‘Sin Tax’ Costs Outweigh Benefits

Burdened by unfunded public pension liabilities and healthcare costs, state and local governments are in bad shape, considering the willingness of voters to embrace new spending proposals and their general reluctance to pay taxes to finance them.

Responding to the latest round of public budget “crises,” policymakers around the country have begun reviving an old, but not necessarily good idea with added enthusiasm—taxing “sin.” What better way to raise revenue than to find something that your neighbor buys or an activity he engages in that you don’t like and tax it?

Alcohol, tobacco, and gambling have been taxed for a long time. A tax on whiskey—and the rebellion it triggered by corn farmers in western Pennsylvania—was, after all, one of Treasury Secretary Alexander Hamilton’s first “revenue-enhancers.” Later on, after Prohibition obviously had failed and the Great Depression had caused income tax receipts to shrink dramatically, Franklin Roosevelt ran for his first term as president on a platform calling for legalizing and taxing alcohol sales.

Vices are attractive targets for selective taxation because sinners are not very sensitive to increases in the prices of the sinful goods and services they buy. They reduce their purchases, of course, but not by much. Taxing sin thus is a tax revenue-generating engine.

In addition to being robust revenue-raisers, the orthodox justification for sin taxes was that they would reduce the costs smokers, drinkers, and gamblers impose on others—drunk driving, exposure to secondhand tobacco smoke, and losing the family paycheck at the craps table. But that rationale was a nonstarter because of the relatively small impact these taxes have on the sinful consumers’ behavior. Such taxes may “nudge” consumption in the desired downward direction, but bad habits are hard to break.

Nowadays, however, sin tax proponents have shifted gears by arguing that taxation is mainly aimed at compensating society for the drains sinners impose on the public healthcare budget and reducing the harm consumers do to themselves. With this new push, the limits of what defines a sin steadily are being expanded.

A Mercatus Center working paper highlights several of these new selective taxes. The obesity “epidemic” supplies grounds for taxing candy bars, sugary soft drinks, “junk food” in general, and many of the items sold at fast-food restaurants. Thirty-six U.S. states collect amusement taxesUtah imposes a “sex” tax; and Alabama levies a tax on decks of playing cards. Some particularly inventive ideas include selling stamps to pay taxes on illegal drug sales, should you ever get caught, and a European proposal to tax airlines not only for flying over domestic airspace, but for air miles flown from takeoff to landing.

While sin taxes might ultimately cause some reduction in “bad behavior,” there are a number of reasons the costs of the tax often outweigh their benefits:

1. Lobbying: Millions of dollars have been spent to thwart taxation of the soft drink industry’s products and to prevent existing taxes from being raised. In 2009 alone, the industry spent more than $57 million on lobbying. Such lobbying expenditures are socially wasteful. How much money is now being spent attempting to block Mayor Bloomberg’s ban on 32-ounce soft drink containers?
2. Regressive taxation: Far from being income-neutral, such taxes are regressive because their burden falls most heavily on people with the fewest options—the poor. Low-income households who continue to purchase goods that are sin-taxed will have even less money left over to spend on other items.
3. Revenue not used for its intended purpose: Sin taxes raise revenue by transferring money from those who continue to buy the taxed items straight to the coffers of the public treasury. Taxing sin might be reasonable if the revenue from these taxes was used to address the underlying negative consequences of consumption. In the real world, however, money generated by the tobacco settlement financed general spending and not smoking cessation programs or treating smoking-related diseases. The social security trust fund has been replaced with treasury IOUs, and the highway trust fund filled by taxing the sin of driving will fail to meet obligations as early as 2015.

Need to justify a new sin tax or raise an existing one? Claim that consuming some good or engaging in some activity contributes to ill health or harms the environment. Argue that “experts” know what choices consumers should make better than the consumers themselves know. Finally, don’t forget to select items for taxation that only a minority of the population buys, but that you and the majority of voters do not. Be a paternalist.