About Sin Taxes and Consumer Behaviour

A so-called “sin tax” is a tax which is specifically levied against products or services that a society has identified as harmful or undesirable, but not so harmful or undesirable that they can or should be banned outright (i.e. prohibition). Common sin taxes include those on alcohol and tobacco, although those regulations which exist in places that have legalized but restricted gambling or prostitution can also be referred to as sin taxes. The purpose of a sin tax is based in economic theory: it intends to reduce consumption of the undesirable good by increasing the price.

Sin taxes are currently levied against a wide variety of social ills which are considered not so serious that they need to be prohibited. Prostitution (in many countries), cocaine, and marijuana are criminalized in most countries, for instance, but alcohol and tobacco are not. In American history, the Prohibition era demonstrated that alcohol could be eliminated from society only at extremely high cost, and in large part alcohol was not eliminated, but simply driven underground onto the black market. Sin taxes are seen as a way of reducing the frequency of socially harmful behaviour without creating an underground criminal economy. This is the approach taken when charging taxes on alcohol, cigarettes, in some countries marijuana and other supposedly mild drugs, and in some current proposals on soft drinks and other sugar-rich junk foods for public health reasons.

In economic theory, a sin tax is also known as a sumptuary tax or a Pigovian tax – a tax which attempts to reduce the collective social harm from a private economic transaction by raising the price of that transaction. The law of supply and demand indicates that when a price for a good or service goes up, more producers will be willing to supply it, but fewer purchasers will be willing to buy it. At the same time, when the price for a good does down, more purchasers will buy it, but fewer producers will be willing to make it in the first place. A tax does both: the end price of the good ends up artificially high so that few people buy it, but the actual money which goes to the seller (i.e. price minus tax) is held artificially low, so that fewer producers enter the market.

Normally economists consider this a generally negative impact of taxation, but in the case of sin taxes, it is seen as a positive – since the purpose of the sin tax is to reduce or even eliminate the harmful behaviour, rather than to encourage economic growth. In theory, a sin tax raises the price of the undesirable good without increasing the profits to the producer. With the price having risen, fewer people will be willing to buy the good. Overall, this results in a general reduction in consumption compared to what it would have been on the free market.

Particularly in countries with advanced social welfare networks, the argument is also often made that sin taxes help society directly by producing a pool of funds to pay for the consequences of undesirable activity. For example, tobacco cigarettes cause lung cancer – which, in almost all advanced countries except the United States, is treated with public funds. Sin taxes on cigarettes create a pool of money out of which lung cancer treatments can be funded, so that non-smokers are not covering the costs of lung cancer through their income taxes.

At the same time, in practice jurisdictions which have sin taxes must balance the benefits of a higher sin tax (in terms of reducing the harmful behaviour) with the risk of creating black markets. Black markets, or underground economies, commonly supply illegal goods in all countries, including illegal drugs. Black markets can only do so at increased cost, to cover risks,pay border smugglers and organized criminal organizations, cover losses to law enforcement, and so on. However, if the added cost of the black market is less than the added cost of the sin tax, then sin taxes may lead to a large underground economy. In some regions of Canada, for example, cigarette smuggling is a profitable activity due to high taxes on cigarettes. Black market cigarettes are produced on Aboriginal reserves or smuggled across the border from the United States.

In addition to this practical problem of managing sin taxes (which must paradoxically be high enough to be effective but low enough to prevent black markets from emerging), there is also an opposition argument from libertarians who argue that the government should not be interfering with individual citizens’ freedom to choose how to spend their money when their choices fundamentally involve harm to themselves rather than harm to others. Of course, this rests on the assumption that the principal social “evils” of alcohol and tobacco consumption are liver cirrhosis and lung cancer suffered by drinkers and smokers themselves, rather than the smaller number of bystanders struck by drunk drivers or stricken with cancer from second-hand smoke.