Living in sin [taxes]

Recent email discussions with my sister have left me in a bit of a philosophical conundrum. A first-year Consumer Behavior PhD at Harvard, Katie's been bombarding me with her insights on microeconomic incentive structures. 'What the hell is that,' you say? Well:

Essentially, an incentive structure is the way your choices are laid out in a particular instance (for a whole lot more, see: Nudge and Jodi Beggs). For example, imagine walking into a supermarket cereal aisle. Often, the supermarket-powers-that-be put the nice, expensive Cocoa Puffs at eye level and the "Choco Rice Cereal Imitation" cereal down by your feet. The objective, of course, is to get you to buy the name brand stuff by altering the way you view your choices.

I can hear you thinking, "I don't fall for that kind of stuff." But here's the thing: yes you do. Exhibit A:


(source)

While it's definitely interesting to see how much money you can take from suckers at the grocery store who don't know that Fruity-Os and Fruit Loops are exactly the same, this type of thinking can also have a pretty significant impact on the way we think about government policy regarding unhealthy choices.

Consider smoking. Actually, don't consider it. Aside from being gross, it's also very unhealthy. But that hasn't kept millions of Americans from smoking cigarettes. (Full disclosure: I've been counted among their ranks a number of times.) The literature seems to say that people are well educated on the negative impacts of smoking; they even overestimate the consequences [citation needed]. So what's going on here?

There are a few possibilities. Smokers could also be overvaluing the benefits of smoking. (Let's face it, nobody looks cooler than a cowboy with a cigarette.) But some smokers could have the costs and benefits completely pegged -- that is, they've taken the loss of additional years into account, and they've come to the conclusion that they would still like to smoke.

Is that wrong? In general, I'm of the mentality that if you take on all the costs, you ought to be able to do whatever you please. I don't mind if you spend a little less time on this earth, as long as you don't take me down with you.

But here's the humdinger: research shows that smokers put negative externalities on society. That is, there are some "spillover" costs that "spill over" onto the rest of us. Second-hand smoke may be a negative externality, and increased health care costs certainly fall into that category.

Historically, economists have lauded Pigovian taxes (read: sin taxes) as the most economically efficient way to internalize a negative externality, assigning those external costs to the person doing the puffing. Still others approve because sin taxes can simultaneously raise government money and save us from ourselves. They provide revenue and cause consumers to cut down on smoking/drinking/polluting/anything fun because of the additional cost.

But let's take another example in the same vein: soda. New York City health officials recently proposed (and struck down) a tax on soda as a way to cut down on the health industry impacts (and, let's face it, unsightliness) of obesity. The idea is the same as a tax on smoking: change the incentives so that it costs more to make an unhealthy decision.

This is where some people begin to draw a line. (Don't tread on my soda intake!) Their protests beg the question: Why is a tax on smoking justifiable but not a tax on soda? I think it's because the public has an easier time imagining a part of the population that drinks soda but doesn't impose a negative externality on society. After all, there are a many soda drinkers that aren't obese and don't have diabetes (yet), and there are those that probably even exercise and take care of their health. But the tax doesn't seek out unhealthy soda drinkers; everyone must pay the cost. (More on Pareto Efficiency in another post.)

Ideally, you would be able to seek out the soda-abusers and alter only their incentives. But even coming at it from the health care perspective, you could never say without a reasonable doubt that your gluttony for high fructose corn syrup was the sole cause of your health issues. Could we somehow change the infrastructure of the health care industry to avoid externalities from unhealthy choices? Not likely.

In closing, it's very important to note that taxes are not the only means of altering an incentive structure. (Indeed, if I didn't note that, Katie's comment would be quite as long as the post itself.) Rest assured, there will be more on nonmonetary incentives soon.