Increasing taxes on alcoholic beverages would improve the efficiency of the U.S. economy, at least marginally. Increases in taxes on tobacco or a new tax on sweetened soft drinks would not.
Whether that assessment influences debate at the national level, where higher alcohol taxes are proposed to help pay for health care changes, or in Minnesota or Wisconsin, where ill-fated bills included such increases, is an open question.
“Economic efficiency” is a criterion dear to the heart of economists, but hardly anyone else. The general public pays much more attention to perceived need and fairness. But the more public debate on this question, the better.
Taxes on alcohol and tobacco go back centuries. While sometimes termed “sin taxes,” a means of discouraging use of frowned-on products, the historic rationale is simpler. The demand for alcohol and tobacco is inelastic. That means that a given percentage increase in the price, say 10 percent, causes a proportionately smaller reduction in the quantity people buy, say 7, 5 or 3 percent.
Yes, such taxes also were defended on the grounds that these goods are not necessities. Taxing luxuries rather than necessities supposedly supports government without making it harder for people to meet their basic needs. But historically, governments that taxed alcohol and tobacco also taxed salt, which certainly is not a luxury.
The economic efficiency argument is much newer than such excise taxes. In 1921, British economist Arthur C. Pigou demonstrated that when goods are produced that impose external costs on society — costs that are borne by someone other than the producer-seller or consumer-buyer — resource use is inefficient. Society gets fewer needs and wants met for a given level of resource use than when such external costs are not present.
The solution, Pigou argued, is to impose a tax on such products equal to the amount of the external cost. That won’t necessarily reduce the external costs to zero, but it will restore optimal efficiency.
Consuming alcohol produces huge external costs for society in the form of damage to life and property from drunken driving, family violence and so on. Note however, that from most economists’ point of view, damage to the consumer of alcohol himself is not an external cost. To the extent that people are rational about an addictive substance, the adult person who decides to drink has balanced off the anticipated pleasure of alcohol consumption against whatever harm to health, wealth or relationships such consumption may cause.
That is why the external costs of tobacco consumption are less. Smoking harms health, but most of the harm is borne by the person who decides to smoke. Yes, there are secondhand smoke damages to other people. But these are small relative to the external costs of booze.
High-calorie soft drinks thus are closer to tobacco. They may contribute to obesity and other health problems. But virtually all the damage accrues to the person who decides to drink that can of Coke.
Yes, the population would be healthier if we drank less of sweetened beverages. That is also true for reduced consumption of jelly doughnuts, fettuccini Alfredo and fresh rhubarb pies made with Crisco and white sugar. Taxing such common foods, however much overeaters like me abuse them, does not make the economy more efficient.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.