Taxation of Sugary Drinks

Taxation of Sugary Drinks MAC TAYLOR LEGISLATIVE ANALYST NOVEMBER 26, 2018 analysis full gutter AN LAO REPORT LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Executive Summary Sugary Drink Taxes. Excise taxes on sugary drinks have become increasingly common in recent years. In June 2018, the Legislature passed a law prohibiting local governments from levying such taxes. The Legislature may now face two decisions: • Should the state levy an excise tax on sugary drinks? • If so, how should the tax be designed? This report provides information and perspectives for the Legislature to consider as it weighs these choices. Why Tax Sugary Drinks? Sugary Drink Taxes Have Two Purposes. Sugary drink tax proponents tend to emphasize two goals: a fiscal goal of raising revenue and a policy goal of improving health. • Fiscal Purpose: Revenue. Sugary drink taxes are one of many options available to policymakers who want to raise revenue. However, sugary drink taxes—and excise taxes more generally—are not an ideal way to achieve this fiscal goal. Excise taxes impose undue burdens on narrowly defined groups. Additionally, such taxes—and narrowly targeted tax policies more generally—make businesses’ success less dependent on marketplace competition and more dependent on political competition. • Policy Purpose: Health. A statewide sugary drink tax likely would reduce sugary drink consumption, potentially leading to improvements in health—such as reduced rates of heart disease and diabetes. However, consumer responses to a sugary drink tax would be complex, so the net health effects of such a tax are uncertain. Key Design Decisions Defining the Tax Base. Many recent sugary drink tax proposals exclude artificially sweetened “diet” drinks, dairy-based drinks, and 100 percent juice. The juice exclusion illustrates a key trade-off. On one hand, policymakers could take a relatively aggressive approach by taxing a broad range of sugary drinks, maximizing potential health benefits. On the other hand, policymakers could take a relatively cautious approach by limiting the tax to drinks—such as soda—that provide no beneficial nutrients. Choosing the Type of Tax. A sugary drink tax can be based on the volume of the drink (for example, 2 cents per ounce) or on the amount of sugar in the drink (for example, 3 cents per teaspoon of sugar). A third alternative is a tiered tax that combines aspects of the other two (for example, 1 or 2 cents per ounce, depending on the amount of sugar). Volume-based taxes are simplest, but sugar-based taxes align more closely with the health goals of the policy. Setting an Initial Tax Rate. A statewide sugary drink tax would reduce sugary drink consumption. For example, a 2 cent per ounce tax likely would reduce consumption by 15 percent to 35 percent. This effect on consumption is central to the policy purpose of the tax, but it affects the fiscal outcome as well. www.lao.ca.gov 1 analysis full gutter AN LAO REPORT Adjusting the Tax Rate Over Time. As time passes, inflation reduces the effectiveness of taxes whose rates are defined as fixed amounts of money (such as 2 cents per ounce). Indexing the rate to inflation can help maintain the fiscal and policy effectiveness of the tax over time. Allocating the Revenue. Allocating sugary drink tax revenues—and tax revenues more generally—to special funds is not a good budgetary practice. Doing so: • Constrains the Legislature’s budgetary choices. • Exacerbates the conflict between the tax’s fiscal goals and policy goals. Moreover, revenues from specific taxes can diverge from the costs of specific programs over time, making ongoing commitments problematic. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT INTRODUCTION Taxes on sugary drinks have become local action. As such, the Legislature may face the increasingly common in recent years. In June 2018, following decisions: the Legislature passed a law (Chapter 61 of 2018 • Should the state levy an excise tax on sugary [AB 1838, Committee on Budget]) prohibiting local drinks? governments from levying such taxes (and other • If so, how should the tax be designed? taxes on groceries) through 2030. The law stated the Legislature’s intent to regulate the imposition This report provides information and and collection of such taxes to the exclusion of perspectives for the Legislature to consider as it weighs these choices. BACKGROUND State and Federal Governments Levy Excise such, the term excludes many other drinks—such Taxes. Unlike broad-based taxes—such as income, as milk—that contain naturally occurring sugars.) property, and sales taxes—excise taxes apply Excise Taxes on Nonalcoholic Drinks to narrow categories of goods. Figure 1 lists examples of goods that are subject to state and Many Jurisdictions Have Levied Excise Taxes federal excise taxes in California. For example, the on Nonalcoholic Drinks. Four California cities federal government and the state of California both levy excise taxes on sugary drinks. As shown in levy excise taxes on alcoholic beverages. Currently, Figure 2 (see next page), Berkeley has levied however, they do not levy excise taxes on sugary such a tax since 2015, while Albany, Oakland, drinks. (In this report, we use the term “sugary and San Francisco have done so since 2017. (The drinks” to refer to drinks containing added sugar, recent ban on local grocery taxes left these four in such as soda, energy drinks, and fruit drinks. As place). Additionally, the state Legislature and the Figure 1 Notable California Excise Taxes Representative Retail Price Tax Base