"Sin" Taxes Put Perverse Incentives on Government

The government has found over time that it is able to sell higher taxes to the voters on certain items if they can portray those items as representing some socially unwanted behavior. These are often called "sin" taxes. The justification for the tax in its beginning is as much about behavior control as revenue generation.  Taxes on cigarettes, alcoholic beverages and even gasoline and plastic grocery bags have all been justified in part by the logic that higher taxes will reduce consumption.

However, a funny thing happens on the way to the treasury.  Over time, government becomes dependent on the revenue from these taxes.  The government begins to suffer when the taxes have their original effect -- ie reducing consumption -- because then tax revenues drop.  The government ultimately finds itself in the odd position of resisting consumption drops or restructuring the tax so it no longer incentivizes reduced consumption so that it can protect its tax revenue collections.

Cigarettes are a great example.  In this article, via overlawyered, from Forbes (simple registration required):

Big tobacco was supposed to come under harsh punishment for decades of deception when it acceded to a tort settlement seven years ago. Philip Morris, R.J.Reynolds, Lorillard and Brown & Williamson agreed to pay 46 states $206 billion over 25 years. This was their punishment for burying evidence of cigarettes' health risks.

But the much-maligned tobacco giants have subtly and shrewdly turned their penance into a windfall. Using that tort settlement, the big brands have hampered tiny cut-rate rivals and raised prices with near impunity. Since the case was settled, the big four have nearly doubled wholesale cigarette prices from a national average of $1.25 a pack (not counting excise taxes) in 1998 to $2.10 now. And they have a potent partner in this scheme: state governments, which have become addicted to tort-settlement payments, now running at $6 billion a year. A key feature of the Big Tobacco-and-state-government cartel: rules that levy tort-settlement costs on upstart cigarette companies, companies that were not even in existence when the tort was being committed.

So, a tax that was originally meant to punish supposed past wrong doing by cigarette makers is causing problems because it was... actually doing what it was supposed to by hurting those companies.  Lots of good stuff, I encourage you to read it all - basically state governments have gone from opponents of the cigarette companies to their partners.  Antarctic Liberation Front opponent Eliot Spitzer comes in for particular attention.

A second example I discussed comes from San Francisco, where a tax aimed at discouraging use of plastic garbage bags was modified so that it collected more money, but no longer discouraged use of plastic.

A third example comes to us via Vodka Pundit, which points out that California now is considering supplementing their gas tax with a per-vehicle-mile tax.  The gas tax was always effectively a per-vehicle-mile tax, since the amount of gas you used was proportional to the number of miles you drove.  And, of course, the gas tax is far easier to manage than a per-vehicle-mile tax (yes, coming soon, its the odometer auditors!)

So why a need for the new tax?  Well, it turns out that Californians are buying a lot of very fuel-efficient cars, including new hybrids, which reduces gas consumption and thus taxes.  Of course, this is EXACTLY what most people hope the gas tax is doing - helping to conserve gasoline and reduce emissions and incentivizing people to purchase efficient vehicles.  Now California is considering substituting a new tax that collects more money but provides no conservation incentives.

UPDATE:  Welcome Carnival of the Vanities!  If you're looking to kill more time at work today, check out my rant on the recent New London eminent domain case in front of the Supreme Court titled "all your base are belong to us".

  • http://www.aclearvoice.org/archives/2005/02/surprise_govern.php Illuminaria's Voice

    Surprise - Governments Out For Money Too

    I saw a very interesting piece at Coyote Blog today. Basically it points out the effect that taxes on certain things, such as cigarettes, that are meant to suppress “socially harmful” behaviors have on the government. Eventually the government come...

  • http://www.aclearvoice.org/archives/2005/02/surprise_govern.php Illuminaria's Voice

    Surprise - Governments Out For Money Too

    I saw a very interesting piece at Coyote Blog today. Basically it points out the effect that taxes on certain things, such as cigarettes, that are meant to suppress “socially harmful” behaviors have on the government. Eventually the government come...

  • http://atrainwreckinmaxwell.blogspot.com/ KurtP

    Over here in Tx, we've got a State Rep, (guess which party) that wants to index fuel taxes to cost. Yep, you're paying more for gas, and your taxes go up, too.

    Thank goodness they're looking out for the poor.

  • http://www.punditguy.com/2005/02/127th_carnival__1.html PunditGuy

    The 127th Carnival of the Vanities

    Welcome to the 127th Carnival of the Vanities! First things first. I'd like to thank Silflay Hraka for creating this weekly event. Take some time to look around his site and if you'd like to host a future carnival, be sure to let him know. To join the ...

  • SteveS

    I just discovered your blog via Instapundit and I am hooked. Great Site and really great blogs. We share some of the same passions: Economics, Business and Public Policy, the Wile E coyote (although I would generalize my love to the area of anything looney toon made before 1970).

    I agree with you that government's appetite for tax revenue is insatiable and that "sin" taxes are an easy target. However, almost all economists agree that "Pigovian taxes", the name preferred by economists, are preferable to regulation. In fact, they are generally considered to be vastly more effective than regulation at dealing with negative externalities. Given that negative externalities are a form of market failure, they sometimes can make a market more efficient rather than less.