not counting the whipped cream).
The student asks whether the argument here is similar to the argument I have often made (such as here and here) in favor of higher taxes on gasoline.

I think the two cases are very different. The argument for a higher gasoline tax is essentially Pigovian: the tax corrects for a variety of externalities. Pigovian taxes try to protect innocent by-standers from the actions of others. By contrast, sin taxes such as the cigarette tax or the Kristof sugar tax try to protect people from themselves. The argument for them is less neoclassical economics than behavioral economics.

A recent paper that makes the case for sin taxes is "Optimal Sin Taxes" by Ted O’Donoghue and Matthew Rabin. Here is the abstract:
We investigate ‘‘sin taxes’’ on unhealthy items, such as fatty foods, that people may (by their own reckoning) consume too much of. We employ a standard optimal-taxation framework, but replace the standard assumption that all consumers have 100% self control with an assumption that some consumers may have some degree of self-control problems. We show that imposing taxes on unhealthy items and returning the proceeds to consumers can generally improve total social surplus. Because such taxes counteract over-consumption by consumers with self-control problems while at the same time they naturally redistribute income to consumers with no self-control problems (who consume less), such taxes can even create Pareto improvements. Finally, we demonstrate with some simple numerical examples that even if the population exhibits relatively few self-control problems, optimal taxes can still be large.
Another relevant paper is by Jonathan Gruber and Sendhil Mullainathan (a Harvard econ prof). It reports evidence that smokers are happier when cigarette taxes are higher. You can find a summary of that research here.

Update: Several people have emailed me asking if sin taxes can be justified on Pigovian grounds because the government pays for much health care. Thus, when one person smokes, others are worse off, because they have to pay higher taxes for the smoker's healthcare. This is a type of externality generated as a side-effect of other government policies.

That is a legitimate argument, but if one takes it seriously, one must take it completely seriously. You have to total up all the financial effects of "sins" like smoking, both positive and negative. Here is the judgment of economist Kip Viscusi (who teaches at the Harvard Law School):

The estimated health risks from smoking have significant external financial consequences for society. Studies at the national level indicate that cigarettes are self-financing since external costs such as those due to illnesses are offset by cost savings associated with premature death, chiefly pension costs.
In other words, according to Viscusi, the amount the government saves on pensions (such as Social Security) balances out the extra health costs generated from smoking. In the end, as an empirical matter, the Pigovian argument does not work.