State Rate Federal Rate (Including Taxes) Gasoline $0.42 per gallon $0.18 per gallon $3.50 per gallon Diesel $0.36 per gallon $0.24 per gallon $3.80 per gallon Cigarettes $2.87 per pack $1.01 per pack $8.00 per pack Other tobacco products 63% of wholesale price Varies across products Varies across products (cigars, chewing tobacco, etc.) Beer 0.2 cent per ounce 0.1 to 0.5 cent per ounce 10 cents per ounce Wine 0.2 cent per ounce 0.1 to 2.7 cents per ounce 40 cents per ounce Distilled Spirits 2.6 cents per ounce 0.7 to 13.4 cents per ounce 50 cents per ounce Cannabisa $9.25 per ounce of flowers, — $300 per ounce of flowers $2.75 per ounce of leaves, and 15 percent of retail price of final product a Local taxes also apply. www.lao.ca.gov 3 analysis full gutter AN LAO REPORT Figure 2 Some Notable Nonalcoholic Drink Tax Proposals Applies Year Tax Only to Went Sugary Status as of Into Jurisdiction Tax Drinks? November 2018 Effect California Berkeley 1 cent/oz of drink volume Yes In effect 2015 Albany 1 cent/oz of drink volume Yes In effect 2017 Oakland 1 cent/oz of drink volume Yes In effect 2017 San Francisco 1 cent/oz of drink volume Yes In effect 2017 El Monte 1 cent/oz of drink volume Yes Did not pass (2012 ballot measure) — Richmond 1 cent/oz of drink volume Yes Did not pass (2012 ballot measure) — California 1 cent/tsp of sugar Yes Did not pass (2009-10 Legislative Session) — California 1 cent/oz of drink volume Yes Did not pass (2013-14 Legislative Session) — California 2 cents/oz of drink volume Yes Did not pass (2017-18 Legislative Session) — California 2 cents/oz of drink volume Yes Collecting signatures (Initiative) — Other States in U.S. West Virginia 0.1 cent/oz of drink volume No In effect 1951 Arkansas 0.2 cent/oz of drink volume No In effect 1993 Washington 0.2 cent/oz of drink volume No Repealed in 2010 2010 Other Local Governments in U.S. Boulder, CO 2 cents/oz of drink volume Yes In effect 2017 Philadelphia, PA 1.5 cents/oz of drink volume No In effect 2017 Seattle, WA 1.75 cents/oz of drink volume Yes In effect 2018 Cook County, IL 1 cent/oz of drink volume No Repealed in 2017 2017 Outside of U.S.a Norway 0.5 to 1.4 cent/oz of drink volume No In effect 1924 France 0.3 to 0.7 cent/oz of drink volume, No In effect 2012 depending on amount of sweetener Chile 8 percentage-point difference in value- Yes In effect 2014 added tax rate between higher-sugar and lower-sugar drinks Mexico 0.3 cent/oz of drink volume Yes In effect 2014 Bahrain, Saudi Arabia, 50 to 100 percent of retail price No In effect 2017 and the United Arab Emirates Catalonia 0.4 to 0.5 cent/oz of drink volume, Yes In effect 2017 depending on amount of sugar Philippines 0.3 to 0.7 cent/oz of drink volume, No In effect 2018 depending on type of sweetener South Africa 1.4 cent/tsp of sugar (except the first tsp Yes In effect 2018 per 3.4 oz) Sri Lanka 0.1 cent/tsp of sugar Yes In effect 2018 United Kingdom and 0.75 to 1 cent/oz of drink volume, Yes In effect 2018 Ireland depending on amount of sugar Denmark 0.7 cent/oz of drink volume No Repealed in 2014 1934 a Foreign tax rates converted to U.S. dollars based on purchasing power parity. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT cities of El Monte and Richmond have considered first policy, the second one levies a larger tax on sugary drink tax proposals but have not adopted the sodas and the cranberry juice cocktail—which them. Outside of California, a variety of local, state, contain relatively large amounts of sugar—and a and national governments have levied excise taxes smaller tax on the lemon iced tea and the sports on nonalcoholic drinks. Most of these policies have drink, which contain more moderate amounts of been in place for less than a decade. sugar. Many Drink Taxes Not Limited to Sugary Sales Taxes on Nonalcoholic Drinks Drinks. The state and local nonalcoholic drink taxes proposed in California have applied only to sugary State and Local Governments Levy Sales Tax drinks. Outside of California, however, many excise on Many Goods. The sales and use tax (hereafter, taxes apply to broader categories of nonalcoholic sales tax) applies to retail sales of tangible goods. drinks. Philadelphia’s tax, for example, applies both The rate varies across the state, ranging from to sugary drinks and to artificially sweetened drinks, 7.25 percent to 10.25 percent, with a statewide such as “diet” soda. average of 8.5 percent. Sugary Drink Tax Examples. Figure 3 illustrates State Constitution Exempts “Food Products” how two hypothetical sugary drink taxes would From Sales Tax. The state has developed a apply to five types of drinks. The first tax is based complex system of rules for determining whether on drink volume: two cents per fluid ounce. This a particular food or drink qualifies for the food tax ranges from $0.24 on a 12-ounce can of cola products exemption. These rules classify many— to $1.28 on a 64-ounce bottle of cranberry juice but not all—drinks as exempt food products. cocktail. The second tax is based on sugar content: For example, juice, milk, and bottled water are 3 cents per teaspoon of sugar. Compared to the considered food products and therefore exempt Figure 3 Sugary Drink Tax Examples $1.60 3 Cent Tax Per Teaspoon of Sugar 2 Cent Tax Per Ounce of Drink Volume 1.20 0.80 0.40 12-oz can of cola 16-oz bottle of 20-oz bottle of 28-oz bottle 64-oz bottle of lemon iced tea lemon-lime soda of sports drink cranberry juice cocktail www.lao.ca.gov 5 analysis full gutter AN LAO REPORT from sales tax. As shown in the Figure 4 first column of Figure 4, however, Does Sales Tax