Illustration of Tax Impacts on Sugar-Sweetened Drinks

When a tax is levied, then tax incidence is the term that aids to divide the tax burden between the seller and the buyer (Tremblay and Tremblay 2016). Depending upon the elasticity of demand and supply, tax incidence is determined. If the elasticity of supply is higher than the elasticity of the demand, then tax burden lies on the buyers and if the elasticity of demand is higher, then the tax burden lies on the buyer (Stiglitz and Rosengard 2015).

Tax on sugary drinks is in practice for the long time, which is aimed to reduce the consumption propensity of the sugary drinks (Briggs 2016). Taxation on the sugary drinks can be acknowledged as the Pigovian tax, which is a type of taxation applied on the market activities that cause externalities. In the case of sugary drinks, it causes negative externalities by enhancing the scope of diabetes. Thus, economic ideas of taxation on sugary drinks states that a tax on these products will enhance the market price of the sugary drinks leading to a fall in demand, which will lead the producer to produce socially optimised amount of sugary drinks (Silano and Agostoni 2017).

Figure 1: Demand and supply of sugar sweetened drinks

Source: (Created by Author)

From figure 1, it can be seen that initial equilibrium was occurred at point E where the equilibrium level of output was Q and the equilibrium level of price was P⁰. Post taxation scenario can be perceived from the same figure 1 that states a shift of equilibrium from E to E*. During post taxation, equilibrium level of price is P*, which is higher than the initial equilibrium price of P¹. Quantity demanded shifted from Q to Q* owing to the taxation and it has caused a reduction in social cost of the sugary drinks, which has been highlighted by the red section of the figure 1. Once the tax is levied, it caused a revenue generation for the government, represented by the yellow section of the figure 1. Though the generation of tax is good, however there will be sum amount of deadweight loss, which has been highlighted by the green section in the diagram represented above (Lal et al. 2017).

Figure 2: Sugar supply and demand and taxation effect

Source: (Created by Author)

Figure 2 shows the supply and demand condition of the Australian sugar market. Initial equilibrium occurs at point E, where the equilibrium price was P and the equilibrium level of quantity produced is Q. If a sugar tax were levied on the sugar market of Australia, then it would certainly alter the existing market equilibrium. Post taxation scenario can be seen from the figure 2, where the market demand curve shifts M₀ to M₁ leading a shift in equilibrium condition. New equilibrium has occurred at E*, where the equilibrium price is P* and the quantity produced is Q*. P* is higher than the initial equilibrium price P and this rise in price has caused the reduction in the demand of the sugar leading to a reduction in production of the sugary drinks.

Changes in Equilibrium Price and Quantity

Figure 3: impact of sugary drink tax on the non-sweetened drinks

Source: (Created by Author)

Figure 3 displays that if a tax on sugary drinks is applied, then it will alter the existing market equilibrium leading to a rise in equilibrium price from P1 to P₂. This rise in price originates due to the change in demand, which has been highlighted by the shift in demand curve from M₀ to M₁. This rise in price will reduce the demand of the sweetened drinks and it will lead to a rise in demand of the non-sugary drinks that can be perceived from the section 2 of the figure 3. Owing to the fact that sugar and non-sugary sweetened drinks are substitute, customers will demand more of non-sugary drinks. This rise in demand will increase the price from P₀ to P₁.

If a change in price leads to a large alteration in the quantity demanded, then it is said that the good is responsive to the changes of price. Depending upon the magnitude of change of demand due to change in price, price elasticity of demand is calculated (Olmstead et al. 2015). A positive elasticity of demand means a rise in demand due to a rise in price and the negative elasticity of demand demonstrates that if the price rises, then the quantity demanded will fall (Sabatelli 2016). Price elasticity of demand for sugar-sweetened beverages is -0.9 means a 10% rise in price of sugary beverages will lead to a reduction of demand of these products by 9%. This elasticity of demand for the sugary beverages demonstrates that if the price of sugary beverages rises, then consumers will shift to the close substitute non-sugary drinks. Thus, if the government use sugary drink tax, then it will be beneficial to curtail the demand of sugary drinks and shifting the preference to non-sugary drinks like milk, fruit juice etc.

Own price elasticity is a measurement that demonstrates the relationship between the quantity demanded and the change in price (Ataman et al. 2016). Own price elasticity measures the change in quantity demanded originated from the percentage change in price (Cobe.boisestate.edu, 2018). If the change of quantity demanded is high due to a small change of price, then the good is said to be more elastic and if there is no change in demand for the change of price, then the good is non-elastic in nature (Meng et al. 2014). Sugar is necessary good but sugary drinks are not necessary goods, thus a change in price can certainly alter the quantity demanded making an elastic good (Schwartz 2017). Own price elasticity of sugary drinks are much higher to the people who are children, teenagers and falls in the low-income group (Colchero et al. 2015). Thus if a sugary tax is imposed by the government, then it will increase the price of sugary beverages, leading to a reduction in quantity demanded.

Reference:

Ataman, B., Pauwels, K., Srinivasan, S. and Vanhuele, M., 2016. Advertising’s Long-Term Impact on Brand Price Elasticity Across Brands and Categories.

Briggs, A., 2016. Sugar tax could sweeten a market failure: Britain has announced a tax on sugary drinks. Countries should go further and target foods that have large carbon footprints, says Adam Briggs. Nature, 531(7596), pp.551-552.

Cobe.boisestate.edu. (2018).  [online] Available at: https://cobe.boisestate.edu/lreynol/WEB/PDF/Elasticity.pdf [Accessed 7 Jan. 2018].

Colchero, M.A., Salgado, J.C., Unar-Munguia, M., Hernandez-Avila, M. and Rivera-Dommarco, J.A., 2015. Price elasticity of the demand for sugar sweetened beverages and soft drinks in Mexico. Economics & Human Biology, 19, pp.129-137.

Lal, A., Mantilla-Herrera, A.M., Veerman, L., Backholer, K., Sacks, G., Moodie, M., Siahpush, M., Carter, R. and Peeters, A., 2017. Modelled health benefits of a sugar-sweetened beverage tax across different socioeconomic groups in Australia: A cost-effectiveness and equity analysis. PLoS medicine, 14(6), p.e1002326.

Meng, Y., Brennan, A., Purshouse, R., Hill-McManus, D., Angus, C., Holmes, J. and Meier, P.S., 2014. Estimation of own and cross price elasticities of alcohol demand in the UK—a pseudo-panel approach using the Living Costs and Food Survey 2001–2009. Journal of health economics, 34, pp.96-103.

Olmstead, T.A., Alessi, S.M., Kline, B., Pacula, R.L. and Petry, N.M., 2015. The price elasticity of demand for heroin: matched longitudinal and experimental evidence. Journal of health economics, 41, pp.59-71.

Sabatelli, L., 2016. Relationship between the uncompensated price elasticity and the income elasticity of demand under conditions of additive preferences. PloS one, 11(3), p.e0151390.

Schwartz, M.B., 2017. moving beyond the debate over restricting sugary drinks in the Supplemental Nutrition Assistance Program.

Silano, M. and Agostoni, C., 2017. To tax or not to tax sugary drinks? This is the question.

Stiglitz, J.E. and Rosengard, J.K., 2015. Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.

Tremblay, M.J. and Tremblay, V.J., 2016. Tax Incidence and Demand Convexity in Cournot, Bertrand, and Cournot–Bertrand Models. Public Finance Review, p.1091142116666671.