Sin Taxes – a soft target that does more harm than good - Biznews

23 February 2021 - The argument for sin taxes is frequently made. Arguments against sin taxes, however, are rarely discussed, and never feature in the National Treasury’s budget speeches.

At first glance sin taxes make sense… The taxed items aren’t essentials and increasing the price of unhealthy substances should reduce their appeal. Ivo Vegter from the Daily Friend delves a little deeper into the most popular indulgences around the world and finds that, in South Africa, sin taxes might not be that simple. During one of the strictest lockdowns in the world, the country was a revealing test case for what happens when cigarettes and alcohol are banned outright. A black market emerged almost over night, drawing ordinarily law-abiding citizens into business with organised crime syndicates. While government ‘fiddles at the margins’, these taxes have a substantial effect on employment, industry and the economy as a whole. The article was first published on Daily Friend.- Melani Nathan.

Ivo Vegter

The argument for sin taxes is frequently made. Arguments against sin taxes, however, are rarely discussed, and never feature in the National Treasury’s budget speeches.

Everyone expects further hikes in sin taxes on products such as tobacco, alcohol and sugar in Wednesday’s big Budget Speech. While better-than-expected (though still dismal) revenue numbers might stave off the spectre of hikes in income taxes, corporate tax, or even VAT, excise taxes are always considered fair game.

The argument for sin taxes is simple. Basic price theory suggests that raising the price of something will reduce demand for it. Since reducing tobacco and alcohol consumption is a long-term health policy goal, ever-rising taxes on these products should support this policy.

It is generally accepted that it does, to some extent. For every percentage point rise in the price of alcohol, consumption declines by about half a percentage point. It is more difficult to discern the effect of taxes on smoking since there are many confounding factors in assessing the effectiveness of the modern cornucopia of anti-smoking policies.

The other argument is simply that levying sin taxes is easy money, and therefore ought to be exploited by the Treasury in support of its revenue targets.

Alcohol abuse
There is a general negative correlation between alcohol pricing and consumption, but the impact of increased prices is less strong among younger drinkers and heavy drinkers – which are exactly the populations that alcohol policy ought to be targeting. This suggests that pricing is minimally effective, and far from a sufficient policy tool to reduce problems associated with alcohol abuse.

In South Africa, according to the WHO, alcohol consumption per capita declined from 10.5 litres of pure alcohol per person in 2010 to 9.3 litres per person in 2016. While that sounds like a lot of heavy drinking, this puts the country on a par with Argentina, Canada, Chile, Spain, Sweden, and the US. Australians, Russians, New Zealanders, and Brits drink more than we do, and the French, Germans, Irish, and Portuguese drink much more.

Only 40.6% of South Africans drink, which is worse than in other African countries, the Middle East, India, and Indonesia, many of which have large Muslim populations. However, it is significantly better than in China (44.1%), Brazil (57.7%), Russia (67.8%), the US (68.9%), Canada (77.1%), Germany (80.3%), the UK (83.9%), Australia (84%), and France (94,8%).

While the WHO reports that 43.4% of liver cirrhosis deaths, 25.2% of road traffic fatalities, and 2.8% of cancer deaths can be attributed to alcohol in South Africa, in nominal terms, that amounts to fewer than 10,000 deaths in total per year.

These numbers suggest that perhaps South Africa’s supposed alcohol problem is not as severe as is often suggested.

One paper from 2018 that received a lot of media coverage claimed that approximately 62 300 adults died from alcohol-attributable causes in South Africa in 2015, which would account for more than 10% of all annual deaths.

However, this number is hard to reconcile with the far lower number (albeit of only three causes) reported by the WHO. It turns out that the study got its alcohol-related mortality data from a survey conducted among 85,000 people living in rural Kwazulu-Natal, around Mtubatuba, north of Richards Bay. This seems like a poor sample from which to extrapolate to the entire South African population.

Tobacco use
About 19% of South Africans over the age of 15 smoke. This is higher than in Australia, Brazil, Canada, India, and the United States, similar to the UK, lower than in China, and much lower than in most of Europe, where about 30% of the population still smoke, or Russia, where the rate exceeds 40%. South Africa’s smoking rate is lower than the global average of 20.6%.

Despite the fact that South Africans probably deserve a little distraction from the disastrous economic slope down which the ANC is leading it, should they so choose, the smoking rate in South Africa is far from high.

Still, our government is infested with nanny-state control freaks who will do anything they can to make life miserable for the country’s remaining smokers. That includes, as we have seen, imposing an entirely unscientific prohibition on tobacco products, justified by the false claim that ‘smoking can increase your chance of getting Covid-19’. It doesn’t. (On the contrary, it is somewhat protective against contracting the disease.)

Smokers seem to be even less amenable than drinkers to public policy that tries to discourage them from smoking. During the prohibition on tobacco products, cigarettes remained easily accessible, but at dramatically higher black-market prices.

I personally witnessed a 1 350% price increase at the darkest time of the prohibition, before black market supply began to catch up with demand. By the end of the prohibition, black market prices were about twice the usual retail price. On average, prices increased by 250% during the ban.

Despite this astronomical price increase, only 9% of smokers quit during the ban, and 93% of continuing smokers purchased cigarettes despite the sales ban, according to a paper by Samantha Filby, Kirsten van der Zee, and Corné van Walbeek, of the Research Unit on the Economics of Excisable Products at the University of Cape Town School of Economics. (That these numbers don’t add up to 100% can be accounted for by an overlap involving people who bought cigarettes early in the prohibition, but later quit.)