Apply? almost all carbonated drinks— including sugary soda, diet soda, and unsweetened sparkling Drink California Texas Florida New York water—are not considered food products and therefore are subject to sales tax. Sugary Soda Sales Taxes on Drinks in Diet Soda Other States. Like California, other states levy sales taxes 100% Juice on many drinks. As shown in (Non-Carbonated) Figure 4, the four most populous states all apply sales tax to Juice with Added Sugar Depends on Depends on sugary soda and to diet soda (Non-Carbonated) Juice Content Juice Content but exempt milk and 100 percent juice. Sales taxation of some Milk other drinks, however, varies across these states. For example, Unsweetened all four have different rules Sparkling Water regarding fruit drinks that contain added sugar. Texas is the only Unsweetened Bottled Water (Non-Carbonated) one of the four that exempts sparkling water from its sales tax, while New York is the only one of the four that applies its sales tax to non-carbonated bottled water. WHY TAX SUGARY DRINKS? Sugary drink tax proponents tend to emphasize • Reducing “Tax Expenditures.” Tax two goals: a fiscal goal of raising revenue and a expenditures are exceptions to the basic policy goal of improving health. tax structure that apply to certain types of taxpayers or transactions. As described Fiscal Purpose: Revenue above, for example, California exempts food A sugary drink tax is one of many options products from the sales tax. available to policymakers who want to raise Excise Taxes Not an Ideal Way to Raise revenue. Other options include: Revenue. As fiscal tools, excise taxes have several • Raising Rates of Existing Taxes. For shortcomings, including: example, Proposition 30 (2012) raised state • Undue Burdens. The cost of funding basic revenue by increasing income tax and sales government services is generally borne by the tax rates. entire public—based on broad measures such • Expanding the Base of Existing Taxes. For as income and wealth. An excise tax, on the example, some policymakers have proposed other hand, is borne by a narrowly defined expanding the sales tax base to include group of businesses or consumers. As such, services. the tax burden can be disproportionately 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT borne. For instance, excise taxes are usually Purpose of Tax regressive, meaning lower-income people tend Should Guide Its Design to spend a higher share of their incomes on Design Choices Should Reflect Rationale for the tax than higher-income people. Tax. Policymakers considering sugary drink taxes • Political Competition. Narrowly targeted face several major design choices: tax policies make businesses’ success less dependent on competition in the marketplace • What types of drinks should be included in the and more dependent on competition for tax base? favorable policy treatment. • Should the tax be based on the volume of the drink, the amount of sugar, or something else? Policy Purpose: Health • What should the tax rate be? A statewide sugary drink tax likely would reduce • How should the revenue be used? sugary drink consumption, potentially leading to As discussed later in this report, the answers to improvements in health. these questions can depend on whether the main Heart Disease and Diabetes Kill Many purpose of the tax is to raise revenue or to improve Californians. Heart disease was California’s leading health. cause of death in 2016, accounting for 23 percent Consider Administrative Burden. In addition to of the state’s deaths. Diabetes was the seventh the fiscal goal of raising revenue and the policy goal most common cause of death at 3.5 percent. of improving health, the design choices listed above These diseases have adverse effects not only on hinge on a third factor: the administrative burden life expectancy, but also on quality of life. Many imposed by the tax. To account for this factor, behavioral and genetic factors contribute to these policymakers should ask two questions of any tax diseases. proposal: Sugary Drink Tax Potentially Could Improve Health. Sugary drink consumption can contribute • Can tax administrators and taxpayers to heart disease and diabetes in multiple ways. For implement the tax successfully? (For example, consumption of these drinks can lead to simplicity, we use the term “taxpayers” to excess caloric intake. Additionally, some research refer to businesses that would register and suggests that the links between sugary drinks and remit the tax. As discussed below, however, chronic disease might not be limited to their caloric consumers would pay much of the tax content. In particular, sugary drinks enable rapid indirectly through price increases.) consumption of large amounts of sugar, and they • How difficult is it for taxpayers to comply with do not contain other nutrients—such as fat, protein, the tax? or fiber—that can help the body process sugar. As Continue Monitoring Evidence Regarding a result, these drinks could contribute to diabetes Efficacy. If the Legislature enacts a sugary drink to a greater extent than would be suggested by tax, it should continue to evaluate the tax and their caloric content alone. (A full assessment of make adjustments as necessary. This evaluation this body of research falls outside of the scope of should monitor evidence not only from California, our expertise.) As discussed later in this report, but also from other states and countries. Ideally, however, consumer responses to a sugary drink tax the evaluation would focus on the ultimate goals could be complex, so the net health