The problem with modeling sodal taxes: price elasticity

In economics, price elasticity measures responsiveness in the marketplace. Necessities are relatively inelastic – we can’t live without them, so we will purchase them in similar quantities even if the price goes up (and we will not purchase much more if the price goes down). In contrast, luxury goods are elastic, since we’ll forgo them when money is tight.

Thus, it seems we have a simple and straightforward way of gauging the effects of tax increases on soda: Just look at what happened to soda consumption in states that did implement soda taxes. Did consumption go down when prices go up? In other words, was the demand elastic enough for the taxes to have an impact on consumption?

Unfortunately, there are complications. Consider the problem of substitute goods. If demand for soda is elastic, then a tax could push consumers to shift their purchases to a substitute product – say, in this case, fruit juice. If the goal of the tax is to curb sugar intake on the grounds of public health, then the health effect of curbing soda consumption will be negated by the fact that fruit juice has as much sugar as soda.

Advocates for soda taxes repeatedly point to the success of taxing cigarettes as a way of reducing smoking. However, the only substitute goods for cigarettes are nicotine patches and gum, while there are numerous high-caloric alternatives to soda, such as fruit juices and chocolate milk. This makes the problem of determining the elasticity of soda even trickier, as the economist Richard Williams, Director of Policy Research at George Mason University’s Mercatus Center, explains. “The bigger the class of goods you estimate an elasticity for, the more inelastic the demand. That's because you are covering all of the close substitutes. In the extreme, the demand for liquid is perfectly inelastic as, without it, you die.  On the other end, if you just looked at demand for, say, Classic Coke, it would have a fairly elastic demand as Pepsi and even other Cokes are pretty good substitutes.”

This is the problem, Williams says, with taxes aimed at sugar sweetened beverages. “If you make the tax extend to a big enough category to cover every substitute that you are concerned about, you are likely making people just stick with their original drink, because you have also taxed what they consider to be likely substitutes. But if you tax narrowly, you get people to substitute other drinks but don't get the health effect you are aiming for.”

This leads to a key problem in the research on soda taxation: “There is relatively weak information on the tax elasticity on consumption of soft drink taxes,” write Fletcher et al. in The effects of soft drink taxes on child and adolescent consumption and weight outcomes, (Journal of Public Economics 94 (2010) 967–974) “and, importantly, the substitution patterns between soft drinks and other (potentially high-calorie) beverages has not been adequately explored in this context.”

They note that the most recent estimates on compensated price elasticity for soft drinks (that is the elasticity that takes into account substitute goods) have a much bigger range than the basic estimates of elasticity for soft drinks , going from -0.15 (Zheng et al., 2008) to -1.90 (Dharmasena et al., 2009), depending on what products are considered as complementary good or as substitutes. In contrast, the basic estimates of elasticity for soft drinks range between −0.8 and −1.0 (Andreyeva et al., 2010) This, says Fletcher et al., suggests considerable uncertainty in predicting the impact of a soda tax on demand.

However, Fletcher et al. note that because a relatively larger proportion of children’s disposable income may be spent on soda than adults, soda taxes may have a bigger impact on children’s consumption, which in turn could have a significant impact on their future weight and health. On the other hand, they add, a soda tax could shift consumption to non-taxed higher calorie beverages and “actually increase weight” [their emphasis].

Fletcher et al. analyzed soft drink consumption through state sales and tax information and the National Health Examination and Nutrition Survey. They found that a one percentage point increase in the soft drink tax is associated with consuming six fewer calories from soda among children and adolescents, a magnitude they describe as “somewhat modest.”

“The point estimates suggest, though, that an increase in the tax rate of over 16 percentage points would be required to effect a reduction in soda of approximately 100 calories per day; however an increase of this magnitude is outside the support of our data.”

At the same time, they found that a one point percentage increase in soft drink taxes leads to an eight calorie increase in whole milk consumption per day for kids. This was true both when school was in session, as well as over vacation, during weekdays and over weekends.

As they note, “the decrease in calories from soft drinks in response to an increase in the soft drink tax rate is completely offset by the increase in calories from whole milk… Therefore the net effect of soda taxes on caloric intake is minimal, and we find no effect in weight outcomes in children and adolescents.”

Another potential problem with modeling elasticity is that, we cannot be sure that the behavioral reaction to taxes will be uniform. As Ayyagari et al. note in Sin Taxes: Do Heterogeneous Responses Undercut Their Value? (NBER Working Paper No. 15124, 2009), subgroups of consumers do not necessarily respond to tax increases in the same way. The evidence from increases in alcohol taxes shows a substantial effect on moderate consumers and an insignificant impact on heavy drinkers. If there is a similar price inelasticity for heavy soda drinkers, then taxes are unlikely to address the consumers most at risk from weight gain.

It seems contrary to intution that decreases in SSB consumption would lead to weight loss, that taxes would lead to decreases in SSB consumption, but yet that there would not be an overall impact on calorie intake. However, a study studying soda reduction may offer reduced calorie substitute drinks for free (such as Ebbeling et al.) or provide education about calorie consumption while a tax may simply encourage a consumer to say, “What else would I prefer that’s cheaper?” One of the problems with the controlled studies on SSB reduction is precisely that they are not measuring the same behavior that would ensue from a tax increase.

 

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