 | | Kip Beckman
Principal Research Associate,
Economic Services
|
Desperate times require desperate measures—and for U.S. state and local governments, many of which are mandated by law to run balanced budgets, these are certainly desperate times. To close gaping budget deficits, some states are considering legalizing marijuana and collecting taxes on its sale. Other states are looking to build more casinos, and this is happening even in states where the governors are vehemently opposed to generating revenue from gambling.
Another idea to raise revenues is the establishing of a special tax on soft drinks. The city council in Washington, D.C., recently implemented this type of tax, and Governor David Paterson of New York supports the idea. During the discussions on health-care reform, a tax on soft drinks was put forward as a way of helping to pay for the overhaul of the entire system.
Economists generally support taxing consumption rather than income, due to the fact that consumption taxes do less to discourage savings, investment, and, ultimately, economic growth. For this reason, many economists support the introduction of a broad-based consumption tax in the United States. The tax would be similar to Canada’s GST, which is a form of a value-added tax (VAT). At this point, however, support for a VAT remains confined to economists—most members of Congress and the general public are not in favour of a consumption tax, despite the fact that it could raise billions of dollars in revenue.
While a tax on a specific good, such as soft drinks, may be more politically acceptable than a VAT, it does raise some important issues. For instance, is it justifiable to single out certain products for higher rates of taxation? Economists advise taxing certain consumer goods at a higher rate because of what are called “negative externalities.” These occur when an economic activity—such as the consumption of certain goods—has an adverse effect on other people. Harvard economics professor Gregory Mankiw provides the example of additional taxes on gasoline, which he argues are justifiable due to the negative externalities that arise from driving. When you go for a drive, the roads become more congested and it takes longer for other drivers to get to their destinations. As well, the chance of a car accident increases, which can affect other drivers and innocent bystanders. The gasoline that you burn also contributes to global warming. A high tax on gasoline encourages consumers to internalize these negative externalities and take into account the negative effects they are having on other drivers—and to act accordingly. Studies suggest that U.S. taxes on gasoline would need to be over $2 per gallon if all negative externalities were taken into account.
Attempting to apply the economic logic behind gasoline taxes and the pricing of negative externalities to soft drinks or other consumer goods is less straight forward. Some proponents of “sin” taxes on alcohol and cigarettes argue that the consumption of these products imposes negative externalities on the rest of us, since higher smoking- and alcohol-related diseases increase health-care costs for everyone, in the form of rising insurance premiums and higher taxes (due to the need by governments for higher revenues to recover the costs). There is, however, a counterpoint to this argument—heavy drinkers and smokers frequently die earlier and, as a result, collect less in Social Security payments and old age pensions.
Professor Mankiw points to an entirely different economic rationale for justifying the taxation of soft drinks. When people buy a can of pop, they actually impose a negative externality on future versions of themselves. Someone enjoying a soft drink today may have to pay the price in terms of poorer health in the future. Taxes on soft drinks, the consumption of which has (very) short-term benefits but long-term costs, essentially make us take into account the effects on our health as we age.
Of course, this line of thinking gets into some difficult philosophical questions. Should society use the power of government to protect us from our own lack of willpower to curtail drinking pop? And once government decides to start taxing products that are deemed bad for us, where do we draw the line? Higher taxes on soft drinks may encourage us to live healthier lifestyles, but should we also then tax chocolate bars and french fries? Should people who eat lots of fruits and vegetables or play tennis regularly receive a subsidy? Taking the logic even further, should people who watch mind-numbing reality TV shows pay higher taxes, while those who improve their brain function by reading Tolstoy or economics textbooks receive a subsidy?
These are obviously difficult questions to answer. In any case, in their search for more revenues, governments today may not be concerned whether higher taxes on soft drinks meet economists’ lofty theoretical considerations. The fact is, demand is highly inelastic for many consumers—people like soft drinks and will likely keep drinking them even if taxes rise sharply. Look for taxes on soft drinks and other similar goods and services to increase, a development that likely won’t be confined to the United States.