Do sin taxes work?

Governments around the world, including in Canada, have for decades slapped taxes on products deemed to be socially problematic. Alcohol and tobacco are long-standing examples; sugar has lately joined that list.

Such taxes generally do reduce consumption, but the speed of that decline varies greatly depending on the product in question. To measure how a tax impacts demand for a product, economists use a measure called price elasticity of demand.

Simply put, elasticity measures how much demand responds to a given change in price. An elasticity of -1 means that, for instance, a 10-per-cent increase in price will decrease demand by 10 per cent. An elasticity between -1 and 0 means that demand falls by a smaller degree than the price increases; those kinds of goods are called inelastic.

So, how do sin taxes stack up on the elasticity measure. Tobacco, as it turns out, is relatively price inelastic. Given the addictive nature of nicotine, that’s not much of a shock. A 2019 study in the Annual Review of Public Health found that tobacco had a price elasticity of -0.4 in high-income countries, meaning that a price increase of 10 per cent led to a decrease in demand of 4 per cent. Recent research from Canada’s Parliamentary Budget Officer articulated a similar elasticity in this country, of -0.47.

Demand for alcohol is slightly more responsive to price, or more elastic in demand, according to that 2019 study. Over all, alcohol had a price elasticity in high-income countries between −0.51 and −0.77. At the high end, that makes demand for alcohol nearly twice as responsive to price changes as tobacco.

But there are big differences within that average. Hard liquor was more price elastic than beer, for instance. And there appears to be an inverse relationship between the degree of drinking and price inelasticity. In other words, heavy drinkers aren’t as influenced by price changes as much as lighter imbibers, with the price elasticity for heavy consumers of alcohol estimated to be around -0.28. As a sin tax, alcohol levies are relatively inefficient.

Sugar taxes are at the other end of the spectrum, according to that study, with a price elasticity of -0.8. If just sugar-sweetened beverages are considered, that elasticity rises to -1.2, meaning that a 10-per-cent increase in prices causes demand to fall by 12 per cent.

Why would sugar taxes be so much more effective? Substitution is the most likely explanation. If the price of sugar-sweetened soda rises, consumers can opt for an artificially sweetened alternative (or even an unsweetened choice, such as water).

That same substitution effect isn’t as powerful for tobacco or alcohol, helping to explain the staying power of demand for those goods despite decades of increasing sin taxes.

The Globe and Mail, June 6, 2021