Wednesday, August 13, 2008

Taxing Sin: some economics of smoking, gambling & booze (revision 1)

This is a draft of a paper I am preparing. Comments very appreciated.


There is a long history of governments taxing activities they disapprove of. In 1604, England’s King James I concluded that tobacco smoking was ‘a custom loathsome to the eye, hateful to the nose, harmful to the brain, dangerous to the lung’ (Brandt (2007, p. 21)). He responded by increasing the import duty on tobacco by 4000 per cent – an early hefty tax on ‘sin’. This was a severe response but non-tax restrictions at this time in history were more severe. In Turkey, Sultan Murad IV had pipes driven through the noses of those found smoking either immediately before or after their beheading! Indeed, Murad IV would patrol the streets and, if he saw a soldier using tobacco or alcohol, would kill the soldier on the spot with his mace.

Despite these discouragements alcohol consumption, smoking and gambling continued to flourish even though they remain heavily restricted in modern times. In Australia, cigarette taxes amount to about $5 on a 20 pack. Alcohol is taxed in various ways. Full strength beer is taxed at $38 per litre of alcohol, spirits at $60-42 per litre alcohol while wine is taxed on its value (ATO, 2008). These charges add significantly to the cost of having a drink. Finally, gambling taxes, particularly those imposed on the most popular form of legal gambling in Australia, namely on gaming machines, provide 9.5 per cent of ‘own source’ state government revenue (Commonwealth Grants Commission, 2008).

Taxes on sin goods need not target sin

Taxes can be levied on ‘sin goods’ on grounds that have nothing to do with their claimed propensity to corrupt morals. Since taxes are needed to fund public spending, one way of selecting them is to find goods yielding much tax revenue but which impose low distortionary costs. Frank Ramsey (1927) showed the best way to do this was to levy taxes on goods in inelastic demand. Cigarettes, alcohol and activities, such as compulsive gambling, have inelastic demands because they are addictive. Taxing sin goods therefore yields good revenues while not impacting much on economic activity.

These revenue objectives provide part of the explanation for current taxes on sin. Tobacco demand elasticities lie between -0.25 to -0.5 so a 10 per cent tax increases tax revenues by 5 to 7.5 per cent (Chaloupka et al., 2001). Price elasticities for alcoholic beverages are around -0.6 so a 10 per cent tax augments revenues by 4 per cent (Selvanathan et al., 2004). The evidence on gambling is mixed since, as has been known from Suits (1979), the demand for gambling on such things as horse racing is probably elastic suggesting a limited ability to yield tax revenues. But with respect to repetitive gambling activities such as gaming machines – these are more addictive - work by this author suggests relatively inelastic demands and good revenue yields.

While governments are often accused of hypocrisy in seeking revenues rather than the moral good in taxing sin, a sensible view is that they are following recommendations of public economists who advocate such taxes when demand elasticities are low. Of course governments are using the fact that these goods are perceived as ‘sinful’ as low resistance ways of accessing revenues. However if the demand for sin goods is inelastic, policies designed to yield revenue do so because the policies will be ineffective in reducing sin (Johnson & Meier, 1990).

Externalities

Another reason for taxing sin goods arises from the externalities associated with their consumption. These are costs imposed on non-consumers by the consumption by others.

For example, cigarette smoking has dangerous effects on bystanders who inhale secondary smoke. Evidence suggests that exposure to such smoke is the most dangerous environmental exposure confronted by US citizens (NCI, 1999). This is, for example, a health concern for non-smokers married to smokers - lung cancer risks of a non-smoking spouse increase by 20-30 per cent and heart disease risks by 23 per cent (Hirayama, 1981). There are also specific dangers to children from passive smoking including increased risks of respiratory disease (DHHS, 2006). There are also damages to workers if co-workers or customers smoke in their workplace.

Excessive alcohol consumption is associated with violence, particularly within the family, while excessive alcohol consumption is the largest single cause of deaths on our roads. Around 28.5 per cent of road deaths among those aged under 65 are due to alcohol. This is a particular problem for young drivers. A driver aged 20+ who has consumed 6 standard drinks has 12 times the chance of a fatal car crash than a sober driver while, for drivers aged 16-19, the risk is 100-times that of a sober driver (Phelps, 1997).

