The Economics of a Soda Tax

Economic Issues
For your Classroom
The Economics
of a Soda Tax
Updated October 11, 2017
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Ed Dolan is a Senior Fellow at the Niskanen Center
and the author of Ed Dolan’s Econ Blog

Tax Flavor of the Year: A Soda Tax
 In 2014, Berkeley, California became
the first city in the US to institute a tax
on sugar-sweetened beverages
(SSBs), popularly known as a “soda
tax”
 Philadelphia, Seattle, Chicago, and
other cities followed. France, Denmark,
and Mexico also have soda taxes.
 The popularity of a Soda tax is due to:
 The need for additional tax revenue at
all levels of government
 Increased concern about obesity and
its associated health-care costs
 But soda taxes face fierce opposition.
Chicago’s was repealed in Oct. 2017
Updated Oct. 11, 2017 Ed Dolan’s Econ Blog

Elasticity of Demand for Soda (1)
 The effectiveness of a tax depends,
in part, on how sensitive soda
consumption is to a change in price
 In economic terminology, the
percentage decrease in consumption
resulting from a 1 percent increase in
price is known as the elasticity of
demand
If a given increase in price produces
a large change in consumption,
demand is “more elastic”
If the increase in price is smaller,
demand is “less elastic”

Elasticity of Demand for Soda (2)
 The effectiveness of a tax depends, in
part, on elasticity of demand
The more elastic demand, the greater
the reduction in consumption
The less elastic demand, the greater the
revenue raised by a given tax
 A recent review of the literature by Lisa
M. Powell and others found:
Elasticity of demand for soft drinks as a
whole was about 0.86
Elasticity for regular SSBs was greater,
about 1.25, since a tax on SSBs would
cause some to switch to diet drinks
Source: Lisa M. Powell et. al, “Assessing the Effectiveness of Food and Beverage Taxes,” http://www.ncbi.nlm.nih.gov/pmc/articles/PMC3556391/

Effect of a Tax on Prices
A soda tax has three main effects
 It raises the price paid by consumers
from P0 to P1
 It lowers the price received by
producers from P0 to P2
 It reduces the quantity sold from Q0
to Q1

Tax Revenue
 The tax revenue received by the
government is equal to the amount
of the tax multiplied by the after-tax
quantity (Q2)
 Other things being equal, less
elastic demand or less elastic
supply will increase the tax revenue
because there will be less change in
quantity sold

Deadweight Loss
A tax also produces a deadweight loss,
shown by the triangle
 Part of the deadweight loss
represents lost consumer surplus
because consumers enjoy fewer
units of the product after the tax
 Part of the deadweight loss
represents lost profit opportunities
because producers sell less after
the tax (lost producer surplus)
 Note: Follow this link for a review of the
concepts of consumer and producer
surplus

Negative Externalities and Social Cost
 If consumption of a good harms other
people, it is said to have a negative
externality , popularly called a “social
cost” or “spillover effect”
 If social cost were included along with
private cost of production, the supply
curve for the good would shift upward
 Many observers think consuming
soda has a negative externality
because it contributes to obesity,
which in turn raises health insurance
costs for everyone

Offsetting social cost with a “sin tax”
 A tax on a good that has harmful
social costs is often called a “sin tax”
 If the tax is equal to the negative
externality, the deadweight loss of the
tax would be offset by the reduced
burden of social cost, so that the tax
would actually improve efficiency
 Revenue from a “sin tax” on soda
could go to any useful purpose . . .
Reduction of budget deficit
Targeted spending for reducing public
health costs associated with obesity

Are Soda Taxes Good Public Policy?
Even if soda taxes work, are they good public policy? According to a
thorough study by Donald Marron and others at the Tax Policy Center*:
 Well-designed taxes can encourage people to make healthier choices and can
encourage businesses to develop and market healthier products.
 However, soda taxes are regressive—they place a relatively greater burden on
people with lower incomes, who consumer relatively more soda
 Other critics say it is bad policy to tie support of schools, healthcare, or another
worthy cause to a dedicated tax rather than to general revenue
 But still others say soda taxes don’t go far enough—we should tax all sugar
 The bottom line: Taxes are an imperfect instrument for addressing nutrition and
health concerns, but they may make sense as part of larger policy efforts
related to obesity and excess sugar consumption
*Donald Marron et al., “Should We Tax Unhealthy Food and Drinks?” Tax Policy Center Dec. 2015

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