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Dear Russia: You’re Doing It Wrong, Sin Taxes Edition…

September 12th, 2010 · 12 Comments
Econ 101 · Policy

In the U.S., you pay sin taxes. In Russia, sin taxes pay you…hmmmmm, that doesn’t work at all. Anyway…

In general, there are a number of reasons that a government might want to place a tax on a particular good or service. One of the main reasons is, not surprisingly, to collect revenue. Another reason is to “internalize” negative externalities that the production and consumption of some goods and services impose on society. In a lot of ways, these two versions of a tax look almost exactly the same. In terms of the desired effect of the tax on market behavior, however, the two types of taxes are very different.

If a tax is designed to simply collect revenue, the government is very much hoping that that tax won’t change the behavior of producers and consumers very much. For example, it is beneficial in a lot of ways if an income tax on labor doesn’t noticeably lower the incentive for workers to seek jobs or for firms to hire people. The reason is that if a tax doesn’t change buying and selling behavior very much, then it acts mainly as a transfer of money to the government rather than an economic black hole:

“Deadweight loss” is the technical term for the economic black hole, and it’s represented by the black triangle on the graph. Deadweight loss measures the value to society of the transactions that the tax made not happen. Geometrically, we can calculate the size of the deadweight loss triangle by noticing that the base of the triangle is the amount of the (per unit) tax, and the height of the triangle is the change in the market quantity of the item. In the example above, this latter quantity is small and our triangle is not very big. This is a win-win from the government’s perspective, since it gets to collect a lot of revenue and, at the same time, not stifle too much economic activity. But what happens if consumers and producers are more price-sensitive?

Our economic black hole is bigger in this case, and our revenue is smaller. (To see the revenue point, keep in mind that the revenue is just the per-unit tax times the number of units sold, so it’s just the size of the rectangle bounded by the prices and after-tax quantity on the graphs.) Granted, we can debate the merits of transfers from the private sector the government, but a transfer used to provide some sort of social services is better than a “transfer” to an economic black hole, right? (I can hear the jokes about the government being an economic black hole from here, thanks.) Therefore, at least from an efficiency perspective, the government should tax more inelastic (less price-sensitive) markets, since these taxes minimize the amount of loss in economic activity. (There are obviously fairness considerations that often run counter to this logic.)

Now what about this second kind of taxes…you know, sin taxes- the ones meant to correct for externalities or save us from ourselves or whatever. In this case, a tax is put in place as a way to curb socially undesirable behavior. For example, if you cost society $1 in pollution for every gallon of gasoline that you use, then a $1 per gallon tax on gasoline will actually raise economic welfare for society. In other words, whereas a decline in production and consumption was bad in our first example, it’s actually a good thing in this case, at least up to a point. (It would not be efficient to keep taxing gasoline at higher and higher rates until no one drove anymore, for example.) This discussion suggests that, when taxing to curb bad behavior, the government should want people to change their behavior a lot in response to the tax.

We can think about what sorts of taxes likely fall into which category. Income taxes are pretty clearly of the first sort, while taxes on items such as gasoline, alcohol and cigarettes are, at least from a public relations perspective, of the second variety. This brings me to my “Dear Russia: You’re doing it wrong” point…from RedEye:

(For the record, RedEye almost redeems Fox News in my mind…almost.)

If you smoke a pack of cigarettes, that means you are giving more to help solve social problems such as boosting demographics, developing other social services and upholding birth rates. People should understand: Those who drink, those who smoke are doing more to help the state.”
— Alexei Kudrin, Russian finance minister

Hm. I think I finally understand why chants of “U-S-A” start when people are consuming large quantities of beer and cigarettes- clearly those patriotic fellows are just doing their part to help the country that they love. Unfortunately, the world doesn’t really work the way in which Mr. Kudrin thinks it does- yes, the increased revenue from taxes on booze and cigarettes will go to the expansion of social programs, but the social programs getting expanded will likely be of the “health care for people who drank and smoked too much” variety. This is probably not a net benefit to Russian society, and, if it is, it calls into question why the tax on booze and cigarettes was so high in the first place- if you’re taxing more than the amount of the externality, you should probably be honest in that the goal of the tax is to raise revenue more than it is to help society or protect people or whatever. To their credit, at least some Russian officials seem comfortable admitting this, assuming that they are correct in thinking that the revenue will lead to a net increase in social programs. (If they aren’t correct on this point, they are effectively handicapping their own economy.) In the U.S. I have a sneaking suspicion that our politicians are less good on this dimension. At least now you know to be a tad suspicious when a government simultaneously tries to “help” people by enacting a tax and then advertising for that thing that is taxed- state lotteries, anyone?