Other alcohol-linked externalities include foetal alcohol syndrome inflicted on infants when mothers consume alcohol during pregnancy (Clarke, 2008). This reduces infant IQ.

Finally, although only 2.1% of Australians are ‘problem gamblers’, five times this percentage (comprising mainly family and work colleagues) are adversely impacted by gambling (Productivity Commission, 1999). These social costs take a terrible toll through interpersonal conflicts generated and problems in workplace performance.

Nevertheless externality arguments for taxing cigarettes, alcohol and gambling are often weaker than public finance reasons because externalities are associated with misuse rather than use per se and often have relatively low cost. The external costs associated with cigarettes are estimated at 40 cents US per pack (Gruber, 2002) and, while this is not negligible, it is dwarfed by private mortality costs of smoking for men of $222 US per pack (Viscusi and Hersch, 2007).

A more effective way of addressing externalities is often to restrict specific activities related to the external damages rather than penalising consumption generally.

For example, with respect to smoking, a better policy to reduce passive smoking damages is to restrict smoking in certain situations rather than taxing smoking per se. This is the motivation for banning smoking in the workforce, in entertainment venues and even in private cars with non-smoking occupants. The latter reform was initiated in South Australia but has now either been introduced elsewhere or is about to be. Smoking in the home that causes damage to children can be discouraged by using ‘moral suasion’ arguments which articulate the health implications for children and others of secondary tobacco smoke.

Likewise, while drinking is the major cause of traffic fatalities, the issue is not drinking per se but drinking before driving. Taxing alcohol at moderate levels will reduce this but the more sensible way to tackle accident externalities is to provide information on accident risks, particularly among adolescents, and to rigorously punish those who threaten life by driving while intoxicated. Booze buses that randomly check for intoxicated motorists, with particularly stringent restrictions on young drivers, are a more effective way of tackling this specific behaviour than low taxes on alcohol. The option of setting very high taxes on use penalises the 74 per cent of Australians who consume alcohol at levels that impose low social costs (Clarke, 2008).

With respect to gambling there are significant social costs linked to the fact that problem gamblers move inevitably towards financial ruin – the ‘gambler’s ruin’ – and end up drawing unreasonably on family and employer resources. Families are destroyed and innocent children experience deprivation as a consequence. Here the harm is excessive gambling which can be controlled if the extent of gambling can be constrained. A difficulty is that problem gamblers have relatively inelastic demands so taxes to significantly reduce gambling need to be high. Society has made the judgement that most gamblers derive significant recreational benefits at low social cost from gambling so that hefty taxes alone would again cut into the innocent pleasures of many. Better policies would target specifically problem gambling.

Several approaches have been developed. The first protects citizens from the excessive gambling that creates externalities by using electronic player cards for repetitive forms of gaming (Dickerson, 2003). These cards are issued on the usual 100 point ID requirements of a cash card. They limit the money an individual can pre-commit to gambling. For most players preferred expenditures would be within regulated limits but, for problem gamblers, such devices limit losses. This approach is currently under consideration in Victoria and other states. Another policy that limits problem gambling is the self-exclusion option that gamblers can now exercise in all states. Gamblers who, between gambling sessions, recognise that they face self-control issues with respect to gambling can elect to have themselves excluded from gambling venues.

These policies reduce costs faced by the consumers themselves, an issue we turn to.

Taxing internalities

Apart from public revenue and externality reasons for restricting sin goods a further motivation is to reduce costs consumers impose on themselves. The main issues are whether such interventions are warranted and, if so, whether taxes are the best restriction.

Historically opposition to sin goods has been based on claimed ‘moral’ costs. Smoking has long been linked to ‘illicit’ sex. This dates at least to images of flimsily dressed wenches rolling cigars on their naked thighs in the cigar factory featured in Bizet’s opera Carmen. Alcohol too has long been viewed as destructive of work ethics and family attachments. It is commonly portrayed as a lever that promotes illicit seduction of the innocent. Gambling is often seen with standard ‘materialist’ misconceptions as a degenerate ‘service’ activity that yields no useful physical output. Indeed Alexander Pope in his Rape of the Lock gives an eloquent picture of a degraded gambling woman and the corrupting influence the practice had on her. Veblen (1899) argued that gamblers impute causality into games of pure chance – psychologists term this the illusion of control - thereby making society more stupid.

