In the Uk excessive drinking of sugary beverages has caused a strain on the National Health Service (NHS). According to Donnelly (2016) Obesity costs the NHS more than £5 billion annually and is predicted to nearly double by the year 2050. In addition, more than 2 million people in the UK are currently suffering from type 2 diabetes and about 90% of these individuals are obese or overweight. These alarmingly high figures show the need of government intervention to reduce consumption of sugary drinks. The Uk government will be forced to increase their health spending, this will widen the government budget deficit. These funds will need to be raised therefor corporation taxes and income taxes could be made higher. Donnelly (2016) states that “Tooth decay has become the most common reason that five to nine-years olds are admitted to hospital’. Dental Health issues are another negative externality related with the over consumption of sugary drinks. Tooth decay is a private cost to the child who suffers from it but an external cost arises when the child goes to the hospital and is using up resources. For example, as a doctor is attending to the child he cannot be seeing another patient with a more serious disease. The marginal social cost of drinking sugary drinks is greater than the marginal private cost.
Indirect tax is a levy imposed by the government on goods and services supplied by businesses in order to reduce consumption and production of the good or service. There are two types of indirect taxes, Ad valorem tax which is a percentage such as VAT and Specific tax which is a fixed value also known as unit tax. Indirect taxes are used as a method of fixing market failure. Market failure occurs when the price mechanism causes an inefficient allocation of resources where demerit goods are over consumed and over produced so the government have to step in to correct it. The basic economic problem is the fact that resources are scarce and so they need to be allocated in the most efficient way.
The main reason for the sugar tax is to decrease significantly the consumption and production of fizzy drinks with hopes of reducing the level of obesity. According to the BMJ (2016) in the first year after the tax was imposed, there was a 12% fall in the sales of sugary drinks. The data shows the tax worked. This is because a 10% tax means that the cost of production to suppliers of sugary drinks has increased therefore the producers will supply less. As a result of the increased price in the cost of production, the suppliers will have to increase their price in order to make a profit and break even. The higher price is an incentive for people to consume less sugary drinks.
The diagram below illustrates the effects of an indirect tax on sugary drinks. As the cost of production increases, producers reduce the quantity at which they supply, causing supply to shift left from S-S1. This is followed by a rise in price from P-P1, as a result quantity drops from Q-Q1 and there is a contraction in demand as consumers are not willing or able to buy fizzy drinks at price P1. The areas labelled C and P represent the incidence of tax. The consumer burden of tax is C and the producer burden of tax is P.
The Journal (2016) suggests that the French tax of €0.72 per litre imposed on drinks with added sugar or sweetners in 2012 was successful in reducing the consumption of sugary drinks. Reports suggest there was a 3.3% drop in consumption of fizzy drinks in just the first 5 months after the tax was put in place. This shows the tax is effective as consumers responded to the higher prices and seeing as France is a richer country than Mexico, the change in Mexico will be greater.
An indirect tax on sugary drinks allows the government to gain revenue, this can be used in the provision of public goods such as national defence by better equipping the military or improving other important sectors such as education through creating more schools. The tax will only affect those who continue to purchase these goods, therefore the external cost is being internalised.
Ceteris Paribus the imposition of an indirect tax on sugary drinks should reduce the consumption of these products. In the real world ceteris paribus does not hold and this is because of factors such as the Price Elasticity of Demand (PED). The responsiveness of demand to a change in price is the PED, if the value of the PED is 0, this means it is perfectly inelastic. Consumers do not act rationally and therefore they will be unresponsive to a change in price. This is a result of habitual consumption and addictions to sugary drinks. The diagram below illustrates the effect of a tax with a perfectly inelastic demand. As supply decreases from S – S1, the quantity remains the same at Q and demand is unchanged even as the price rises from P – P1. The area shaded C shows that the burden of tax lies solely on the consumers, this means that the producers passed on all the taxes to consumers as higher prices and so they are not affected by the tax and have no incentive to reduce supply in the long run.
The main purpose of an indirect tax is to increase the cost of production for producers causing supply to decrease. In response to indirect taxes producers could release workers to reduce their costs. This increases unemployment, which is a counter to a main macroeconomic objective that is to reach full employment. This is an example of government failure, when government intervention in markets leads to a further misallocation of resources. Subsequently, these taxes can be harmful to industries as it reduces the total revenue of firms. According to Guthrie and Estrel (2015) Mexico’s soda industry fell by 1.9% in 2014.
Moreover, the magnitude of the tax imposed has an effect on how much reduction falls by. For example, Donelly (2016) states the tax in Mexico reduced sales of sugary drinks by 12% in the first year. However, the consumption rose again a year later. This could be because of the magnitude of the tax, it was only 10% and therefore did not have a long-term effect on consumers of sugary drinks. The government might have suffered from poor information and so they did not implement the tax to an effective level.
Another major drawback is the fact that Indirect Taxes are regressive. This means they have a larger affect on poor people than rich people because they take a higher proportion of poorer individuals earnings. This further widens the inequality gap and could lead to more people seeking benefits from the government. Moseley (2015) mentions the sugar tax in Mexico had a bigger impact on low income households as their consumption of sugary drinks had reduced by 17%.
The Mexican government can provide information to the public through advdertising and education about the negative impacts of sugary drinks. This method is less aggressive but might not be enough to tackle the growing obesity rates in Mexico.
There are other methods of government intervention that could be used to correct this market failure. A subsidy is a grant given by the government to producers in order to reduce their costs of production, subsequently increasing the production of the good. Merit goods such as water and other healthy drinks with no added sugar could be subsidized as they have positive externalities associated with their consumption. The diagram shows that a subsidy increases the supply of the healthy drinks from S – S1 and so the price of these drinks will fall from P – P1. There is an extension in Demand and an increase in quantity sold. This will be a better option than an indirect tax because it is producing goods that will be under provided and under consumed in a free market.
Alcohol Focus Scotland (2016) states that the government has imposed a 50p per unit minimum price on Alcohol in Scotland. Research shows that this action by the government can potentially save thousands of life and significantly reduce the level of crime because it will reduce alcohol consumption. A minimum price can also be introduced in Mexico as an alternate method of dealing with an over consumption of a demerit good. A minimum price is a floor price set by the government on a demerit good such as fizzy drinks below which it cannot fall. The diagram below illustrates the effects of a minimum price. The price will be set at Pmin, which is above the equilibrium (market price). There will be a contraction in demand as a result of the higher price but an extension in supply as producers aim to maximise profit.
Regulations on the production of sugary drinks can be set to limit the amount of sugar manufacturers are allowed to put in these drinks. This method is amicable to producers as it gives them the option to alter their products to meet the government requirements. However, failure to comply with the regulations will have consequences such as fines.
In conclusion, the most effective way of decreasing the consumption of Sugary drinks is through multiple government interventions. Sugary drinks have proven to be highly inelastic and so various methods such as a minimum price and regulations need to be implemented to reduce consumption of these beverages. Subsidies and provision of information will promote the consumption of merit goods like water and low-level sugary drinks which are substitutes for fizzy drinks. This will create more positive externalities and move the economy closer to a Social Optimum.