Tags: Econ 101 · Policy

12 responses so far ↓

  • 1 Ahren // Sep 13, 2010 at 6:36 am

    But… you can’t win if you don’t play?

  • 2 Maxine Udall (girl economist) // Sep 13, 2010 at 10:10 am

    You might want to take a look at this article by Will Manning and others that appeared in JAMA in 1989. I’m sorry to say that smokers are probably helping the state by eliminating themselves before they are old enough to start collecting publicly funded pensions. Alcoholics, on the other hand, have the option of substituting to (much) cheaper booze, thereby avoiding the full impact of the tax’s effect on demand (a tax which in the US has fallen in real terms since the 1950s). However, unlike smokers, alcohol abusers and problem drinkers don’t die young and therefore impose significant costs on the rest of us. You should note that the Manning et al study was done before the significant health effects of second hand smoke had been established. Their calculations do not take this into account and would likely alter their conclusions somewhat. Here’s a link to the JAMA article followed by a link to the RAND report:
    http://jama.ama-assn.org/cgi/content/abstract/261/11/1604

    http://www.rand.org/pubs/notes/N2941/

    You might also find this report by Phillip Morris (now Altria) in which they “help” Czechoslovakia to see that smoking would save the government money (because of the “early mortality of smokers.”)

    http://www.tobaccofreekids.org/reports/philipmorris/pmczechstudy.pdf (see also http://www.tobaccofreekids.org/reports/philipmorris/#czech).

    You’ll see from all of this that your conjecture about offsetting health care costs is not supported (at least by the evidence to date).

    I’m sorry to say that Russia is probably doing it right, if their only goal is to improve government revenues without regard to the health and well-being of all their people.

  • 3 Joao Pedro Afonso // Sep 13, 2010 at 6:47 pm

    What I think weird is that these declarations of Alexei Kudrin apparently appears in the “morning” of the introduction of important measures to stop alcohol consume, in such a way that they are already talking about a “return” to the dry law of Gorbachev.

    Without more information, I’m going to do an educated guess: instead of an official position of the Russian government, his was an opinion in the war between the “in favor” and “against” the Alcohol consume in Russia. There’s a lot against those present measures, and Kudrin must be siding with them. If Russia is indeed counting on those revenues, then it wouldn’t be reinforcing bans and prohibitions related to alcohol. This return us to the more healthy debate, if Kudrin is right or not. After all, if the Russian vices are responsible for ten years less in the expected life span of the Russians, a simple way of increase Russian population and to use more efficiently the education system would be to raise that life span…

  • 4 Amarsir // Sep 14, 2010 at 4:10 am

    You had me at “RedEye.”

    Felix Dennis basically said this same point too: smokers aren’t dying of heart disease instead of immortality. They’re dying of heart disease instead of more expensive things later. Of course you also have to consider if they are losing productive years.

    The whole disincentive aspect is why I’d embrace cap and trade if it were to replace (rather than supplement) the 16th Amendment. We’ll forever debate the elasticity of hiring, but accepting that the demand curve isn’t vertical…

  • 5 Timothy Cullen // Sep 17, 2010 at 11:56 am

    I love this post because I detest arguing with those who think they can have it both ways with sin taxes raising both revenues and deterring the alleged negative behavior; however I do think there is one problem with saying that smokers create a negative externality.

    That problem is that such an externality is largely artificial, it exists only because government forces taxpayers to pay for other people’s health care; as opposed to a naturally occurring externality like pollution. As such it isn’t a market failure, but a problem stemming from government interference in markets to redistribute wealth. At the very least it should be portrayed as such, smokers don’t impose costs upon society; government imposes the costs of their behavior on us when it forces us to pay for their health care.

  • 6 Dave // Sep 20, 2010 at 12:37 pm

    Excellent comment, Tim.

  • 7 Dear Russia: You’re Doing It Wrong, Sin Taxes Edition… « eLearning and economics – digging a little deeper // Sep 21, 2010 at 10:17 am

    […] Dear Russia: You’re Doing It Wrong, Sin Taxes Edition… September 21, 2010 by Andrew McCarthy Dear Russia: You’re Doing It Wrong, Sin Taxes Edition…. […]

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