For the most part, these activities are not regarded nowadays as ‘sinful’ in a narrow moral sense. Instead they are seen as costly to the individual because they imply private health and psychological costs from licit drug consumption or financial ruin from gambling.

The health costs identified go beyond the damage bills accruing to governments. They even exceed the total health costs that accrue to governments and the individuals concerned, reflecting also loss of life and increased morbidity.

Intervening to restrict consumption raises charges of ‘wowserism’ with governments disallowing free choices. Two sub-claims support this criticism. First, that governments may not have better information than private citizens and, second, that even if citizens do hold mistaken views, that they are entitled to be wrong and it is better for them to make their own mistakes. Indeed, the claim is often that government intervention to ‘protect people from themselves’ has the moral hazard consequence of creating more dangerous, risk-taking behaviours.

Some argue that interventions to limit consumption of sin goods can be justified by considering within-person externalities or internalities (Gruber, 2002/03) arising because individuals do not account adequately for the costs of actions on their future selves. The thesis is that individual decision making is time inconsistent with today’s ‘self’ being impatient but tomorrow’s ‘self’ being patient. Planning for the distant future is ‘reasoned’ and involves low impulsiveness but short-term responses are driven by the myopic emotions. Thus agents assess risky activities by hyperbolically discounting (Ainslie, 2001) with short-term impulsiveness and long-term rationality ‘fighting it out’. Paternalist policy seeks to help the dispassionate self gain control over the emotionally-driven choices considered by a conflicted individual.

Short-term selves are supposed to be strong among adolescents who engage in socially desirable experimentation to help them define adult roles but who thereby become susceptible to risky pursuits such as drugs and gambling.

In Australia almost everyone who takes up smoking does so when young: the average age of initiating smoking is 15.9 years (ABS, 2006). Such adolescents apply high rates of discount to longer-term costs of smoking. Even if they do correctly identify these costs they substantially overestimate their ability to quit the habit. These high rates of discount decline with age so when individuals are in their mid-twenties they are less impulsive and risk-loving. They then regret their decision to initiate smoking (most smokers do regret initiating the habit!) but find it unexpectedly difficult to quit. There is again a case for intervention to limit consumption.

Similarly excessive drinking, including ‘binge drinking’, is often initiated during adolescence when neuroscientists tell us that the regions of the brain involved in executive control and motivation are underdeveloped. Moreover, the vulnerability to alcoholism is greatest among those initiating drinking early in life but those with difficulties making decisions at any age - those suffering depression, anxiety, ADHD and schizophrenia - tend to be alcohol abusers (Clarke, 2008). There is again a case for limiting consumption.

These arguments are strengthened by recent evidence suggesting specific damages to brain development from consumption of alcohol (White, 2003) and tobacco (Krystal et al., 2005) during adolescence. Also relevant are internalised damages associated with drink-driving by youth that impose drastic internalised costs.

Finally, problem gambling begins at early ages. About 33 per cent of problem gamblers began betting before they were 10 years of age with 47 per cent beginning between 11 to 18 years. These youth often have co-occurring alcohol, cigarette and other drug problems that, with gambling, are correlated with impulsivity and low cognitive control (Petry, 2005).

The ethical debate concerning the case for paternalism with respect to sin goods seems academic at least with respect to youth who make flawed decisions. It remains however to ask whether tax policies are the appropriate means of initiating restrictions.

Young people have limited incomes so their demand for such things as cigarettes and alcohol are relatively price elastic. To this extent taxes will impact on consumption choices although it is doubtful that they would ever be the only policy instrument used in this context.

For example with respect to tobacco smoking, a 10 per cent increase in price leads to only a modest 2.4 to 4.7 per cent increase in cessation probabilities among US youth with uncertain impacts on smoking initiation (Chaloupka, 2001; Taurus et al, 2001). Increasing taxes to high levels provides stronger effects but encourages substitution of injurious home-grown tobaccos (‘chop chop’ home grown causes fungal infections of the lung) and the intensification of smoking through ‘puffing harder’. A 1 per cent increase in price provides a 0.4 per cent increase in smoking intensity and a new range of more dangerous adenocarcinomas lower in the lungs (Adda et al, 2006; Henschke et al, 2002).

