Sin Tax Error?

My AFR op-ed today is on tobacco and alcohol taxes. Full text over the fold. Some references are hyperlinked, and there’s more detail at the end of the piece.

‘High Taxes Not Without Sin’, Australian Financial Review, 30 March 2010

In The Australian Legend, Russell Ward wrote ‘no people on the face of the earth ever absorbed more alcohol per head of population’ than Australians in the 1800s. While scholars debate Ward’s precise claim, it is clear that European settlers consumed vast quantities of alcohol. And 80-90 percent of men smoked.

Substance abuse is inextricably linked to Australian history, where rum and tobacco often took the place of cash. Today, 19 percent of us are regular smokers, while 13 percent of us are risky drinkers (defined as more than 4 drinks a day for men, and more than 2 drinks a day for women). Compared with other developed countries, we have relatively few smokers, and a slightly above-average level of alcohol consumption.

Can sin taxes make us pure? In the case of cigarettes, you might expect that most buyers would be addicts, and therefore unresponsive to prices. But it turns out that smokers are surprisingly price-sensitive. On average, a 10 percent price hike cuts cigarette sales by 5 percent. Although this is offset slightly by an increase in intensity (higher taxes induce smokers to take a few extra puffs out of each cigarette), the health benefits are still substantial. Teens are two to three times as price-responsive as the rest of us.

Put another way, if tax increases were to raise the price of a cigarette from 50 cents to 55 cents, we might expect 150,000 of Australia’s 3 million smokers to kick the habit. The same price rise would probably also deter thousands of high school students from becoming addicted in the first place. Because many smokers want to quit, half of all smokers support higher cigarette taxes – suggesting that such a policy might find favour at the ballot box.

For alcohol, it is less obvious that higher taxes lead to better health outcomes. Unlike smoking, moderate alcohol consumption does not seem to be bad for you (indeed, occasional tipplers may even gain a health benefit). So raising the price of grog is only a good public health measure if it reduces the kind of heavy consumption that is associated with cirrhosis of the liver and misuse (such as drink driving and domestic violence). If higher alcohol taxes deter grandma from having a glass of sherry, but do nothing to prevent the lad on the corner pub from sinking his sixth schooner, we should rate them a public policy failure.

It turns out that alcohol taxes deter both groups. On average, a 10 percent increase in price reduces overall consumption by 5 percent, and lowers heavy drinking by a little less – perhaps around 3 percent. There is also some direct evidence that higher alcohol taxes reduce drink driving, with one US study suggesting that a 10 percent increase in alcohol prices would reduce road fatalities by 6 percent (saving perhaps 90 lives annually). However, because binge drinkers are less price-responsive than the rest of us, alcohol taxes are a blunt instrument for cutting road deaths.

What about the equity implications of sin taxes? In the case of alcohol, drinking rates rise with incomes, so alcohol taxes are modestly progressive.

Cigarette taxes create something of a paradox. Since the poor are more likely to smoke, cigarette taxes are regressive. Yet a rise in cigarette taxes induces more quitters among the low-income population. So for hard-core addicts, cigarette taxes fall more heavily on the poor. But cigarette taxes can be a powerful tool for improving health outcomes among the disadvantaged. Over recent decades, much of the drop in smoking has been due to higher prices, so you don’t have to be a wowser to see the potential for increased taxes to produce better health outcomes.

Will this election give Australian headline writers the chance to bring out those old front pages that said ‘Beer, cigs up’? In conjunction with restrictions on sales and advertising, sin taxes have proved an effective public health policy. Alas, they also have unintended consequences – reducing moderate alcohol consumption, and acting as a regressive tax on low-income smokers who are never going to quit. Even virtuous taxes have their vices.

Andrew Leigh is a professor in the Research School of Economics at the Australian National University. He is presently a candidate in the ALP preselection for the federal seat of Fraser.

In case you’re wondering about whether a 10% rise in alcohol prices is a good way to save 90 lives, here’s my thinking. According to my research assistant Jenny Chesters and the 2003-04 Household Expenditure Survey, Australia spends $9.3 billion per year on alcohol (7.7 million households x $1200), so a 10% price rise is $930 million. Assuming reasonable deadweight costs, it’s likely that the social cost of this exceeds the cost of saving 90 lives (which standard benchmarks would put around $315 million). In other words, for the same societal resources, we could save more lives in other ways.

