Have a Coke and a Tax

The economic case against soda taxes

With the federal deficit reaching $1.4 trillion and most state budgets deep in the red, policy makers are desperately searching for new sources of revenue that the tapped-out American public might support. They think they've found one at the corner store: a tax on carbonated beverages. Charging a few more cents for a soft drink, legislators claim, will not only refresh exhausted state and federal revenues; it will make us thinner.

Several versions of this year's health care bills included a soda tax to help offset new costs. In a September interview with Men's Health, President Barack Obama called it ''an idea that we should be exploring" because "our kids drink way too much soda." The idea had been dropped from the health care legislation at press time but is expected to resurface next year.

The proposal is perennially popular on the state and local levels too. Thirty-three states tax the sale of soft drinks, at an average rate of 5.2 percent, and politicians in other jurisdictions are eager to jump on the bandwagon. After New York Gov. David A. Patterson floated the idea of a soda tax in December 2008, New York City Mayor Michael Bloomberg launched his own campaign to tax sugary drinks. "All the studies show that young kids drink an enormous amount of soda, and if they drink the sodas with all the sugar in it, it adds a great deal of weight to them," Bloomberg said in April.

The economic literature tells a different story. The rationale behind a tax on soft drinks, or any sin tax, is that when the government raises prices on a certain good, it will become so expensive that consumers will give it up. Having been forced to eschew that sin because of the high monetary price, consumers will reap the moral and/or physical benefits of not indulging, thereby bettering themselves and society.

The story sounds plausible. The trouble is that sin taxers don't appreciate human creativity: Consumers have a knack for replacing one sin with another. When the price of a "sinful" good increases, people often substitute an equally "bad" good in its place.

A 1998 study by William N. Evans, an economist at the University of Notre Dame du Lac, and Matthew C. Farrelly, a public health researcher at RTI International, found that smokers in high-tax states tend to consume cigarettes that are longer and higher in tar and nicotine than smokers in low-tax states. This effect is especially pronounced among 18-to- 24-year-olds because they are more responsive to tax changes than older smokers. They have less money, so they want more bang for their bucks.

A 1992 study by University of Michigan economist John E. DiNardo and University of British Columbia economist Thomas Lemieux found that when states raised beer taxes or increased the minimum drinking age, teen marijuana consumption increased. A 1994 study by University of Illinois economist Frank Chaloupka and Chulalongkorn University economist Adit Laixuthai replicated those results—and also found that beer consumption declined in states that decriminalized marijuana.

Are soda lovers likely to do something similar? Richard Williams and Katelyn Christ, two economists at the Mercatus Center (where I work), argue that soda drinkers would. In a 2009 study, they wrote: "The assumption is that this sin tax would reduce caloric intake because consumers would stop drinking high-calorie drinks and/or switch to lower-calorie drinks. However…if consumers respond to the proposed sin tax on sodas and sports drinks by switching to some of the potential substitute drinks [see table], their caloric intake would either remain the same or actually increase."

In a 2008 working paper, Emory University economists Jason Fletcher, David Frisvold, and Nathan Tefft examined the impact that changes in states' taxation rates from 1990 to 2006 had on body mass index and obesity. They concluded that soft drink taxes have a vanishingly small impact on weight because, even when untaxed, soft drinks represent only 7 percent of the average soda drinker's total calorie intake.

Yet in a recent New England Journal of Medicine article, Arkansas' surgeon general, New York City's health commissioner, and five experts on health and economics insisted that a penny-per-ounce tax on sugared beverages could lead the average consumer to reduce soda consumption by about 10 percent and lose two pounds. The authors argue that the soda tax would be effective at reducing the number of soda drinkers because the federal cigarette tax, which amounts on average to $1.34 per cigarette pack, has been effective at reducing the number of smokers. Yet several widely reported studies found that the tax on cigarettes as a whole has reduced smoking in adults by just 2 percent and in teens by 7 percent.

So the soda tax won't do much to help us lose weight. But does it raise much revenue? Supporters say yes, but there's a problem here too. If the tax is effective at discouraging soda consumption, it won't raise much money because people won't be buying soda. Which does the government actually prefer? Skinnier citizens or fatter coffers?

Last July the Congressional Budget Office estimated that a federal three-cent-per-12-ounce soft drink tax would generate $24 billion over the next four years. Needless to say, that won't fix the current budget crisis, but the NEJM authors argue that it could have an effect on obesity rates in America. They propose using any money raised by the tax for child nutrition and obesity prevention programs. That way, the thinking goes, even if people still drink soda the tax will help the fight against fat.

If that does happen, the government won't be able to use the funds to reduce the deficit, subsidize health insurance, or fulfill the other hopes politicians have for the money. But there's a fair chance it wouldn't happen in the first place. Governments don't always spend sin tax money the way they promise. Money from the Master Settlement Agreement, the deal that ended state litigation against the major tobacco companies, was supposed to fund smoking cessation programs and defray the costs that smoking imposes on public health systems. Once they had the money, though, states used it as a giant slush fund, diverting it to schools, roads, and various pet projects. They even invested some of it in tobacco stocks.

Americans may be fat, but the federal budget is morbidly obese; our hunger for chips and soda is nothing compared to the feds' hunger for our money. If I had to choose between putting the average citizen or the government on a diet, I know which would be better for our fiscal health.

Contributing Editor Veronique de Rugy ([e-mail]) is a senior research fellow at the Mercatus Center at George Mason University.