Sugar tax – good intentions, with unintended consequences

It looks like nothing’s going to stop the introduction of sugar tax on soft drinks in the UK. Draft legislation has been published and the new tax is set to start in 2018. There have been numerous studies demonstrating the need for this indirect tax, or predicting its likely impact (see the most recent one here). The problem is, that none of the previous studies (at least not the ones I’m aware of) consider the dynamics of what will unfold after the introduction of this new tax. Effects on the prices of other products are elegantly ignored. Because a hike in the price of sugary drinks is likely to be accompanied by an increase in the price of healthier alternatives, my bet is that the tax will not significantly reduce sugar consumption. On the other hand it will lead to a more general price increase, hitting the poorest more than the rich.

The Government is showing no sign of changing their mind on the sugar tax and it appears that it is now destined to be introduced in 2018. The cynical part of me should rejoice as such policy changes offer brilliant subject for academic studies in the future, bdominos-fall-by-david-castillo-dominici-fdput my compassionate self is filled with concern.

As always, the introduction of the sugar tax is well-intentioned: the reduction of the consumption of sugary drinks and thereby the improvement of public health. The problem is that in practice these ‘sin taxes’ do not live up to the expectations of eliminating the undesirable things they’re purported to eliminate. Take tobacco taxes for example. Most studies show that the effect of taxes is negligible, and a noticeable drop in tobacco consumption would require dramatic price increases. On the other hand unintended consequences are not sparse. Taxing (or otherwise regulating) tobacco products has generated illicit markets. Combating these illicit markets triggers large enforcement costs. Moreover, enforcement often begets more crime (often violent crime).

Taxing sugar is no different and unintended consequences are just as likely. To demonstrate, first consider how much of the tax is borne by consumers. A study looking at the effect of sugar tax introduced in Berkeley, California found that around 43% of the tax is passed on to consumers (i.e. a 20% tax on sugar would increase prices by more than 8 percent). But the Berkeley study relates to a market which is surrounded by untaxed geographical markets (the tax was only introduced in Berkeley). Having the possibility to shop from outside the taxed area increases price elasticity of demand because consumers can always buy their sugary drinks – with some extra transaction costs (and it might work out cheaper if large enough quantities are bought). If a sugar tax is introduced at national level in the UK, there wouldn’t be similarly obvious substitutes. It’s likely that a larger proportion of the tax would be passed on to consumers, i.e. the price of sugary drinks would increase significantly in the UK. Good, say regulators, that is the reason the tax is introduced.

The problem is: when the price of sugary drinks go up, it doesn’t happen in isolation. It’s immensely myopic to assume that consumers can flock to alternative, non-sugary products and such switching won’t affect the price of these products. There is simply no reason why non-sugary products wouldn’t follow the price increase. Again, this is quite understandable. Sugar-free products have – for a long time – been considered as the healthy alternative, and products with a ‘healthy alternative’ halo are sold for more than the unhealthy option. Again, there is no reason why this would change once the price of sugary drinks goes up. It is unlikely that businesses will price their “bad” product above their “good” product. And if healthy alternatives remain more expensive, why should any sugar aficionado switch to the non-sugary version? I simply don’t find it plausible that we’ll experience significant changes to the consumption of sugary drinks.

On the other hand, it is very likely that the tax increase lifts the price of all drinks. The poor consume more of the unhealthy sugary drinks. If the alternatives also become more expensive, they are less likely to switch, and will carry on consuming large amounts of sugary drinks – i.e. the sugar tax hits them proportionately more. Furthermore, to cover the price increase they will have to reduce other consumption (food, clothing, leisure) or their savings (if they have any).

Reducing obesity is a laudable objective but doing it through a sin tax is an ineffective, and harmful solution.

And if you don’t buy my polemic rant just consider what happened in Denmark when a tax was introduced on saturated fat. It led to inflation, cross-border shopping, job losses, huge administrative costs, and … no significant reduction in the consumption of saturated fat.

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