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Taxing sin

By Andrew Leigh - posted Wednesday, 7 April 2010

In The Australian Legend, Russell Ward wrote “no people on the face of the earth ever absorbed more alcohol per head of population” than Australians in the 1800s. While scholars debate Ward’s precise claim, it is clear that European settlers consumed vast quantities of alcohol. And 80-90 per cent of men smoked.

Substance abuse is inextricably linked to Australian history, where rum and tobacco often took the place of cash. Today, 19 per cent of us are regular smokers, while 13 per cent of us are risky drinkers (defined as more than four drinks a day for men, and more than two drinks a day for women). Compared with other developed countries, we have relatively few smokers, and a slightly above-average level of alcohol consumption.

Can sin taxes make us pure? In the case of cigarettes, you might expect that most buyers would be addicts, and therefore unresponsive to prices. But it turns out that smokers are surprisingly price-sensitive. On average, a 10 per cent price hike cuts cigarette sales by 5 per cent. Although this is offset slightly by an increase in intensity (higher taxes induce smokers to take a few extra puffs out of each cigarette), the health benefits are still substantial. Teens are two to three times as price-responsive as the rest of us.


Put another way, if tax increases were to raise the price of a cigarette from 50 cents to 55 cents, we might expect 150,000 of Australia’s 3 million smokers to kick the habit. The same price rise would probably also deter thousands of high school students from becoming addicted in the first place. Because many smokers want to quit, half of all smokers support higher cigarette taxes - suggesting that such a policy might find favour at the ballot box.

For alcohol, it is less obvious that higher taxes lead to better health outcomes. Unlike smoking, moderate alcohol consumption does not seem to be bad for you (indeed, occasional tipplers may even gain a health benefit). So raising the price of grog is only a good public health measure if it reduces the kind of heavy consumption that is associated with cirrhosis of the liver and misuse (such as drink driving and domestic violence). If higher alcohol taxes deter grandma from having a glass of sherry, but do nothing to prevent the lad on the corner pub from sinking his sixth schooner, we should rate them a public policy failure.

It turns out that alcohol taxes deter both groups. On average, a 10 per cent increase in price reduces overall consumption by 5 per cent, and lowers heavy drinking by a little less - perhaps around 3 per cent. There is also some direct evidence that higher alcohol taxes reduce drink driving, with one US study suggesting that a 10 per cent increase in alcohol prices would reduce road fatalities by 6 per cent (saving perhaps 90 lives annually). However, because binge drinkers are less price-responsive than the rest of us, alcohol taxes are a blunt instrument for cutting road deaths.

What about the equity implications of sin taxes? In the case of alcohol, drinking rates rise with incomes, so alcohol taxes are modestly progressive.

Cigarette taxes create something of a paradox. Since the poor are more likely to smoke, cigarette taxes are regressive. Yet a rise in cigarette taxes induces more quitters among the low-income population. So for hard-core addicts, cigarette taxes fall more heavily on the poor. But cigarette taxes can be a powerful tool for improving health outcomes among the disadvantaged. Over recent decades, much of the drop in smoking has been due to higher prices, so you don’t have to be a wowser to see the potential for increased taxes to produce better health outcomes.

Will this election give Australian headline writers the chance to bring out those old front pages that said “Beer, cigs up”? In conjunction with restrictions on sales and advertising, sin taxes have proved an effective public health policy. Alas, they also have unintended consequences - reducing moderate alcohol consumption, and acting as a regressive tax on low-income smokers who are never going to quit. Even virtuous taxes have their vices.

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First published in the Australian Financial Review on March 30, 2010.

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About the Author

Andrew Leigh is the member for Fraser (ACT). Prior to his election in 2010, he was a professor in the Research School of Economics at the Australian National University, and has previously worked as associate to Justice Michael Kirby of the High Court of Australia, a lawyer for Clifford Chance (London), and a researcher for the Progressive Policy Institute (Washington DC). He holds a PhD from Harvard University and has published three books and over 50 journal articles. His books include Disconnected (2010), Battlers and Billionaires (2013) and The Economics of Just About Everything (2014).

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