Written by Charlie Sammé and Joey Hearn - City of London Freemens School
The Rationality Argument: Charlie
Many may argue that choices to do with eating and drinking are individual and that people should not be charged higher prices and essentially punished for choosing to eat what they enjoy, healthy or not. There is an assumption we apply in classical economic theories, which is that consumers always act rationally. However, it is quite apparent that this assumption is not realistically applicable.
Figure 1 - Adobe Stock
From a survey completed by over 950 consumers, it was discovered that 2 in 3 people consume fast food once a week, on average people spend $148 on fast food each month and more concerningly, 13% of people consume fast food every day. (Rodgers, 2024). Fast food is not the only good that can be considered unhealthy. Tobacco/Nicotine products, alcohol, fizzy drinks, sweets and chocolate, pastries and processed foods are all further examples of goods which are undoubtably unhealthy for consumers. So, the overconsumption of fast food as an example, is certainly not a rational decision and is an obvious example of a negative consumption externality, as a result of only considering the short-term personal benefits of consumption by irrational consumers who are vulnerable to cravings and temptation. Whilst irrational decisions are understandable and part of human nature, government intervention is most certainly necessary to combat and discourage the overconsumption of unhealthy, demerit goods, for the benefit of both individuals and society, especially to alleviate stress on the NHS and our populations general physical health.
If in an ideal society we were able to rely on all consumers to act rationally, then there would be no need for any regulations, as consumers would consider their decisions carefully, in an almost Utilitarian way of considering what achieves the greatest good and what fits the preferences of all. However, unfortunately this is a very idealistic way of living and we are all capable of irrationally and spontaneously making poor choices, despite our best intentions. Hence government intervention through the allocation of taxes would be a justifiable action in protecting our population and labour force. “Our findings indicate that overweight or obesity had negative associations with labour market performance” (Medicine, 2024). There is a clear correlation between the ‘healthiness’ of a work force and it’s productivity, therefore, actively attempting to discourage the consumption of unhealthy (demerit) goods, would be a positive attempt by the government to improve the lives of the work force and their productivity.
Figure 2 - Negative consumption externality
The overconsumption of goods that are unhealthy leads to negative externalities, as shown by the diagram. Consuming the likes of fast food and cigarettes at the private optimum level of output, inflicts a higher marginal cost on both the individual and society, than the cost that would be inflicted at the social optimum, had the consumer considered the 3rd party impact which is not compensated. This is explained well through Keynes’ Theory of ‘Self-interest’, where the consumer only considers their increased private benefit and are ignorant to the cost imposed on society. By adding taxes to these unhealthy goods, the marginal private benefit would be decreased, by disincentivising consumers to buy unhealthy goods at the rate they do due to the change in price, shifting the MPB line downwards towards the MSB line and so reducing the area/size of the green triangle which represents the social welfare loss.
However, the effectiveness of adding a tax to unhealthy goods would be dependent on the elasticity of demand for these goods. If the goods are addictive such as nicotine/tobacco products, alcohol or in some sense fast food, then these goods are likely to have an inelastic price elasticity of demand and so adding a tax would have very little impact on the consumption patterns (demand). Instead inflicting this tax would just have a heavy impact on those who already struggle economically and so could be considered a regressive tax, only impacting those in the lower income bracket who may continue to consume whilst struggling to afford these unhealthy goods. Although this is an example of where the government could implicate information schemes to tackle this externality. In combination with a tax, if those who were struggling to continue funding their unhealthy good consumption were informed about the negative impacts unhealthy goods can have, then this may contradict the inelastic nature and soon these people may be more encouraged to stop spending on these goods or find healthy alternatives (which are possibly cheaper if they aren’t being taxed).
Nonetheless, the intentions indirect taxes on unhealthy goods could be redundant if the large firms being taxed, such as Philip Morris International, Burger King or Absolute Vodka are able to absorb the majority of the tax burden without passing a large percentage on to the consumers. This would mean a small rise in the price of these unhealthy goods and so possibly would not be a significant deterrent for consumers. Hence the government would have to look to ensure a proportion of this tax was imposed on the consumers and so disincentivise them consequentially. However, due to the profit incentive of these firms it is highly unlikely that they do not push the majority of the tax burden on to their consumers, in order to keep their costs of production lower.
Finally, taxing unhealthy goods would be an economic ‘jackpot’, because not only would the government be benefiting their labour forces productivity by taking action to avoid the commonness of obesity and so ideally achieving greater output levels and so growth. The government can also hypothecate the tax revenue from unhealthy goods and use it to support the healthcare system and possibly subsidise companies looking to produce healthier substitutes to unhealthy goods, such as Leon, who produce healthy fast food as an alternative to the oligopolistic fast-food firms like KFC and MacDonalds. Whether taxing unhealthy goods would make the government ‘unpopular’ or not, it is necessary behaviour irrespective of the initial opinions of irrational consumers, in order to help our country and people thrive in the long-term.
