Optimal Taxation of Externalities: A Case Study on Sugar Taxes, Study Guides, Projects, Research of Design

Download Optimal Taxation of Externalities: A Case Study on Sugar Taxes and more Study Guides, Projects, Research Design in PDF only on Docsity! Corrective Taxes Kate Smith Institute for Fiscal Studies January 2017 What are corrective taxes? Corrective (or “Pigouvian”) taxes can be used to correct for the presence of externalities or “internalities” in a market: • externality: costs imposed on others • internality: costs imposed on the individual themselves Corrective taxes are commonly implemented as “excise taxes”: • e.g. on motor fuels, tobacco, and alcohol • taxes on these goods comprise 7.2% of total tax receipts Taxes should be set based on the marginal social harm associated with consumption. Smith (IFS) Public Economics Lectures January 2017 2 / 31 Corrective tax = marginal externality Smith (IFS) Public Economics Lectures January 2017 5 / 31 Simple model Consider a social planner who maximises the sum of consumer surplus, tax revenue minus the externality cost: max t W (t) = [ V (t) α ] ︸ ︷︷ ︸ consumer surplus + R(t)︸︷︷︸ tax revenue − φ(Q(t))︸ ︷︷ ︸ external costs • t is the tax policy • α: marginal utility of income • V (t): indirect utility from consumption • Q(t): quantity consumed of externality generating good • φ(Q(t)): externality generated What is the optimal t in this case? Smith (IFS) Public Economics Lectures January 2017 6 / 31 Pigouvian taxes Differentiating W (t) with respect to t and using Roy’s identity yields the familiar Pigouvian tax result: t∗ = φ′(Q(t∗)) i.e. the optimal tax equals the marginal externality of consumption at that tax rate. This looks very simple, BUT, in reality there are complicating factors: • variation across consumers • measuring the externality • restricted instruments available to government Smith (IFS) Public Economics Lectures January 2017 7 / 31 The externalities of alcohol consumption Significant health costs: • 5.9% global deaths, and 5.1% of the global burden of disease and injury is attributable to alcohol (WHO, 2014) • roughly 70% of liver cirrhosis is attributable to alcohol Linked to violence and crime: • almost half of all violent crime is alcohol related • around 1/3 domestic violence occurs when the perpetrator is under the influence of alcohol • the alcohol attributable fraction of road traffic deaths is 16.6% for men and 6.7% for women Smith (IFS) Public Economics Lectures January 2017 10 / 31 Variation in the marginal externality There is a large amount of evidence that suggests that externalities are convex in alcohol consumption • i.e. the more you drink the greater the external cost associated with one more drink Threshold effect with some diseases: at low levels of alcohol consumption the risk is not elevated, but this risk increases sharply above a certain point. Higher levels of alcohol consumption create an exponential risk of accidents: • odds of injury from 8 pints almost 18 times greater than the odds of injury from 1 pint Smith (IFS) Public Economics Lectures January 2017 11 / 31 What is the optimal ethanol tax in this case? Recall that the optimal Pigouvian tax, that achieves the first best, is to set the tax equal to the marginal externality: t∗ = φ′(Q(t∗)) But if the marginal externality varies across consumers (indexed i) and we have to set a single tax rate for all consumers, we can no longer achieve the first best: • some consumers will face a tax rate that’s too high, and some too low Diamond (1973) showed that the second best ethanol tax in this case is to set the tax equal to a weighted average of the marginal externalities: t∗ = ∑ i φ′iwi But can we improve upon this? Smith (IFS) Public Economics Lectures January 2017 12 / 31 Price elasticity of demand for ethanol -2 .5 -2 -1 .5 -1 -.5 0 P ri ce e la st ic it y of d em an d fo r et ha no l <7 7-14 14-21 21-35 >35 Units of pure alcohol per adult per week Smith (IFS) Public Economics Lectures January 2017 15 / 31 Current UK alcohol tax system 0 10 20 30 40 50 E xc is e du ty p er u ni t of e th an ol ( pe nc e) 0 10 20 30 40 Alcoholic strength (ABV %) Beer Still wine Sparkling wine Spirits Cider Smith (IFS) Public Economics Lectures January 2017 16 / 31 Optimal alcohol taxes 0 10 20 30 40 T ax r at e (p en ce p er u ni t) Ale La ge r St ou t Red w ine W hit e w ine Rose w ine Bran dy Gin Rum Vod ka W his ky Liq ue ur s Po rt Sh err y Verm ou th Oth er for t. wine Cide r FA Bs Optimal taxes UK taxes Smith (IFS) Public Economics Lectures January 2017 17 / 31 A tax on sugar? In the March 2016 Budget, the government introduced a tax on sugar-sweetened soft drinks. 