With respect to youth there is a case for an infinite tax on smoking, alcohol and gambling activities by prohibiting them. Minimum pack sizes, bans on advertising and bans on smoking in entertainment venues are also ways of curbing youth consumption. Bans on selling to youth backed by stringent penalties and penalties on purchasing are also effective. Negative advertising that emphasises current costs of smoking and alcohol in terms of lost physical fitness provide disincentives for youth that are more tailored and carry greater clout than modest tax hikes.

At best, taxes will be one component of a package of policies that seek to restrict the consumption of sin goods by youth and by citizens more generally.

Final comments

Economists seeking to limit external and privately-borne costs of sin goods should devise policies that target problem areas as directly as possible. General policies that have broad impacts will generate by-product costs on non-targeted groups and bring about harmful substitutions that may lead to additional harm through unintended consequences. Taxes on sin reduce costly externalities and high personal health costs but are not the sole way of advancing this objective.

A strong argument for taxing sin goods is that the taxes yield revenue without distorting economic activity greatly and with low political flack. Such taxes do help restrict the damages consumers of sin impose on others and on themselves but almost always need to be supplemented by other policies to have significant impacts.

References

J. Adda, & F. Cornaglia, ‘The Effect of Bans and Taxes on Passive Smoking’, Institute for the Study of Labour (IZA), Discussion Paper No. 2191, 2006.

G. Ainslie, Breakdown of Will, Cambridge University Press, 2001.

Australian Bureau of Statistics, Tobacco Smoking in Australia – A Snapshot 2004-05, ABS Canberra, 2006

Australian Taxation Office, Excise Tariff Working Pages, Canberra, 2008.

A. M. Brandt, The Cigarette Century, Perseus, New York, 2007.

F. Chaloupka, M. Wakefield & C. Czart, ‘Taxing Tobacco’ in R. Rabin & S. Sugarman (eds) Regulating Tobacco, Oxford University Press, 2001,

H. Clarke, ‘The Economist’s Way of Thinking about Alcohol Policy’, Agenda, 15, 2008, 27-41.

M. Dickerson, ‘What if there were no problem gamblers’, mimeo, 2003.

Commonwealth Grants Commission, Gambling Taxation, Commonwealth of Australia, 2008.

J. Gruber, ‘Smoking internalities’, Regulation, Winter, 2002-2003, 52-57.

C. Henschke & P. McCarthy, Lung Cancer, Norton 2002.

T. Hirayama, ‘Non-smoking wives of heavy smokers have a higher risk of lung cancer: a study from Japan’, British Medical Journal, 1981, 282: 183–185.

C. Johnson & K. Meier, ‘The wages of sin: Taxing America’s legal vices’, Western Political Quarterly, 43, 3, 1990, 577-595.

J. Krystal, W. Mencl, M. Westerveld, S. Frost & K. Pugh ‘ Smoking causes cognitive and memory impairment in adolescence’, Biological Psychiatry, 57, 2005, 56–66.

NCI, Smoking and Health Monograph No. 10: Health Effects of Exposure to Environmental Tobacco Smoke: Report of the California Environmental Protection Agency, National Cancer Institute, 1999.

N. Petry, Pathological Gambling, American Psychological Association, Washington, 2005.

C. Phelps, Health Economics, Addison-Wesley, 1997.

Productivity Commission, Australia’s Gambling Industries, Summary Report, Canberra, 1999.

F.Ramsey, ‘A contribution to the theory of taxation’, Economic Journal, 37, 1927, 47-61.

E. Selvanathan & S. Selvanathan, ‘Economic and demographic factors in Australian alcohol demand’, Applied Economics, 36, 2004, 2405-2417.

D. Suits, ‘The demand for gambling’, Quarterly Journal of Economics, 93, 1979, 155-162.

J. Taurus & F. Chaloupka, ‘Determinants of Smoking Cessation’ in M. Grossman & C. Hsieh (eds) The Economic Analysis of Substance Abuse, Edward Elgar, 2001.

