Sin taxes and sindustry: revenue, paternalism, and political interest.

• Author: Hoffer, Adam J.
• Position: Essay

Revenue shortfalls associated with the Great Recession and the slow recovery that followed have placed the budgets of many U.S. state and local governments under heavy stress. In the past several years, lingering economic troubles have eroded governmental tax bases while voters have remained strongly resistant to proposals for cutting public spending or raising taxes on income, property, or other broad bases. This has left many states searching for new revenue sources. Particularly attractive targets for "revenue enhancement" are goods that policymakers deem to be "sinful" or misguided because they are bad for the user or generate negative externalities or both. Historically, consumer goods such as tobacco, alcohol, and motor fuels have been singled out for selective excise taxation. (1)

Recent additions to the sin tax category are foods that are high in sugar, transfats, and other ingredients the public-health establishment has associated with rising incidences of obesity, (2) Type 2 diabetes, and similar so-called epidemics. Indeed, thirty-three states have already implemented a soft-drink tax. Because public-health expenditures are correlated with the consumption of these goods, a case has been made for the selective taxation of all sugar-sweetened beverages (SSBs), junk food, and many items on the menus of fast-food restaurants (see Jacobson and Brownell 2000; Brownell et al. 2009).

This paper discusses the two main motives for taxing activities roughly defined as "sins": (1) the objective to offset the costs sinners impose on others and (2) the paternalistic impulse to reduce or eliminate sinful behavior. As we shall see, these two motives increasingly interact politically nowadays. Although the primary economic justification for tax intervention is an ostensible failure of certain markets to perform ideally, that discussion hinges on the ability of excise tax policy to deliver on promises of improvement based on a strictly social engineering perspective. Because the "market failure" justification alone cannot explain the resurgence of sin taxes, what remains is a strong revenue-raising objective, coupled with a reinvigoration of paternalism in policymaking circles, which provides political cover for expanding the definition of sin. The effects of these two forces are seen, as discussed, in the recent rapid growth of lobbying and political campaign contributions by what we call the "sindustry"--namely, the producers of the goods selected for taxation as well as the individuals and groups that either will be harmed by or will benefit from sin tax policy changes.

We use the standard public-choice model of rent seeking (Tullock 1967; Krueger 1974) in building a case against the way selective taxation is now framed by the new paternalists. To do so, we first summarize the standard social welfare arguments underlying sin tax policies. We then discuss the shift toward "libertarian paternalism" (e.g., Thaler and Sunstein 2008) and critique the idea that "noncoercive" policy interventions, such as reconfiguring the choice architecture, are mostly unobjectionable ways of "nudging" consumer behavior in directions that will make them better off than they would be otherwise. Although selective excise taxes are policy instruments that obviously are more blunt than "nudges," we see them as being animated by similar paternalistic impulses. Third, we document the rapid expansion of lobbying by the sindustry in response to proposals for imposing new excise taxes or raising existing tax rates.

Taxation of Sin

In orthodox welfare economics, selectively taxing a good is justified when consumption of that good has negative external effects. In other words, consuming the good imposes a cost on some third party not involved in either its consumption or its production. Thus, social welfare can in principle be improved by increasing the after-tax price paid by consumers, thereby reducing the quantity of the good they buy and curbing the behavior that generates the negative externality. The Pigouvian rationale (Pigou [1920] 1952) for correcting such market failures rests on a set of strictly technical assumptions. (3) The reasons for taxing sin, by contrast, are much more expansive than these considerations imply, and, moreover, they have morphed over time. As the justification for sin taxes shifts from solving a social engineering problem to a more explicit paternalistic approach, the logic of the argument shifts. The main consequence of expanding the taxation of goods and services that simply are disfavored policywise rather than falling under the traditional definition of "sin" is that the connection between the two weakens and the emphasis on raising revenue or extracting rents by other means becomes more salient.

