Would a soda tax make Americans better off?

Oct 20 2009

Published by Jason Welker at 10:25 pm under

Econ professor and blogger Tim Haab has posted a great story on market failure, efficiency and corrective taxes at his blog, Environmental Economics: I love when someone else does my work for me.

With appreciation, I re-post his blog here in its entirety. Tim’s “Questions to consider” are perfect for IB and AP Econ students to answer in their Market Failure unit. Read and answer Tim’s discussion questions in the comments:

Today’s Econ 101 topic–actually AED Economics 200 but same diff–the deadweight loss from taxes in otherwise well-functioning markets. In my neverending–futile?–attempt to stay current, I plan to use this example from today’s Wall Street Journal:

Senate leaders are considering new federal taxes on soda and other sugary drinks to help pay for an overhaul of the nation’s health-care system.

The taxes would pay for only a fraction of the cost to expand health-insurance coverage to all Americans and would face strong opposition from the beverage industry. They also could spark a backlash from consumers who would have to pay several cents more for a soft drink.

The Center for Science in the Public Interest, a Washington-based watchdog group that pressures food companies to make healthier products, plans to propose a federal excise tax on soda, certain fruit drinks, energy drinks, sports drinks and ready-to-drink teas. It would not include most diet beverages. Excise taxes are levied on goods and manufacturers typically pass them on to consumers.

…

The Congressional Budget Office, which is providing lawmakers with cost estimates for each potential change in the health overhaul, included the option in a broad report on health-system financing in December. The office estimated that adding a tax of three cents per 12-ounce serving to these types of sweetened drinks would generate $24 billion over the next four years. So far, lawmakers have not indicated how big a tax they are considering.

Proponents of the tax cite research showing that consuming sugar-sweetened drinks can lead to obesity, diabetes and other ailments. They say the tax would lower consumption, reduce health problems and save medical costs. At least a dozen states already have some type of taxes on sugary beverages, said Michael Jacobson, executive director of the Center for Science in the Public Interest.

Questions to consider:

How do you reconcile the seemingly conflicting goals of reducing soda consumption and raising revenues to pay for health care?
Which effect do you expect to dominate: reduction in quantity demanded due to higher prices or increased revenue from higher prices?
Assuming the market for sodas (pop around here) is currently working efficiently, what effect do you expect a new tax to have on consumer well-being, producer well-being, government revenue and total social welfare?
What role do the elasticity of demand and elasticity of supply play in your answers to 1,2 and 3?

About the author: Jason Welker is a teacher at Zurich International School in Switzerland, where he teaches Advanced Placement and International Baccalaureate Economics. Jason was an international school student in Malaysia before studying economics at Seattle University then earning his Masters in Education. He calls Seattle and Northern Idaho home. In addition to maintaining an economics wiki and this blog for economics student and educators, Jason also gives presentations on using Web 2.0 tools in education at workshops and conferences around the world. His economics wiki won the 2007 "Best Educational Wiki" award from the "EduBlog Awards".

2 responses so far

2 Responses to “Would a soda tax make Americans better off?”

# David Dzidzikashvilion 23 Oct 2009 at 5:18 am

I think the question should be does any tax make Americans better off? Soda tax is just an additional price increase that will be passed on to the consumers. This can lower the demand and this will have no real benefit. If we assume that demand won’t change for soda sales, then this should bring more tax money, but during economic hard times, this does not look like a smart policy decision. We need to keep people buying more goods & products, any price increase won’t result in more buying, taking in consideration that people are more careful with spending, due to economic crisis.
# Khairul Rusydion 10 Nov 2009 at 8:51 pm

1. This can be done by imposing a tax on the producers of soda. The revenue generated from this tax can then be used to finance healthcare policies. With a specific-tax, for example, the new equilibrium price increases ceteris paribus, as demonstrated by a leftward shift in the SS curve (or the Marginal Private Cost Curve). At this higher price, the qty dd and consumption of soda thus decreases.
2. Both will occur. Dominance of one over the other is indeterminate unless the PED of soda is known. Assuming that the demand for all soda is elastic, due to the availability of other sugary beverages like sports drinks and hot chocolate (who could resist hot chocolate anyway?) and assuming that the utility and satisfaction that consumers get from these is equivalent to that of soda, a PED that is positive and more than 1 indicates that an increase in price would lead to to a more than proportional fall in quantity demanded. Thus there would be a net revenue lost to the producer.
3. Assume that ‘working efficiently’ here implies that it is at the Socially Optinal Level and hence no negative externalities that would otherwise arise from the health problems from excessive drinking of soda and the strain it would place on state-funded healthcare, which are manifestations of Deadweight Welfare Loss.
Hence in this hypothetically optimal state of production and consumption, consumer surplus would decrease, producer surplus would decrease, government revenue would increase and total social welfare would decrease. This is because there would be a DWL when a tax is imposed on an efficient market as there is now an underproduction compared to the Socially Optimal Level of output that was initially determined at the previous equilibrium level of Price and Qty.
4. PED and PES would influence the incidence of the tax and whether greater burden would fall on the producer or consumer. If PED is (relatively more) inelastic (than PES), the consumer’s share of the tax would be greater. If PES is (relatively more) inelastic than (than PED), the producer’s share of the tax would be greater.