DHHS, Health Consequences of Involuntary Exposure to Tobacco Smoke: A Report of the Surgeon General. U.S. Department of Health and Human Services, 2006.

T. Veblen, ‘The sporting instinct’ in Theory of the Leisure Class, Macmillan, New York, 1899.

W. Kip Viscusi & J. Hersch, ‘The mortality cost to smokers’, NBER Working Paper 13599, National Bureau of Economic Research, November 2007.

A. White, ‘Substance use and adolescent brain development’, Youth Studies Australia, 22, 2003, 39-45.

15 comments:

Francis Xavier Holden said...

harry I havent read it closely but I would be interested in some short history. From my memory there was a time when smoking and drinking(beer only) wasn't considered sinful for adult australian men and a rise in taxes in the budget was cause for worrying about the higher prices of "the working man's necessities".

Can one of your myriad of exploited research assistants / PhD students tell me if this was ever true from news clippings and if the taxation rate backs up the necessities line?

jc said...

harry:

You may want to explain why US drug use numbers have remained constant since 1900 when drug laws were virtually inexistent. It was 1.3% of the population and has remained 1.3% since (with the war on drugs).

John said...

For example, cigarette smoking has dangerous effects on bystanders who inhale secondary smoke. Evidence suggests that exposure to such smoke is the most dangerous environmental exposure confronted by US citizens (NCI, 1999).

Incorrect. Air pollution constitutes a far greater risk. Diesel particulates are a big problem. Why don't we tax those?

conrad said...

I finally had a bit time to read and think about that

1) I found it interesting, especially the initial arguments about elasticity and not taxing sin.

2) Don't cite yourself for schizophrenics etc. use more alcohol (and smoke too, incidentally). There must be medical style references to that -- you'll just like a self-citing idiot when you obviously don't need too. If I was a reviewer, I'd call you sloppy for that!

3) I doubt the moral suasion arguments are really used because they are the best way of reducing externalities on children -- they're used because its the only thing governments can do. (kids suing parents will be fun :).

4) It's already illegal to give cigarettes to people 18, so it's not clear what your argument is -- it appears like a novel idea, but the reality is that is exactly what is happening already. Similar restrictions apply to alcohol -- and it's not like parents are going to let their kids get smashed.

5) The effect of a lot of these things is not quantified. i.e., If you want a serious paper you need to provide info like: If I make these things illegal with punishement XX, I expect YY to happen. Now all you are saying is that lots of things could be done -- most of which already occur now.
This would shut people like john up (you could give both values if it was meaningful -- with the air pollution as a comparison)

So -- not to be rude, I'm not a health psychologist, but if I got that to a review at any reasonable journal (and god I do enough reviews!), I'd reject it.

John said...

I would argue that the particulate matter is worse. The below studies are dated and while smoking has decreased over recent decades, road traffic has increased and so has asthma. More worryingly, a animal study found that diesel particulates travel along the olfactory axons to the olfactory bulb, find their way into the hippocampus, and can create microenvironmental inflammatory sites in the brain: a great way to induce dementia decades later.

People who argue we should tolerate passive smoking are a basically saying they can enjoy their habit at the expense of others. Selfish little prats. However, to be consistent, we should be very concerned about general air pollution.

Harry cites an EPA monograph from California(1999). For such a field of investigation that is too dated and a monograph is not a study. I suspect Harry was looking for the worst possible conclusion to be found.

Another issue Harry might want to explore is the differences between taxation effects and social attitude effects. Given the costs to society in general these "sins" should be taxed but I suspect that social attitudes act as a greater deterrent.


LONDON, United Kingdom, May 3, 2001 (ENS) Long term exposure
to fine particle pollution is likely to be as dangerous as passive
smoking, UK government scientists said today. They were releasing
details of their first attempt to quantify effects of long term exposure
on life expectancy.

...

The article can be downloaded here:

The COMEAP report is available online at:
http://www.doh.gov.uk/comeap/longtermeffects.pdf

The U.S. Environmental Protection Agency website on PM2.5 particle
pollution is online at:
http://www.epa.gov/ttn/chief/eiip/pm25inventory/index.html

hc said...

Some very useful comments here.