Of course, the optimal alcohol tax rate would be low on the first drink, and rising steadily thereafter. Fame and riches to anyone who can work out how to implement this in practice.

Other useful sources include this Cato debate. Harry Clarke also has extensive writings on tobacco and alcohol, which I probably should have referenced in the AFR.

In case anyone is interested in the politics of it all, the only publicly available survey I could find that asked about voting and smoking was the 1990 Australian Election Study. On primary votes, never-smokers split 39% ALP/48% Coalition, ex-smokers broke 41% ALP/48% Coalition, and chain smokers (>20/day) voted 52% ALP/35% Coalition.

6 thoughts on “Sin Tax Error?”

  1. Andrew, Most of your article I strongly agree with.  A couple of minor quibbles.

    The cigarette quit elasticities are only about half the consumption level elasticities – so on your figures a 10% increase in taxes will cauuse quits of about only 2.5%. Still that is valuable.  As you mention if addicts smoke less they puff harder and inhale more carcinogens.  This effect might not be negligible. In the UK in the 1960s taxes on smokes were high and people had very high lung cancer rates. 

    Workplace bans and bans in bars on smoking are very effective in increasing the user costs of smoking – particularly for wealthy smokers who can shrug off tax increases.  There is also evidence they encourage quits and discourage initiation of smoking. 

    Also I think sending out the message that smoking is an activity for losers – you won’t get your woman/man if your mouth smells like an ashtray – is far more effective at discouraging young kids from initiating smoking than warning of prospective health damages 50 years in the future.   Rates of smoking among young kids have plunged in recent years – it is seen as a socially dumb activity by many.

    Among older people who face the prospects of adverse health events (strokes, cancer, heart attacks)  negative advertising warning of these problems is useful in encouraging quits.

    Those who cannot quit their nicotine addictions should be encouraged to switch to tar-less products such as nicobate and to continue consuming these products indefinitely (and in large amounts) if necessary rather than to continue smoking.  This is true even for pregnant women whose foetuses might face health damages from nicotine.  The reason – the damages are less dangerous to the foetus than is smoking.  Of course the best thing is to quit entirely.

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  2. What impact would the rise in cigarette taxes that Turnbull proposed (instead of cutting the private health insurance rebate) have had?

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  3. Nice article Andrew.  Yes I was also puzzled by your implicit suggestion that a 5% reduction in consumption meant 5% of smokers quitting.

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  4. Harry, thanks for taking the time to comment. To coin a phrase, most of your comment I strongly agree with. My only quibble is over banning smoking in bars, because of the evidence that it harms children.
    As to quits, I had understood that much of the response was indeed on the extensive margin, and therefore that it was reasonable to assume the same quit elasticity as overall elasticity (see the literature surveyed at 13.1.5 of this report). But the literature seems weaker on this point.

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  5. Andrew,
    to what extent are sin taxes Pigovian (eg by reducing drink driving or passive smoking) rather than simply paternalistic?  Morally and economically, Pigovian taxes seem to me to be a “no brainer”, whereas the case for paternalistic taxes is less straightforward.
     
    Of course, if we divide our present and future selves, even paternalistic taxes become Pigovian, but that is kind of cheating.

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  6. Andrew, I know of the evidence than bans in bars cause people to smoke elsewhere injuring kids.  Not to be ignored as kids suffer particularly severe health damages from smoking.

    But I still like these bans because of evidence that they encourage quits and discourage initiations – smoking becomes a high-cost hassle as the one occasion you really want to smoke is denied – when you have a drink .

    I think it is true now that many Australian states ban smoking in cars with children (SA has) which is a good move and I think bans on smoking inside the family home make sense. But they are difficult to enforce so get adults to smoke outside using moral suasion – ‘if you must smoke then do so outside – don’t inflict health damages on your children’. 

    On kids smoking it is still clear that shops are providing cigarettes to kids in quantity – this should be easy to stop with huge fines and an inspection policy. 

    I am an extremist on this issue. In my view purchasing cigarettes should be something you do as a registered nicotine addict.  You can only purchase cigarettes if you show a card from your GP confirming your addict status. 

    Of course no duty free cigarettes and international visitors should only be able to purchase limited quantities for a month or so by showing passports and airtickets.

    Smoking cigarettes only really took off in the 1920s.  By the 1950s it was known to be deadly and by the mid-1960s government agencies recognised this and provided forecast body counts.  We should target the ending of this dangerous habit in one generation. 

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