The economics of taxing sin

THERE IS ECONOMICS in everyday life. Even in traditional vices such as cigarette smoking or drinking alcohol. Indeed, there is an economic explanation for the consumption of alcohol and tobacco. This goes back to the law of demand, which in this particular case could be stated as: when the price of tobacco or alcohol goes up, the amount consumed falls. As an economic subject, the demand for vice would then have what economists call a utility function. An individual utility or pleasure from consuming cigarettes or alcohol depends on the quantity of cigarettes or alcohol one consumes, the pleasure derived from other goods and individual tastes. This individual maximizes this utility subject to a budget constraint, which would involve the price of his vice, his income and the prices of all other goods. This constrained maximization determines the demand for the vice where its consumption is related to the price of cigarettes or alcohol, price of related goods, individual income and tastes. This would mean that if an individuals paycheck is shrinking, he might spend less on vices, which are nonessentials. During an economic slowdown like the one we are currently in, there is high likelihood of lower consumption of alcohol and cigarettes as peoples incomes are expected to take a hit. The other side of the story, however, is that bingeing on vices could also occur during an economic downturn. When people are stressed about the economy, they might turn to outlets like smoking or drinking. Taking the slowdown scenario out of the scene, the demand for cigarettes or alcohol behaves according to its demand elasticity, or the amount by which demand for the good changes with a unit increase in its price. As addiction to vices is possible, demand for vices is not very elastic. Increasing the price of alcohol or cigarettes will cause only a modest fall in demand.

SIN

TAXES

From the economic workings of vices came sin taxes. Sin taxes are a form of indirect taxes or taxes on consumption taxes factored into the prices of goods and services. The value added tax (VAT), sales tax, and service tax, for instance, are all indirect taxes. Sin tax is termed such because the commodities being taxed are those considered moral ills to society. What is the reason behind sin taxes? The main reason behind the sin tax, as with any other tax measure is to raise revenue for the government. Apart from being a revenue stream for government revenues, taxing tobacco or alcohol is a way to account for the social costs or what economists term externalities related to smoking or drinking. With sin taxes, the resulting price of a pack of cigarette somehow accounts for second-hand smoke and the impact of cigarette smoking on the health and enjoyment of others. Likewise, the price of alcohol should, in a way, include the costs of things like drunk driving and other general impairment of ones faculties, which can pose a menace to society. These social costs become the burden of the smoker or drinker through the imposition of sin taxes. Another rationale for sin tax is to discourage consumption of alcohol or cigarettes. As earlier discussed, the consumption of these goods is a function of their price and with the price now higher given the inclusion of sin taxes, the demand for it should fall, even at gradual rates. Lately, some governments including the Philippines own have been mulling raising sin taxes, to abate a bulging deficit at this time of economic downturn. Arguments for or against such move were voiced.

Those who favored a sin tax hike echoed the arguments earlier explained. The reasoning of those opposing the move, meanwhile, also revolved around the same points, albeit from a different perspective. First, they argue that the revenue contribution of cigarettes and alcohol is already high enough. Some even go to the extremes of saying they do not cost the government much because they die early and save pension and health care spending, which they in a way paid for. The next argument is on the demand elasticity of these products. Critics of sin taxes argue that increasing the prices of cigarettes or alcohol through increased taxation would not do much to deter smokers from lighting a stick or alcoholics from downing a shot of alcohol. Nevertheless, studies show that there are decreases in consumption, no matter how nominal. On the other hand, if a hefty taxation regime does result in smoking cessation, then the government will not have achieved the increased revenues that it seeks. Economists, however, argue that money that should have been put into vices is not gone, it is simply rechanneled to other consumer items, which are also subject to tax. Another argument against raising sin tax is related to its structure. Being an indirect tax, while effective, is regressive, meaning the poor pay more relative to the rich. Sin tax hike advocates rebuttal to this is that since there is higher incidence of smoking and drinking among the lower income groups, the higher taxes might seem regressive but in the long-run will save them much more in health expenses. Another argument against increased sin taxes is that higher taxes will encourage people to smuggle to avoid paying the taxes. The primary purpose of raising more revenues, therefore, is defeated. Finally, another important question raised is whether it is wise to raise sin taxes or any tax at a time of economic slump. On one hand, tax hikes hurt consumers who have less disposable income, as well as businesses as consumption drops. This leads to many businesses reducing their workforce, or even closing shop. The economy contracts and living standards fall - which is bad for the tobacco and alcohol business. On the other hand, some countries have implemented tax hikes without a hitch. Even the US, the one at the center of the global economic slowdown, instituted a sin tax hike under US President Barack Obama.

_________________________________________________________________________ Questions: 1. Explain why elasticity in consuming tobacco and alcoholic beverages is inelastic. Elasticity in consuming tobacco and alcoholic beverages is inelastic because

the consumers will pay the increased price and wont change their consumption much.

2. How sin taxes would be helpful to minimize the users of cigarettes and alcoholic drinkers?

Sin taxes would be to minimize the users of cigarrets and alcoholic drinkers because adding the tax will raise the price of tobacco and alcohol

therefore, reducing the amount of tobacco and alcohol people or users can afford to buy.

3. What are the advantages and disadvantages of raising sin taxes? The advantages are we can have a healthier population who are using less tobacco and alcohol both of which can be harmful to your health. The disadvantage could be; the mercahant who wont be selling as much tobacco and alcohol.

4. Comment on this: The government can always raise sin taxes and get income out of it because there is always demand for cigarettes and alcoholic drinks.

It is true. Government can always raise sin taxes to help control any substance abuse.

5. Is there any opportunity cost on increasing sin taxes? Why and How? Yes, the opportunity might be slow the sales. Because the price is higher

and the consumers will purchase less.