effects of such of these policies—such as improvements in health. a tax are uncertain. In practice, however, estimating the effects of the taxes on those ultimate goals could be very difficult. Accordingly, monitoring some intermediate outcomes—such as consumption of sugary drinks—could be useful as well. www.lao.ca.gov 7 analysis full gutter AN LAO REPORT DEFINING THE TAX BASE Should the Tax Base Include Food? An excise Should the Tax Exempt Milk? Most sugary tax designed to reduce heart disease and diabetes drink taxes do not apply to dairy-based drinks need not be limited to sugary drinks. It also could despite their significant sugar content (including apply to foods that contribute to those diseases. naturally occurring sugars). If the main goal of the In principle, broadening the base in this way could tax is to raise revenue, then this narrowing of the help the tax achieve both its health goals and its base clearly is counterproductive. If, however, fiscal goals more effectively. In practice, however, the main goal of the tax is health-related, then designing, administering, and complying with such the decision to exclude dairy from the base is a tax could be difficult at the state or local level for more nuanced. Although most dairy-based drinks a couple of reasons: contain sugar, they also contain fat and protein. If, as some researchers argue, sugary drinks • The distinctions between taxed and untaxed contribute to diabetes primarily because they lack foods could be subtle and hard to track. these nutrients, it is reasonable to exclude dairy • Such a tax would apply to a much larger from these taxes. Furthermore, some types of dairy set of taxpayers with a much wider variety products—such as yogurt-based or cream-based of products, business models, and industry products—can blur the line between drinks and structures. food, which could make administration and compliance more difficult. Common Features of Recent Proposals. Many recent sugary drink tax proposals—including Should the Tax Exempt Juice? Sugary drink local ordinances enacted in Boulder, Seattle, and tax bases typically exclude 100 percent juice but four California cities, and recent bills introduced include other fruit drinks. Excluding 100 percent in the Legislature—define their tax bases similarly. juice reduces revenue, just as excluding dairy In particular, their bases do not include artificially does. However, the nutritional case for excluding sweetened drinks, dairy-based drinks, or 100 percent juice appears to be much weaker 100 percent juice. than the case for excluding dairy. Some types of 100 percent juice contain protein or fiber, but many Below, we discuss the merits of each of these others do not. Many types of 100 percent juice choices. contain vitamins and minerals, but so do many Key Decisions Regarding the sugary fruit drinks and energy drinks. Accordingly, Tax Base the American Academy of Pediatrics has recommended limiting children’s intake of juice. Should the Tax Apply to Artificially Sweetened Key Trade-Off: Main Policy Goal vs. Other Drinks? As shown in Figure 2, some soft drink Health Effects. The potential exclusion of taxes apply only to sugary drinks, while others 100 percent juice illustrates a general trade-off apply to artificially sweetened drinks as well. If the in the design of sugary drink taxes. Some sugary primary goal of an excise tax is to improve health, drinks contain beneficial nutrients. At one end of then the decision to omit artificially sweetened the spectrum, policymakers could take a relatively drinks should depend on an assessment of the aggressive approach by applying the tax to as health effects of consuming those drinks. If sugary many sugary drinks as possible. This approach drinks present much greater health concerns than likely would lead to the greatest reduction in artificially sweetened drinks, then a health-focused sugary drink consumption, maximizing potential tax should apply only to sugary drinks and not to reductions in the key diseases of interest—heart any others. disease and diabetes. However, this approach also 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT could reduce intake of some beneficial nutrients, This approach likely would have weaker effects such as vitamins. At the other end of the spectrum, on sugary drink consumption, but it also would be policymakers could take a relatively cautious less likely to reduce intake of vitamins and other approach by limiting the tax to sugary drinks— nutrients. such as soda—that provide no beneficial nutrients. CHOOSING THE TYPE OF TAX Different Types of Sugary Drink Taxes equivalent to 0.8 cent per ounce U.S.) for drinks with three-eighths to three-fifths of a teaspoon; Volume-Based Tax. Under a volume-based and a higher rate (roughly equivalent to 1 cent per tax, the amount of tax owed depends only on the ounce U.S.) for drinks with more than three-fifths volume of the taxed drink. As shown in Figure 3, of a teaspoon. (For example, many sweetened teas for example, a one cent per ounce tax results in are in the middle tier, while most sodas are in the a tax of $0.12 on a can of cola and $0.64 on a highest tier.) large bottle of cranberry juice cocktail. For a given container size, this type of tax treats all sugary Trade-Offs Among Types drinks equally, regardless of their sugar content Volume-Based Tax Simplest. The simpler a tax, or other characteristics. This is the most common the easier it is for taxpayers and tax administrators type of excise tax levied on sugary drinks. to implement. Volume-based taxes are the simplest