This suggests that smokers are particularly price-insensitive, which casts doubt on the value of excise taxes as a means to discourage smokers.

Small change
In total, the government receives about R50bn from specific excise taxes. According to the aforementioned Van Walbeek, speaking to Moneyweb (paywalled), sin taxes in a normal year generate about R14bn of revenue for tobacco, R25bn to R30bn for alcohol, and R3bn to R4bn from the recently imposed sugar tax.

This sounds like a lot, especially when the government is whining about where to find R20-odd billion to pay for vaccines, but it isn’t, really. Against the 2020 Budget (pre-Covid), that represents a mere 2.8% of the government’s total revenue.

Higher-than-expected tax paid by the mining sector alone closed the expected revenue shortfall announced in the 2020 Medium-Term Budget Policy Statement by more than R100bn, which dwarfs the contribution of sin taxes.

In total, the prohibitions on alcohol alone cost the economy between R36.3bn and R51.9bn, depending on who you believe, and cost the fiscus some R8.7bn in lost taxes.

Unseen impacts
The 19th-century economist Frédérick Bastiat once wrote a brilliant pamphlet about the seen and the unseen effects of public policy. With sin taxes, there are also seen, and unseen effects.

The obvious effects are that people pay more for the goods being taxed, and are therefore encouraged to buy less of it and that the government squeezes a little more coin from defenceless citizens.

The unseen effects, however, show up in lower revenues for retailers, bars, and restaurants. That, in turn, affects revenue further up the production chain, from manufacturing to packaging, transport and mining. It also affects rents, as well as wages and employment.

There is little data available on the impact of sin taxes on employment. A 2017 study tries to model the effect of alcohol taxes on job losses in the industries directly affected, as well as on the other industries that might be expected to benefit from the disposable income that otherwise would have been spent on alcohol. Surprisingly, it finds that there is a net employment gain, although that gain includes not only private sector employment, but also the additional government jobs created by the tax revenue.

The problem with this analysis is that it was conducted in a country (the US) that is very near to full employment, and where the job market can easily absorb those displaced from the alcohol sales business. Whether this would happen in South Africa, with its catastrophic unemployment levels, is highly doubtful.

Taxes on alcohol and tobacco are also highly regressive. Both are consumed in greater quantities by people on the lower end of the income spectrum. While the rich can afford to pay a little more for their favourite tipple, this is not true for the poor. Sin taxes, therefore, divert money that could have been spent on food, education, or clothing to the government.

Illicit market
The biggest impact of the prohibitions on alcohol and tobacco was to boost the illicit market. According to SARS commissioner, Edward Kieswetter, the organised crime syndicates that added alcohol and tobacco to their usual portfolio of hard drugs, protection, weapons, and prostitution, now have a foothold with otherwise law-abiding citizens, and the impact will take years to reverse.

Raising sin taxes has a similar, albeit less severe, impact on the market. The more expensive legitimate products are, the more attractive less expensive illicit products become.

A well-developed illicit market poses a number of threats to the country. Consumers are more likely to be exposed to low quality, or even toxic, products. Money is diverted away from legitimate, tax-paying businesses, further reducing the government’s own revenue. Money flowing to organised crime syndicates fund all sorts of undesirable activity, from gang warfare to human trafficking.

A friend I recently spoke to said he was very uncomfortable with the idea of supporting the nefarious activities of the black market, but between his lockdown-battered income, the tobacco ban, and his 40-a-day addiction, he was forced to turn to the illicit trade and hasn’t looked back.

Fiddling at the margins
Another unseen effect is that as long as the government thinks it can squeeze more blood out of the sin tax stone, it is under correspondingly less pressure to get its financial house in order.

According to the Centre for Risk Analysis, a Johannesburg-based risk advisory group, the budget deficit expected for the next few years rivals only the deficits during the two World Wars and the final days of Apartheid isolation. Tax revenues approaching 30% of GDP are the highest they’ve been since 1994, but government expenditure is rising even faster. Meanwhile, the composite leading business cycle indicator, which showed its biggest sustained rise during the Mbeki era, has been flat or declining ever since.

This cannot last. Plugging small holes in the budget by raising sin taxes merely postpones the inevitable reckoning. The government needs to dramatically restructure itself, not fiddle at the margins.

Instead of raising sin taxes, the government could give the battered retail and hospitality sector a little relief by slashing them. The benefits of sin taxes, both in promoting healthier lifestyles and in revenue generation, are marginal.

Meanwhile, they cause significant harm to an economy that desperately needs to recover, if it is to grow enough to pay the ballooning public debt and create meaningful employment.

Now, more than ever, the government should jettison all anti-growth policies instead of doubling down on them. There are bigger issues, but sin taxes really cannot be justified in the present economic climate.

This article was first published on the IRR's online platform, Daily Friend.

Ivo Vegter is a freelance journalist, columnist and speaker who loves debunking myths and misconceptions, and addresses topics from the perspective of individual liberty and free markets. As an independent researcher, he is the author of the recent report from the Institute of Race Relations (IRR) – South Africa’s Minibus Taxi Industry, Resistance to Formalisation and Innovation – which assesses the potential for innovation and modernisation in this vital transport sector.

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