The Laffer Curve: Joey
Unhealthy goods, commonly known in the economics world as demerit goods, are defined as a good (or service) whose consumption is considered harmful to the consumer and society. Many people seem to think that a tax on a good is there to deter you from purchasing the item. To use smoking as an example, in the United Kingdom, the tax on a packet of 20 cigarettes is 16.5% of the original retail price plus £6.33.[1] These higher prices should decrease the sales of cigarettes and prevent problems such as coronary heart disease and lung cancer. This might lower the stress on the NHS, as they may have to deal with fewer patients that are in hospital because of health problems induced from smoking. However, goods like cigarettes have an inelastic demand because they are addictive. This essentially means that no matter the price, there will still be people that pay that price. Despite the government wanting to promote a healthier lifestyle, by advertising the risks a consumer takes when smoking, they are happy for people to carry on consuming cigarettes as it generates a greater tax revenue.
If the government is looking to generate a higher tax revenue, they will have to find the optimum tax level. In this case, I will use the Laffer curve.
Figure 3 - The Laffer Curve, Investopedia
The Laffer curve was proposed by an economist named Arthur Laffer in the 1970s, used to show the relationship between tax revenue and tax rate. To generate maximum tax revenue, the government wants the tax rate to be operating in line with T*. If the tax rate is to the left of T* then an increase in the tax rate is likely to increase tax revenue, but if you increase the tax rate past the point T* then your tax revenue will start to decline. Some consequences of not operating at T* is that you may have insufficient public services, such as education. If the government wants people to stop consuming unhealthy goods, then education is the best way to provide people with information about it. A knock-on effect would be that the government may have to increase their budget deficit to ensure that their public services are working efficiently. An increase in national debt may result in a need for higher interest rates. An increase in interest rates would cause consumption to decrease, ceteris paribus, aggregate demand will decrease. Hence, leading to an increase in the negative output gap and a shrinking economy.
If the government had a tax rate in place that allowed them to receive maximum tax revenue, they would have the ability to do many things (other than using it to decrease the budget deficit). They may choose to use the money to fund subsidies to firms, perhaps to encourage the development of merit goods such as education and healthcare. However, this would only be useful to society if the subsidized firm uses the money as the government wanted. They may also want to use the revenue gained from the negative consumption externality of smoking to help reduce the market failure that comes with the underconsumption of merit goods.
Figure 4 - Adobe Stock
Regardless of the positive effects of taxing unhealthy goods, it could come with some unintended consequences. Taxes may distort the market, resulting in opportunities for black markets to arise. The problem with black markets is that they can quite easily evade taxes, which prevents the government from gaining any revenue from the good. Black markets could also cause barriers to entry for some firms, as they can avoid rules and regulations, making it very difficult for new small firms to thrive. Some people believe that taxes on unhealthy goods are stopping them from having freedom in what they choose. They believe they should be in control and be able to make their own decisions on whether they should consume said unhealthy goods. Taxes stop them from doing that. For many lower income households that may consume unhealthy demerit goods, the tax may make it unaffordable and may take up a large proportion of their disposable income. Some people rely on these goods, and to essentially take them away without providing affordable healthy alternatives could put these households under much more financial strain.
To conclude, the government should take lots of caution when deciding to tax unhealthy goods. There is a wide range of goods that would be considered unhealthy, so their choice should differ between goods. After writing this essay, I have realized that taxing unhealthy goods could come with many benefits but, on the other hand, come with lots of flaws. When thinking about taxing a good, the government should predominantly think about the consequences. Who will it affect…? What will we do with the tax revenue that is generated…? Ultimately, will it damage the economy…? Only recently did the UK government have to perform a U-turn on abolishing the top rate of tax for the rich after the threat of a backbench conservative rebellion. Effectively derailing Liz Truss’ time in office. Despite this example being about income tax, I think it shows how important it is for the government to correctly assign taxes on unhealthy goods, if they decide to do so.
Sources:
Medicine, N. L. (2024, June 19th ). Impact of Obesity on Employment and Wages among Young Adults: Observational Study with Panel Data. Retrieved from National Library of Medicine : https://www.ncbi.nlm.nih.gov/pmc/articles/PMC6338917/
Rodgers, E. (2024, June 10th). 75+ Fast Food Consumption Statistics. Retrieved from driveresearch : https://www.driveresearch.com/market-research-company-blog/fast-food-consumption-statistics/
Government Digital Service (2014) Tax on shopping and services.
https://www.gov.uk/tax-on-shopping/alcohol-tobacco [20/06/2024]
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