Note to subscribers: The next edition of the Tax and Spend newsletter will arrive in your inboxes on June 21.
Do Sin Taxes Work?
Governments around the world, including Canada, have for decades imposed taxes on products deemed socially problematic. Alcohol and tobacco are long standing examples; sugar recently joined this list.
Such taxes generally reduce consumption, but the speed of this decrease varies greatly depending on the product in question. To measure the impact of a tax on the demand for a product, economists use a measure called the price elasticity of demand.
Simply put, elasticity measures how well demand responds to a given price change. An elasticity of -1 means that, for example, a 10% price increase will cause demand to decrease by 10%. An elasticity between -1 and 0 means that demand decreases less than prices increase; these types of goods are called inelastic.
So how do taxes on sin compare to the measure of elasticity. It turns out that tobacco is relatively inelastic to price. Considering the addictive nature of nicotine, this isn’t much of a shock. A 2019 study published in the Annual Review of Public Health found that tobacco had a price elasticity of -0.4 in high-income countries, meaning that a 10% price increase resulted in a 4% drop in demand. Recent research by Canada’s Parliamentary Budget Officer has shown a similar elasticity in this country of -0.47.
Demand for alcohol is slightly more price sensitive, or more elastic to demand, according to this 2019 study. Overall, the price elasticity of alcohol in high-income countries was between −0 , 51 and −0.77. At the high end, this makes the demand for alcohol almost twice as sensitive to price changes as tobacco.
But there are big differences within this average. Hard liquors were more price elastic than beer, for example. And there seems to be an inverse relationship between the degree of consumption and price inelasticity. In other words, heavy drinkers are not as influenced by price changes as lighter drinkers, with the price elasticity for heavy drinkers estimated to be around -0.28. As a sin tax, alcohol levies are relatively ineffective.
Sugar taxes are on the other end of the spectrum, according to this study, with a price elasticity of -0.8. If we consider only sugary drinks, this elasticity drops to -1.2, which means that a price increase of 10% leads to a decrease in demand of 12%.
Why would sugar taxes be so much more effective? Substitution is the most likely explanation. If the price of sugary soda goes up, consumers can opt for an artificially sweetened alternative (or even an unsweetened choice, like water).
This same substitution effect is not as strong for tobacco or alcohol, which explains the persistence of demand for these products despite decades of increasing sin taxes.
Commenting on a recent Tax and Spend report on Ottawa’s new hiring subsidy, one reader asks how increasing the wages of existing employees would be considered more important than creating new jobs.
Canada’s Stimulus Hiring Program, despite its name, provides payments for more than hiring new employees, as it reimburses companies for a portion of payroll increases. Increasing the hours of existing employees can also generate subsidies for a business, as can simply giving a raise to current workers. It is this last facet with which the reader contests.
There is some merit to the reader’s point.
First of all, however, it’s worth noting what Finance Minister Chrystia Freeland had to say about it last week at a press conference that touched on the hiring program, which kicks off this week. Ms Freeland said the inclusion of increases in the calculation of the payroll increase was deliberate, a recognition that some companies might reinstate past pay cuts or reward their loyal employees.
Perhaps, although the limits the government has set on wage increases so far largely focus on a cap on how much can be subsidized for each employee (as well as other restrictions). For the most part, regular salaries that fall below this ceiling will be taken into account, regardless of the employer’s motivation, as long as the company qualifies elsewhere.
Going back to the reader’s comment, it’s quite possible that a company could choose to increase wages (or pay overtime in the case of hourly workers) instead of hiring a new employee. If and when this happens, it will run counter to the notion of hiring assistance.
News from SSUC: My colleague, business journalist Matt Lundy, sparked a multi-faceted debate on Twitter with his smart look at the differences between the US and Canadian labor markets, including the positive impact of Canada’s emergency wage subsidy program. . In response, Bhuvana Rai, senior partner in Borden Ladner Gervais’ tax group, tweeted that severance pay requirements under Canadian labor law also help explain cross-border differences in job losses. Brendon Bernard, economist at Indeed Canada, had a take: Public employment has held up much better in Canada than in the United States. Just look at the private sector, and the United States is slightly outperforming Canada, he says.
Follow me on Twitter @PatrickBrethour or ask your tax question here.
Subscribe to the Tax and Spend newsletter here