1. What is the economic justification for a sugar tax? 2. Is the proposed tax structure sensible? Smith (IFS) Public Economics Lectures January 2017 20 / 31 Rationale for policies to curb sugar consumption Health risks: • increases risk of consuming too many calories, hence obesity • obesity increases risk of heart disease, type 2 diabetes, strokes • linked to tooth decay in children Many of the health costs are borne by the individual, but may also generate external costs borne by society (e.g. public health costs). Also likely that the full costs of sugar consumption are not taken into account by the individual at the point of consumption. • especially true for children • evidence of self-control problems Smith (IFS) Public Economics Lectures January 2017 21 / 31 Taxing sugar In order to correct for these excess costs, we need to set the tax equal to the marginal externality or internality. But the marginal externality (or internality) is likely to vary across people and consumption occasions: • compare an obese person and a competitive athlete eating the same chocolate bar This means that there is a trade-off between reducing the consumption of people who consume more than is ideal and raising the prices faced by individuals whose behaviour does not generate external costs: • suggests that we should target products disproportionately bought by those about whom we’re particularly concerned Smith (IFS) Public Economics Lectures January 2017 22 / 31 Taxing sugary soft drinks Households who consume too much sugar, and households with children, get a disproportionate amount of sugar from soft drinks • suggests that a soft drinks tax might be reasonably well targeted But how will consumers respond to the price changes induced by a tax? • if they switch to chocolate or confectionery then this could offset the reduction in sugar from soft drinks Smith (IFS) Public Economics Lectures January 2017 25 / 31 Illustrative example Scenario: (1) (2) (3) (4) Taste for sugar For households that buy: high amount of added sugar Weak Moderate Strong Strong low amount of added sugar Weak Moderate Strong Moderate % change in total sugar For households that buy: high amount of added sugar -3.0% -2.4% -1.6% -1.6% low amount of added sugar -3.0% -2.4% -1.6% -2.4% Average -3.0% -2.4% -1.6% -2.1% Notes: We assume that: a tax on sugary drinks (carbonated, non-carbonated and fruit juice) would lead to a price increase of 15%, the own-price elasticity of sugary drinks is -1.0, the cross price elasticities of chocolate and confectionery with respect to the change in the price of sugary drinks is 0 in scenario (1), 0.2 in scenario (2), 0.5 in scenario (3) and 0.5 for high added sugar households and 0.2 for low added sugar households in scenario (4). We consider households that purchase less/more than 15% of their calories from added sugar as households that buy a high/low amount of sugar. Smith (IFS) Public Economics Lectures January 2017 26 / 31 The ‘Soft Drinks Levy’ Tax paid by producers and importers of soft drinks that contain added sugar implemented from April 2018 onwards • excludes pure fruit juices and milk-based drinks The tax will operate with a specific revenue target of £500 million for the second year of implementation (2019-20). The OBR estimates that this implies levy rates of: • main rate charge: 18p/litre for drinks with 5-8g of sugar per 100ml • higher rate charge: 24p/litre for drinks with >8g sugar per 100ml The tax is levied per litre of product, which means that tax per gram of sugar is lower for sugar products. Smith (IFS) Public Economics Lectures January 2017 27 / 31 Other anomalies of the proposed design Someone could pay less tax and consume more sugar by choosing different products: • 3l Coca Cola: 318 grams of sugar, 72p of tax • 2l Sainsbury’s Orange Energy Drink: 318 grams of sugar, 48p of tax Smith (IFS) Public Economics Lectures January 2017 30 / 31 Conclusion Corrective taxes are effective instruments for correcting for the presence of externalities or internalities in a market. Implementing them involves overcoming complicating factors: • variation in the marginal externality of consumption across individuals • often poor measurement of the external costs • legislative barriers to designing the taxes that would be optimal But we can use economic theory and empirical analysis to tackle these issues and help guide better corrective tax design. Smith (IFS) Public Economics Lectures January 2017 31 / 31