November 15, 2013

Taxes are never going to be popular and when governments implement new taxes it is always controversial. However, when taxes target certain products or services — especially when it involves things people are passionate about — things get really interesting. This is the situation with the so-called sin taxes: taxes on products and services which are considered dangerous or detrimental, such as alcohol, tobacco, pot, and prostitution.

Effect of Taxes

Usually, the undesired effect of taxing a product or service is that demand for it drops, which obviously hurts businesses and their ability to pay more taxes. That is why tax policymakers try to find the sweet spot that maximizes revenue without hurting production excessively.

Take for example income tax brackets. In 2013, any income between $36,250 and $87,850 was taxed at 25%, but anything between $87,850 and $184,250 was taxed at 28%. Having to pay 28% taxes on your income is not fun, but it probably won’t stop you from working harder or accepting a job with more responsibility and a larger salary. But what if you earned $87,000 and the tax on income over $87,850 were 90%, would it be worth your time to work harder?

Sin Taxes Rationale

When it comes to sin taxes, the rules change completely. Policymakers generally want to either curb demand for the product or service taxed, or their priority is to maximize revenue from the sin tax, which is then put toward alleviating the negative side effects it generates.

Consider the tobacco tax. In New York City, which has the highest cigarette tax in the United States, smokers pay $5.85 a pack in state and local taxes. Some feel this tax is unfair because smokers are mostly low-income taxpayers who generally don’t reduce their tobacco consumption and higher taxes simply leave them with less income for life essentials. However, supporters of the tobacco tax argue that these taxes do discourage consumption and simply reflect the true cost of smoking. There is no arguing against the fact that smoking is expensive. Every year, $96 billion are spent on the treatment of tobacco-related illnesses according to a 2012 report by the American Cancer Society. 

The rationale for taxing wine, beer and hard liquor is similar. According to a 2013 report by the Centers of Disease Control, over drinking cost each state a median of $2.9 billion in 2006. California had the largest economic burden due to excessive drinking: $32 billion. When you calculate the cost of these additional expenses per drink – what an economist would call calculating the consumption externalities of a product — the CDC estimates the median cost per state for each alcoholic consumed at $1.91.

Tobacco and Booze Are Just the Beginning

Governments are not stopping at alcohol and cigarettes. Last week, Mexico, which recently took the United States’ place as the most obese country in the world, passed an 8% tax on candy, chips and other high-calorie foods.

Last Tuesday Colorado passed proposition AA, a 15% excise tax – which is measured by the amount of business done – and a 10% sales tax on all recreational marijuana sales in the state. The revenue from the new pot tax is estimated at $70 million and will be used to regulate the marijuana industry and educate people about the harmful effects of consuming the ganja. 

In Holland, prostitutes are required to charge a 19% sales tax for each transaction. In the United States, Nevada is the only state where prostitution is legalized – albeit only in certain counties. Although legal brothels and prostitutes must pay federal income tax, there isn’t a specific tax on prostitution. According to Dennis Hof, owner of the Nevada Moonlight Bunny Ranch brothel, the federal government is missing out on an $18 billion business, which could generate $6 billion in income tax and $2 billion in licensing fees.

Controversial and Discriminatory

Alcohol, tobacco, high-calorie foods and prostitution can have very real and harmful health effects on the health of consumers. There is an argument for saying that production costs don’t take into consideration the cost of treating their side effects and taxes are simply accounting for these negative externalities and giving a more accurate reflection of their true cost to society.

Sin taxes are controversial because they discriminate certain habits and lifestyles over others. Some consider them an unwarranted encroachment of the government into our personal lives. Others argue they are inefficient and simply add to the woes of the poorest sectors of society.

Photo: PabloEvans