Please understand I was given 2500 words. While it should be accurate it is not for the BMJ.

FXH, There is a history of Australian Smoking which would tell you this. Real cigarette prices have risen (Bardsley/Olekalns) so, yes, taxes have risen.

jc, This is mainly about licit vices. Cigarette smoking has fallen drastically as has the lung cancer rates. Illicit drugs are not taxed.

John, the article I cited did make that claim. I'll check it out and follow out the links you provide. Thanks greatly.

Conrad, Your comments appreciatede. Thgis is not being submitted to a health economics journal but provides a general introduction.

The self reference on schizophrenia was designed to save a list of citations. The claim is correct and well-known.

The costs of intervening in home with fines etc are too high. Moral suasion the only viable policy. The 'smoke outside' campaign working well.

It is illegal to sell to kids - a proposal is to also make it illegal to purchase.

I do quantify the elasticity impacts and the article is on taxes. Many of the claims I bvack up elsewhere empirically but I just ran out of space - give me another 1000 words I will do so.

Thanks again to you all, very helpful.

Harry

John said...

Hmmm, decided to check one of my assumptions. Not good:

Toxicol Pathol. 2004 Nov-Dec;32(6):650-8.Click here to read Links
Brain inflammation and Alzheimer's-like pathology in individuals exposed to severe air pollution.

Air pollution is a complex mixture of gases (e.g., ozone), particulate matter, and organic compounds present in outdoor and indoor air. Dogs exposed to severe air pollution exhibit chronic inflammation and acceleration of Alzheimer's-like pathology, suggesting that the brain is adversely affected by pollutants. We investigated whether residency in cities with high levels of air pollution is associated with human brain inflammation. Expression of cyclooxygenase-2 (COX2), an inflammatory mediator, and accumulation of the 42-amino acid form of beta-amyloid (Abeta42), a cause of neuronal dysfunction, were measured in autopsy brain tissues of cognitively and neurologically intact lifelong residents of cities having low (n:9) or high (n:10) levels of air pollution. Genomic DNA apurinic/apyrimidinic sites, nuclear factor-kappaB activation and apolipoprotein E genotype were also evaluated. Residents of cities with severe air pollution had significantly higher COX2 expression in frontal cortex and hippocampus and greater neuronal and astrocytic accumulation of Abeta42 compared to residents in low air pollution cities. Increased COX2 expression and Abeta42 accumulation were also observed in the olfactory bulb. These findings suggest that exposure to severe air pollution is associated with brain inflammation and Abeta42 accumulation, two causes of neuronal dysfunction that precede the appearance of neuritic plaques and neurofibrillary tangles, hallmarks of Alzheimer's disease.

PMID: 15513908 [PubMed - indexed for MEDLINE]

conrad said...

"Please understand I was given 2500 words."

That makes sense, you're obviously trying to get a Nature paper :). Your management will love you.

John said...

I just came across this news release. It helps explain why non-smoking lung cancer rates have been rising for some time.

Newly detected air pollutant mimics damaging effects of cigarette smoke
...
Inhaling those pollutants exposes the average person up to 300 times more free radicals daily than from smoking one cigarette, they added.

http://www.eurekalert.org/pub_releases/2008-08/acs-nda072308.php

Yes, we should start taxing major air polluters. Conrad, now who is going to shut me up?

---

hc said...

That is interesting John. Lung cancer was unknown at start of century but created by smoking. Recent lung cancer rates show 10-15% incidence unrelated to cigarette smoking. In the US this has been attributed to argon in home cellars but not true in Australia where argon concentrations are low.

Maybe the link you point too provides an alternative explanation that works better.

John said...

Harry,

This goes well beyond lung cancer. Studies have found a direct correlation between air pollution and dementia rates, atherosclerosis, and stroke. There is even a linkage with diabetes regulation and air pollution. The latter may seem paradoxical but is not.

Yobbo said...

A big reason for rising cancer rates is simply longer lifespans.

Cancer takes a long time to develop. Very few people died from it in the 1800's because most people were dead by the time they were 60 anyway from other things like smallpox, syphillus and Tuberculosis.

Cures for those more easily tackled causes of death have left cancer as the biggest killer simply because it's the last man standing.

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