Sugar-Based Tax. Sugar-based taxes have sugary drink taxes, as they depend only on rates that vary depending on the amount of sugar information that is commonly tracked and relatively that drinks contain. In the 2009-10 session, for easy to verify. Sugar-based or tiered taxes are example, the Legislature considered two bills that more complex, as they require taxpayers and tax would have levied a tax of one cent per teaspoon of administrators to track drinks’ sugar content. This sugar in each drink. Compared to a volume-based information already appears on federally mandated tax, a sugar-based tax would lead to higher taxes nutrition labels, so a sugar-based or tiered tax on drinks with more sugar and lower taxes on likely would be feasible at the state level. Local drinks with less sugar. As shown in Figure 3, governments have less tax administration capacity for example, a sugar-based tax would result than the state, so their ability to administer such a in somewhat higher taxes on many sodas and tax is less clear. fruit drinks, and somewhat lower taxes on many Sugar-Based Tax Likely Most Effective for sweetened teas and sports drinks. Health. Volume-based taxes discourage production Tiered Tax. Many volume-based taxes exempt and consumption of all sugary drinks similarly. In drinks with small amounts of sugar. Berkeley’s contrast, a sugar-based tax would discourage tax, for example, does not apply to drinks that production and consumption proportionally to contain less than two calories per ounce. (Very the amount of sugar in the drink. As a result, we few sugary drinks fall below this threshold.) As would expect a sugar-based tax to reduce liquid a result, these taxes effectively separate sugary sugar consumption to a greater degree than a drinks into two categories, or tiers, based on sugar volume-based tax. Furthermore, sugar-based taxes content. Some other jurisdictions—such as the give drink manufacturers an incentive to reduce United Kingdom (U.K.) and Catalonia—have taxes the sugar content of their drinks—an incentive that that extend this concept with more than two tiers. volume-based taxes do not provide. Tiered taxes The U.K. tax, for example, has three tiers: a zero provide this incentive to some degree, but much rate for drinks with less than three-eighths of a more weakly than sugar-based taxes. Given the teaspoon of sugar per ounce; a middle rate (roughly www.lao.ca.gov 9 analysis full gutter AN LAO REPORT central role of sugar content in the health rationale sugar-based, and tiered taxes affects the relative for these taxes, we would expect sugar-based tax rates on different types of sugary drinks. taxes to be more effective for achieving health However, the rates of any of these taxes could goals than volume-based or tiered taxes. be set to raise a given amount of revenue, so All Types Could Raise Similar Amounts of this choice has little bearing on the tax’s fiscal Revenue. The choice among volume-based, effectiveness. SETTING THE TAX RATE Setting Rate to Achieve a Policy Goal Setting Rate to Achieve a Revenue Goal Statewide Tax Would Reduce Sugary Drink Consumption. Based on our review of available Revenue Depends on Initial Size of Base . . . evidence (discussed in the Appendix), we would At a basic level, the amount of revenue produced expect a statewide sugary drink tax to lead to by a given tax is equal to the tax rate times the higher prices for the taxed drinks and lower size of the tax base. Based on this relationship, consumption of those drinks. The Legislature can policymakers can set the tax rate to raise the set the tax rate based on the reduction in sugary desired amount of revenue. A complication arises, drink consumption that it wants to achieve. For however, due to the consumer response described example, a two cent per ounce tax likely would earlier. Due to that response, the size of the tax reduce consumption by 15 percent to 35 percent. base depends, in turn, on the tax rate. Complex Relationship Between Tax and . . . And Magnitude of Consumer Response. Potential Health Improvements. The tax would As noted above, we estimate that a two cent per affect health due to the drop in aggregate sugary ounce statewide sugary drink tax likely would drink consumption described above. The net reduce the size of the tax base by 15 percent effects of the tax on health would depend not only to 35 percent. A lower rate would lead to a on that drop in consumption, but also on: proportionally smaller reduction in the tax base, while a higher rate would lead to a proportionally • How the reductions in consumption are larger reduction in the tax base. distributed among people who face different health risks. In particular, the health effects of Adjusting Rate Over Time the tax would depend disproportionately on the responses of people who face a relatively Inflation Can Reduce Real Tax Rates Over high risk of heart disease and diabetes. Time. Prices tend to rise over time. Due to this inflation, the real value of any fixed amount of • Other consumer responses, such as changes money—such as a tax rate defined as a specific in consumption of other foods and drinks. number of cents per ounce—diminishes over time. If, for example, consumers respond by As shown in Figure 5, for example, California’s real consuming more candy or beer, the net health tax rate on distilled spirits has declined gradually benefits of the tax could be minimal. If, on due to inflation. This gradual decline has more than the other hand, consumers respond to the offset the modest one-time rate increases enacted tax by eating more vegetables, the tax could by the Legislature in 1968 and 1991. In the case lead to larger health improvements than of cigarettes, however, several large one-time rate those resulting from the drop in sugary drink increases have more than offset the gradual decline consumption alone. resulting from inflation, so the real rate has risen over time. 