First, what is meant by the term sin tax? Sin taxes are the latest manifestation of a long conversation that harkens to the sumptuary laws of the late medieval period and beyond (Tuchman 1987, 19-21). (4) In a public-economics context, W. Mark Crain and his colleagues (1977) discuss sin taxes as modern sumptuary laws. This is a useful comparison as virtually every culture has engaged in singling out one or more socially objectionable goods and taxing or regulating their consumption. Sumptuary laws, it is true, were designed to preserve the status of people at the top of society. Selective excise taxation of what we shall henceforth call "disfavored goods" seems designed to discourage the consumption of things that today's political elites disapprove of. The phrase sin taxes originated in the 1970s but found its first public-policy support in the U.S. surgeon general's report Smoking and Health in 1964. The following text from that document is often pointed to as the beginning of the contemporary sin tax regime: "Cigarette smoking is a health hazard of sufficient importance in the United States to warrant appropriate remedial action" (U.S. Department of Health, Education, and Welfare 1964, 33).

The surgeon general's announcement of a smoking-related public-health crisis launched a change in policy from merely perceiving cigarette smoking unfavorably (despite the portrayal of smoking as "cool" in many books and movies, cigarettes were called "coffin nails" more than a century ago) to one of attempting to reduce smoking as an outright policy aim. (5) The first major push to impose or to increase cigarette taxes in the 1960s helped shift excise tax policy from a tool for generating revenue, primarily at the state level, to a means of modifying behavior. Daniel Horn and Selwyn Waingrow (1966), for example, offered advice intended to assist in the design of public policies for curbing cigarette consumption. Such policy advice, published just two years after the surgeon general informed the public that smoking had been linked to lung cancer, began a new era in selective excise taxation. Cigarette smoking from then on clearly became sinful. And it was a sin not so much because smoking imposed uncompensated costs on others--it wasn't until the late 1980s that exposure to secondhand smoke and recovering the publicly financed costs of treating smoking-related diseases became policy concerns--but rather because smokers were harming themselves. The camel's nose of paternalism was under the fiscal-policy tent.

Taxes on cigarettes and other tobacco products assuredly are not the only modern examples of sin taxes. Alcohol--beer, wine, and distilled spirits--has been taxed selectively since colonial days, and Congress--on the recommendation of Treasury Secretary Alexander Hamilton--imposed a tax on whiskey before the ink on the U.S. Constitution was dry. (6) Taxes on cigarettes, alcohol, and motor fuels (the latter taxes are arguably a highway user fee, as discussed in the next section) are the "Big Three" excise taxes in terms of revenue generation. With the proliferation of land-based and river-based casinos that began in the 1990s, gambling also has emerged as an important taxable sin in many states.

Taxing a sin can be an improvement over banning it. The United States learned that lesson painfully during Prohibition, and many commentators nowadays explicitly question the value of the "war on drugs," as states including Colorado, Washington, and California roll back restrictions on marijuana. The attention paid to sin taxes in the economics literature reflects acceptance of the conclusion that prohibition is often not an effective policy tool. Not only does prohibition sometimes fail to reduce consumption substantially, but it also generates numerous negative "unintended" consequences. However, very high excise tax rates, such as those imposed on retail cigarette sales in New York City (where the combined state and city tax amounts to $5.85 per pack) start to look like prohibition. A Tax Foundation report, for example, found that 60.9 percent of the cigarettes sold in New York City either had no tax stamp affixed or displayed another state's tax stamp (Henchman and Drenkard 2013). A substantial black market in cigarettes has developed there. Smuggling, cross-border shopping, political corruption, and violence are the predictable outcomes as buyers and sellers attempt to evade New York's punitively high tobacco tax. Similarly, the State of Washington imposes an excise tax of $3.02 per pack (nearly double the national average of $1.53); official estimates suggest that 101.4 million packs currently bought and sold in the state do not carry any tax stamp (Washington State Department of Revenue 2013).

Setting an excise tax rate that modifies behavior without triggering too many untoward consequences can be thought of as solving a policy-optimization problem. On the one hand, a moderate tax that increases revenue more than it inspires evasion can be revenue maximizing. On the other hand, a tax rate set high enough to trigger widespread dodging must be motivated by other policy objectives, such as paternalism. (7)...