Sin Taxes: Inferior Revenue Sources

Sin Taxes: Inferior Revenue Sources
July 1, 2004

The search for government revenue in fiscally tight times tempts legislators to raise revenue by imposing unusually high excise taxes on cigarettes, liquor, gambling, and so on. This type of charge, often called a "sin tax," appeals to voters who view it as a way of discouraging consumption of certain objectionable products. Yet the temptation to impose sin taxes is one that should be resisted for economic reasons.

The consequences of the sin tax are often the very opposite of those intended by its designers. Rather than increasing revenue, the sin tax can reduce it. Rather than discouraging what are regarded as morally questionable behaviors, the sin tax can make them more appealing. Rather than reducing what are perceived to be internal costs of the sin, the sin tax can increase them and expand them to society as a whole.

Long-Standing Tradition

The use of sin taxes and controls on vice generally date back to before the Founding. Puritan New England was awash in laws attempting to control sin, and the means varied from taxes to outright prohibition. These were known as sumptuary laws, defined as the regulation of extravagance in food, dress, tobacco use, and drinking on religious and other grounds.

Our present era, though hardly akin to Puritan times in its faith in God, is no less anxious to pass laws to enforce minute aspects of behavior. Rather than let these laws go unenforced, as the Puritans eventually did, today we seem to have become even more confident about the ability of the right legislation to overcome intractable desires on the part of the consuming public.

Canada's experience with cigarette taxes provides a poignant case. Throughout the 1980s and early 1990s, Canadian and American smugglers met at the border, many driving in snowmobiles so as to avoid customs agents. Violence and gunplay increased. Apparently most of the cigarettes being brought into Canada in underground markets were actually manufactured in Canada, exported to the United States, and brought back into the country by disreputable elements. The same wholesalers have been known to buy back the cigarettes and sell them again.

In the official market, a case of cigarettes, which is 50 cartons, sold at an official price of $2,500. But in the informal market, smugglers pay only $700. They then sell it back in the underground at a price of $1,500. As much as 80 percent of Canada's export market ends up back in Canada. That means an enormous amount of fast profits high enough to lead people to take exorbitant risks. In three months, from November 1993 to January 1994, 125 people were arrested for possession of bootleg cigarettes.

In this case, the informal-market cigarettes were sold to the public in rented warehouses and homes at a rate approximately half the price of the official market. Complicating matters, the Indian reservations in Canada are exempt from the law. In February 1994, this led to an actual shoot-out between the Indians and the government. At last, the Canadian government gave in and cut cigarette taxes in half. That put to an instantaneous end the more egregious aspects of informalism in the Canadian cigarette market.

How Consumers Respond

American cigarette taxes, at about 56 cents per pack, are among the lowest in the world (compared with the United Kingdom at $2.52, Canada at $3.01, and Denmark at $3.68).

The effect of the sin tax cannot be measured or predicted by its percentage of the overall retail price of the good or service. It must be measured by the way consumers respond to price changes, which differs from person to person. If demand is low, a high tax will have less startling effects in terms of creating underground markets. People will just give up the habit. On the other hand, if people would rather fight than switch, the social consequences of even a small tax are to induce informal entrepreneurs into the market.

History suggests that the demand for tobacco and liquor in the United States is probably very intense. Even relatively small changes in the tobacco tax at the state level have resulted in large-scale interstate smuggling.

As sensible as the reduction of the tax seems, anti-smoking groups in the United States immediately denounced the Canadian government for the change. These people had high hopes that the problems associated with Canada's high taxes were solely due to the discrepancy with the United States, a discrepancy that could only be remedied by vastly increasing the American tobacco tax. The Clinton administration proposed raising the tax to 75 cents per pack in 1994.

"Canada has been our greatest role model in demonstrating the effectiveness of tobacco taxes in preventing disease and premature death," said Cliff Douglas of the American Cancer Society in 1994. "We're using the Canadian data and experience heavily in our effort to persuade the United States Congress to follow suit by substantially raising federal tobacco taxes here."

Such policy would only make matters worse. Rather than ending the social chaos, it would merely export it to the United States. Tobacco would come across the borders at cheap prices one way or the other. Massive police power would have been expended to prevent leakage on both our Southern and Northern borders. Even that would not have prevented the inevitable growth of the underground.

Many Hurt by Sin Taxes

We find that any sin tax--whether a direct binary tax or a triangular tax that hits buyer and seller--is harmful in a number of ways.

  • It reduces the income of the buyer.
  • It lowers profits for the seller, and leads to reduced investment, wages, and jobs.
  • It is not likely to seriously discourage consumption habits when those habits are intensely desired.
  • It may eventually decrease government revenue, especially as people move their business to the informal sector.
  • It encourages people to turn to harder substances to feed their habits at the same price.
  • It creates underground markets, which tend toward corruption and violence, and fosters disrespect for the law.
  • It sets up a moral hazard for policy makers, who vacillate between wanting to discourage undesirable behavior and wanting to encourage it for revenue purposes.

Whatever economic or social benefits one can dream up from the sin tax, we must also realize that the decision to tax must be weighed against the social benefits for reducing the behavior by slow and deliberate persuasion and voluntary action. When it comes to public policy, the preferred method of discouraging sin should fall under the category of alternative institutions, especially family, church, and school.


Robert A. Sirico is president and co-founder of the Acton Institute for the Study of Religion and Liberty. His email address is rsirico@acton.org.