Leaving Taxes or Candy on the Table

Research suggests sin tax projections in Washington will just create a heavier tax burden and leave the state needing to make future cuts

State lawmakers in Washington State have claimed the projected revenues from the new taxes on candy, pop, and bottled water are needed in order to help close the budget deficit for 2011-2013. And if Initiative 1107 is passed next week, repealing these so-called “sin taxes,” advocates argue the state will be leaving much needed revenue on the table.

However, recent research of similar taxes like those that I-1107 seeks to repeal suggests the revenue projections may be overstated, leaving legislators to make cuts anyway in place of the money they expected to have, while Washingtonians deal with a heavier tax burden.

In 2008, as Chicago faced a $217 million budget deficit and declining tax revenues, city leaders turned to tax hikes, including a new five-cent bottled water tax, a series of tax increases on beer, liquor and wine, and a surcharge for 911 emergency services. The bottled water tax alone was supposed to raise over $10 million in its first year, and help balance the struggling city budget.

But the Windy City found out that sin taxes are not always the windfall they are projected to be. Six months into the year, the bottled water tax raised just $2.6 million of the projected $10.5 million. And by the end of the year, the tax brought in $7.6 million, about three-quarters of what the city had predicted. Mayor Richard Daley, confronted by the failure of this and other emergency tax measures, had to make an additional $20 million in spending cuts by June 2008.

And Chicago is not alone. For many years, taxes on junk food have proven irresistible to state and municipal lawmakers across the country. They appear to be a quick and easy way to juice revenues and maintain spending without the political fallout of a broad-based tax increase on, for instance, income.

But one reason these taxes sometimes fail to meet revenue projections is changes in consumer demand as a result of the increased price. Even in normal times, but especially in a recession, consumers can be very sensitive to price changes in “non-essential” goods and will often times shift to a substitute-like tap water for bottled water, or juice or milk for pop. A recent review of 160 academic studies by the Rudd Center for Food Policy & Obesity found that soft drinks are among the food groups most vulnerable to a fall in demand due to a change in price.

This high price responsiveness makes it likely that Washington’s new levies on food will fall into the trap of so many sin taxes by vastly overestimating revenue potential. The effect is likely to be even more dramatic in the current economic environment as consumers scale back on discretionary purchases. Ironically, one of the major selling points of candy and pop taxes among sympathetic legislators is that they target “non-essential” products. But if tax proponents are right, shoppers will likely cut back on these items even more than other more “necessary” products because of the increased tax burden, further harming revenue prospects and accomplishing the opposite of what policymakers intend.

If this weren’t enough, our research shows that taxes like these have a history of inflicting unintended, negative effects on the lower classes in society. Sin taxes-whether on cigarettes, booze, or pop-often take their harshest toll on the most economically vulnerable segments of the population, as the poor spend proportionately more of their income on pop and candy.

Plus, it is not a stretch to believe that legislators trying to avoid making necessary cuts now will stick to the same game plan in years to come. Though the taxes covered by I-1107 were billed as a “temporary” hike to help the state budget through hard times, it would be naive to expect them to expire anytime soon, especially if current budgetary woes persist. It took Maine’s taxpayers 10 years to repeal a 1991 snack food tax that was pitched as a one-year budget solution.

At the end of the day, sin taxes are an unreliable source of revenue. It is more fiscally responsible to leave junk food and bottled water on the table and make the same hard financial choices that face recession-battered Washingtonians every day, rather than trying to gobble up every tax opportunity in sight.

Anthony Randazzo is director of economic research at Reason Foundation. David Godow is a research assistant at Reason Foundation.