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Inflation Indexing Helps Figure 5 Achieve Fiscal Goals . . . Due to Inflation Can Reduce Real Tax Rates Over Time inflation, sugary drink taxes that are fixed in dollar terms will raise Real Tax Rate on Distilled Spirits declining amounts of real revenue 2018 Dollars Per Ounce over time. Instead of keeping $0.14 excise tax rates fixed in dollar Legislative Increase 1967 terms, policymakers could index 0.12 them to inflation—automatically 0.10 keeping their real value constant over time. For example, an 0.08 inflation-indexed tax on sugary 0.06 drinks would raise an amount of Legislative Increase 1991 real revenue per ounce that is 0.04 constant over time, instead of 0.02 one that diminishes over time. (In either case, total revenue would 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 depend not only on revenue per ounce, but on the total number of ounces consumed.) Real Tax Rate on Cigarettes . . . And Policy Goals. Inflation 2018 Dollars Per Pack gradually erodes fixed-rate taxes Proposition 56 $3.00 2016 not only from a fiscal standpoint, but also from a policy standpoint. 2.50 As the real value of the tax gets smaller, the incentives it provides—and hence its effects 2.00 on consumers’ behavior— Proposition 10 become weaker. In contrast, 1.50 1998 the incentives provided by an inflation-indexed tax are unlikely Legislative to decline over time. 1.00 Increase 1967 Proposition 99 1988 Multiple Indices Available. 0.50 Inflation measurement is not straightforward. Many economists have raised concerns that the 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 most commonly used measures of inflation—Consumer Price Indices—tend to overstate increases in the cost of living. Some alternative measures Furthermore, some key prices in California—such of inflation—known as chained indices—likely as housing prices—historically have risen faster overstate inflation to a lesser degree. However, than the national average, so nationwide indices chained indices are not available at the state level. may well understate inflation in California. www.lao.ca.gov 11 analysis full gutter AN LAO REPORT ALLOCATING THE REVENUE Tax Revenues Are Typically Available the resulting funding often diverges from program for General Fund Purposes. Historically, the costs over time. Legislature has placed almost all tax revenue in the • Example: First 5 California. First 5 General Fund. This has also been the case for most California—which funds services for children excise taxes (except for fuel taxes). For instance, under 5 years old—receives the vast majority the Legislature has placed revenues from the excise of its funding from tobacco taxes. As shown taxes on cigarettes and alcoholic beverages into in the top panel of Figure 6, the number the General Fund. In recent decades, however, of births in California—the main factor ballot measures have allocated increases in excise determining the number of children served by tax revenue—such as tobacco tax increases First 5—has remained roughly constant over and new taxes on cannabis—to special funds time. Real tobacco tax revenue, however, has designated for specific purposes. In our view, this declined steadily over time. is not a good budgetary practice, as it constrains • Example: Developmental Services. Several the Legislature in its annual budgetary choices. years ago, the Legislature considered— In addition, the revenues from an excise tax can but did not adopt—a proposal to fund the diverge from the costs of a specific program over Department of Developmental Services (DDS) time. Below, we elaborate on these concerns. by raising taxes on distilled spirits. As shown Legislature’s Priorities Tend to Change Over in the bottom panel of Figure 6, however, Time. If the current Legislature sets aside revenue DDS regional center caseloads—the primary for specific programs, then it will be more difficult driver of the department’s costs—have grown for future Legislatures to make choices that are steadily over time, while real revenue from the consistent with their own priorities. This is because: distilled spirits tax has remained flat. • Future Legislatures could assess the value General Fund Reduces Conflict Between of alternative programs very differently. For Fiscal Goals and Policy Goals. As noted above, example, a future Legislature might feel the Legislature can use excise taxes to meet policy that additional spending on child care was goals as well as fiscal goals, but these goals can preferred over whatever program had been conflict with each other in some scenarios. In the specified to receive the excise tax funds. first panel of Figure 6, for example, the decline • Future Legislatures could face circumstances in cigarette sales has reduced funding for certain that the current Legislature does not early childhood services. In this instance, the anticipate. In a budget crisis, for example, policy goal of reducing smoking conflicts with the the current Legislature might want the future fiscal goal of funding early childhood services. Legislature to use the excise tax revenue to Depositing excise tax revenues in the General lessen cuts to existing programs supported by Fund can help the Legislature avoid such conflicts. the General Fund rather than go for expanded Proportionally large changes in an excise tax services to the program specified for the base—such as the dramatic decline in smoking excise tax revenues. over the last half-century—lead to revenue changes Excise Tax Revenue and Program Costs Often that are minor compared to General Fund revenue. Diverge Over Time. When policymakers link a Consequently, if such revenues are part of the program’s budget to revenue from a specific tax, General Fund, the Legislature can deal with the 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT fiscal effects of such revenue Figure 6 changes by making proportionally Excise Tax Revenues and modest adjustments to spending Program Costs Often Diverge Over Time or to other tax rates. This approach would enable the Legislature to design and adjust Example A: First 5 California excise taxes based primarily on Total Percent Change Since 2001-02 policy goals rather than fiscal 10% goals. As described below, Births however, there are some limits to the flexibility of General Fund -10 revenue. -20 Tobacco Tax Revenue (2018 Dollars) Tax Likely Would Increase -30 Funding Requirement for -40 Schools. Proposition 98, approved by voters in 1988 and -50 modified in 1990, establishes 01-02 03-04 05-06 07-08 09-10 11-12 13-14 15-16 a minimum funding level for schools and community colleges. Example B: Developmental Services Proposal This minimum guarantee Total Percent Change Since 2007-08 depends, in part, on General Fund tax revenues. When the 35% Legislature raises General Fund 30 tax revenue, the minimum 25 guarantee generally increases. 20 Over the long run, the minimum DDS Regional Center Caseloads 15 guarantee increases by roughly 10 40 cents for every dollar of new 5 Distilled Spirits Revenue (2018 Dollars) revenue. As a result, the net increase in revenue available for nonschool purposes is smaller -5 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 than the increase in General Fund revenue. DDS = Department of Developmental Services. CONCLUSION The effectiveness of sugary drink taxes as fiscal revenue. We encourage the Legislature to consider tools and as policy tools depends on several each of these features carefully as it decides aspects of their design, such as the tax base, whether and how to enact such a tax. the type of tax, the tax rate, and the use of the www.lao.ca.gov 13 analysis full gutter AN LAO REPORT 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT APPENDIX: THE EFFECTS OF SUGARY DRINK TAXES This Appendix discusses our estimates of the • In most cases, retailers charge sales tax at effects of a statewide tax on sugary drinks in the register instead of including it in posted California. prices. As a result, sales taxes likely have smaller effects on consumers’ behavior than Research on Sugary Drink Taxes equivalent excise taxes, which tend to be Assessing Studies. We reviewed a wide range reflected in posted prices. of studies related to the effects of sugary drink LAO Estimates Place Very Little Weight on taxes. To assess the usefulness of each study, we Sales Tax Studies. Summaries of evidence on considered many factors, including: sugary drink taxes often draw heavily upon studies • The quality of the data and methods used. of changes in sales tax rates. As discussed above, changes in sales tax rates are different from sugary • The degree of similarity between the context drink taxes in several important ways. As a result, studied and present-day California. these studies do not tell us much about sugary • The degree of similarity between the policies drink taxes. studied and the policies discussed in this report. Effects on Prices LAO Estimates Place Very Little Weight on Higher Prices for Sugary Drinks. A statewide Studies of Local Taxes. Local excise taxes tend tax on sugary drinks would lead to higher prices for to be less effective fiscal and policy tools than the taxed drinks. The higher the tax rate, the larger statewide or national excise taxes for two reasons: the resulting price increase. For example, a tax of two cents per ounce likely would increase the price • Cross-Border Shopping. Some consumers of the taxed drinks by 15 percent to 25 percent respond to the tax by buying the taxed good on average. This estimate is based on research in other jurisdictions instead of reducing their on nationwide sugary drink taxes implemented consumption. in Mexico and Chile and on statewide fuel and • Price Setting. Large retail chains often set tobacco taxes implemented in the U.S. prices on a regional basis. Consequently, Broad Price Increases on Groceries Very a modest tax that covers only a small area Unlikely. Some discussions of sugary drink taxes might not lead such chains’ stores to raise have raised the possibility that retailers would their prices. respond to these taxes by raising prices across Sugary Drink Taxes Are Different From Sales the board, resulting in a de facto “grocery tax.” Taxes. As mentioned in the “Background” section This outcome is very unlikely for several reasons, of the report, state and local sales taxes apply to including: many sugary drinks. However, sugary drink taxes • Sugary drink taxes have no direct effect on the are distinct from sales taxes in four important ways: cost of selling other products. • Sales taxes apply to a wide variety of goods • Changing prices can be costly. These costs besides sugary drinks. discourage retailers from making small price • Many sugary drinks—such as fruit drinks—are changes to a large number of products. exempt from sales tax. • When the cost of a product increases, it can • Recently proposed sugary drink tax rates become harder for retailers to compete for are much larger than typical sales tax rate shoppers by selling that product cheaply. As changes. a result, retailers can have an incentive to compete for shoppers by lowering the prices of other products. www.lao.ca.gov 15 analysis full gutter AN LAO REPORT • Just like sugary drink taxes, most existing Allcott, Hunt, Rebecca Diamond, and excise taxes—including taxes on fuel, Jean-Pierre Dube (2018). “The Geography of tobacco, and alcohol—apply to products sold Poverty and Nutrition: Food Deserts and Food by multiproduct retailers. We are not aware of Choices Across the United States.” National Bureau any credible evidence that these taxes have of Economic Research Working Paper 24094. led to across-the-board price increases at the Allcott, Hunt, Benjamin Lockwood, and Dmitry affected retailers. Taubinsky (2018). “Regressive Sin Taxes, with an Application to the Optimal Soda Tax.” Mimeo, New Effects on Food and York University. Drink Consumption Chetty, Raj, Adam Looney, and Kory Kroft (2009). “Salience and Taxation: Theory and Evidence.” Lower Consumption of Sugary Drinks. Due to American Economic Review 99(4):1145-1177. the price increases described above, consumers Colchero, M. Arantxa, Carlos Manuel would buy fewer sugary drinks. The magnitude of Guerrero-Lopez, Mariana Molina, and Juan Angel the drop in consumption would depend crucially Rivera (2016). “Beverage Sales in Mexico Before on the tax rate. For example, a two cent per ounce and After Implementation of a Sugar Sweetened tax likely would reduce consumption by 15 percent Beverage Tax.” PLoS ONE 11(9). to 35 percent. This estimate is based primarily Colchero, M. Arantxa, Juan Carlos Salgardo, on studies of sugary drink taxes implemented in Mishel Unar-Munguia, Mariana Molina, Shuwen Mexico and Chile and of simulated sugary drink Ng, and Juan Angel Rivera-Dommarco (2015). taxes in the U.S. In our view, the most useful study “Changes in Prices After an Excise Tax to is Allcott, Lockwood, and Taubinsky (2018), which Sweetened Sugar Beverages Was Implemented in uses data on U.S. households’ grocery purchases Mexico: Evidence from Urban Areas.” PLoS ONE from 2006 through 2015 to estimate the consumer 10(12). response to hypothetical sugary drink taxes. DellaVigna, Stefano and Matthew Gentzkow Potential Changes in Consumption of Other (2017). “Uniform Pricing in U.S. Retail Chains.” Foods and Drinks. A sugary drink tax would National Bureau of Economic Research Working lead to changes in behavior extending well Paper No. 23996. beyond a reduction in sugary drink consumption. When consumers buy fewer sugary drinks, they Grogger, Jeffrey (2017). “Soda Taxes and the also reduce their purchases of complementary Prices of Sodas and Other Drinks: Evidence goods. At the same time, they increase their From Mexico.” American Journal of Agricultural purchases of substitute goods. For example, to Economics 99(2). the extent that people buy drinks because they are Harding, Matthew, Ephraim Leibtag, and Michael thirsty, we might expect the reduction in sugary Lovenheim (2012). “The Heterogeneous Geographic drink consumption to coincide with increased and Socioeconomic Incidence of Cigarette Taxes: consumption of other drinks. As noted above, the Evidence from Nielsen Homescan Data.” American net effects of the tax on health depend crucially Economic Journal: Economic Policy 4(4):169-198. on a broad range of behavioral responses beyond Harding, Matthew and Michael the change in sugary drink consumption. Available Lovenheim (2017). “The Effect of Prices evidence, however, does not support clear on Nutrition: Comparing the Impact of conclusions about these effects. Product- and Nutrient-Specific Taxes.” Journal of Health Economics 53. Selected References Kopczuk, Wojciech, Justin Marion, Erich Aguilar, Arturo, Emilio Gutierrez, and Enrique Muehlegger, and Joel Slemrod (2016). “Does Seira (2017). “The Effectiveness of Sin Food Tax-Collection Invariance Hold? Evasion and the Taxes: Evidence From Mexico.” Mimeo, Instituto Pass-Through of State Diesel Taxes.” American Tecnológico Autónomo de México. Economic Journal: Economic Policy 8(2). 16 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Marion, Justin and Erich Muehlegger (2011). Powell, Lisa, Zeynep Isgor, Leah Rimkus, and “Fuel Tax Incidence and Supply Conditions.” Frank Chaloupka (2014). “Sugar-Sweetened Journal of Public Economics 95. Beverage Prices: Estimates From a National McMillan, Rob (2007). “Different Flavor, Sample of Food Outlets.” Bridging the Gap Same Price: The Puzzle of Uniform Pricing for research brief. Differentiated Products.” Mimeo, Federal Trade Rahkovsky, Ilya and Samantha Snyder (2015). Commission. “Food Choices and Store Proximity.” United States Nakamura, Ryota, Andrew Mirelman, Cristobal Department of Agriculture Economic Research Cuadrado, Nicolas Silva-Illanes, Jocelyn Dunstan, Service Report No. 195. and Marc Suhrcke (2018). “Evaluating the 2014 Thomassen, Oyvind, Howard Smith, Sugar-Sweetened Beverage Tax in Chile: An Stephan Seiler, and Pasquale Schiraldi (2017). Observational Study in Urban Areas.” PLoS “Multi-Category Competition and Market Power: A Medicine 15(7). Model of Supermarket Pricing.” American Economic Review 107(8). www.lao.ca.gov 17 analysis full gutter AN LAO REPORT LAO PUBLICATIONS This report was prepared by Seth Kerstein and reviewed by Brian Uhler and Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 18 LEGISLATIVE ANALYST’S OFFICE