Sugar tax in Newfoundland and Labrador

Impact of soft drink tax in Newfoundland and Labrador and alternate policies to benefit society as a whole against sugary beverages This periodical analyses a hike in the indirect tax on sugary drinks in the Canadian province of Newfoundland and Labrador. It deals with problems related to negative consumption externalities together with welfare loss and provides solutions such as negative advertising, a cap on the quantity of sugary beverages produced, and collaboration with other companies such as Givaudan and Sensient technologies to reduce sugar levels. Sugary beverages are deemed as demerit goods since they are goods which are more harmful to individual consumers than they realise. Large consumption of sugary drinks can lead to obesity which refers to a disorder regarding excess body fat due to which there is an increase in the risks of health problems. Sugary beverages are dangerous since there is a strong correlation between sugary beverages and a high risk of cardiovascular diseases. In order to tackle this problem and keep it at a socially optimum level in terms of quantity consumed, an indirect tax was imposed in Newfoundland and Labrador. An indirect tax refers to a type of tax where the burden of the tax can be shifted from the taxpayer to someone else. This indirect tax has been imposed from April 2022, aiming to “place greater emphasis on healthy living which is central to achieving better health outcomes.” The indirect tax is levied on the supply of goods and services purchased in Canada.

The key concept identified is government intervention, where governments become involved with the working of markets. The intervention of the government is aimed at ensuring the success of the economic well-being of society since "over half of Newfoundlanders and Labradorians residents aged 12 years of age and over have at least one chronic disease, and many people live with more than one.”

Sugary beverages are deemed as demerit goods since they are undesirable to society and are overproduced. This causes negative consumption externalities: consumers create external costs which are borne by a third party - in this case increasing health care costs - causing market failure. The government’s increase in tax may reduce overconsumption by raising prices, decreasing demand, and correcting the overallocation of resources.

Figure 1: [Correcting negative consumption externalities] In the above diagram, MPC refers to the firm’s private cost of producing one more unit of the sugary beverage and MSC refers to society’s cost of producing one more unit of the sugary beverage. MPB refers to the benefit received by consumers from consuming one more unit of the good and MSB refers to the benefit received by society as a whole from consuming one more unit of the good.

The overconsumption of sugary beverages causes adverse effects on third parties who are not a part of the consumption or production of the good, such as an increase in health care costs. According to Figure 1, the result is a decrease in supply from MPC to MPC + tax. If the tax equals the external cost, the MPC + tax curve intersects MPB at the socially optimal level of output (Qopt), so the quantity produced and consumed drops to Qopt. To reduce this external cost and internalise the negative consumption externality, the government has imposed a tax, shown above as a leftward shift of the supply curve to S=MPC + Tax and a downward shift of the demand curve from MPB to MSB. The consumption of sugary drinks can cause external costs such as increasing health care costs which can be thought of as negative benefits due to which the MSB curve lies below the MPB curve. By changing the relative prices of sugary drinks, the tax creates an incentive for consumers to change their consumption patterns: the goods that are taxed become more expensive so consumption is reduced. However, there are a number of difficulties with this approach, since the tax level is not exactly quantifiable. Knowing the right level of taxation is difficult for the government since there are technical difficulties in trying to assess who and what is affected, as well as to determine the value of the external costs, on the basis of which a tax can be designed. A multi-pronged approach using financial, information, defaults, and availability strategies are required. As a result of this, the sugar tax might be set too low, so the externality would not be internalised as the price increase is not large enough to decrease the equilibrium quantity to the socially optimum level of output. If the tax is set too high, there may be unintended consequences that can lead to government failure where the cost of intervention outweighs the benefits. For example, firms may shut down or leave the market.

Demand for sugary beverages is price inelastic because they may be considered necessities, certain people find them addictive, and they lack substitutes. Therefore, as the price increases from Pm to Pc, the quantity decreases from Qm to Qopt (by the law of demand). However, the percentage decrease in quantity demanded is smaller than the percentage increase in price, the decrease in quantity will help reduce the misallocation of resources but not fully solve the market failure. In this sense, if consumers are absorbing a large proportion of the price rise and not greatly reducing consumption, problems of overconsumption and overproduction will remain.

Figure 2: [Welfare Loss] Figure 2 shows the welfare loss from negative consumption externalities shaded in gray. It represents the reduction in benefits for society due to the overallocation of resources to the production of the good. For all units greater than Qopt, MSC>MSB, indicating that sugary drinks are being overproduced. The welfare loss is equal to the difference between the MSC and MSB curves for the amount of output that is overproduced relative to what is socially optimum. If intervention takes place and this externality was corrected, society would experience a welfare gain represented by the shaded area.

Figure 3: [Negative advertising to solve demerit good market failure]

To prevent adverse effects detailed above, such as consumers absorbing the price increase and not greatly reducing consumption, the government could pursue alternative policies aimed at reducing demand by spreading awareness about the health hazards of sugary beverages. Negative advertising or information provision, as shown in Figure 3, could help to solve market failure where information failure is the root cause of the problem. This could take the form of TV campaigns, print advertising, or changes in the school curriculum. Individual consumers would become better informed when making decisions about sugary beverages as they will understand the adverse health effects. Therefore, they will consume less, f shifting the demand curve to the left from MPB to MSB. The market will then operate at the socially optimal level of output, solving overconsumption and overproduction, and attaining allocative efficiency.

The government could cap the quantity of sugary beverages produced, but this is likely to raise prices and lead to the emergence of unregulated black markets, which may sell low-quality sugary beverages, raising serious health concerns.

The tax imposed as a result of government intervention is regressive in nature, which means that lower-income earners pay a greater proportion of their income as tax than those with higher incomes, thus widening income inequality. However, the government could use the income from this increase in taxation for other schemes which benefit those on lower incomes, in order to counteract this increase in income inequality. This could take the form of the provision of merit goods so that lower-income earners can alter their consumption to improve their standard of living.

A single policy such as a tax does not have the capabilities to immediately reduce sugary beverage consumption to socially optimum levels and significantly improve the health of the population. In order to create meaningful change in the level of sugary beverage consumption patterns, current and future policies should be dynamic, adapting to changes in the market, and consumption conditions and patterns.“Scaling sugar-sweetened beverage policies with demonstrated effectiveness, testing innovative approaches, and implementing multiple tactics to address consumption-related issues concurrently will also help to maximize impact.”2

Newfoundland and Labrador would require a diverse approach to address problems related to health outcomes that is fair to all the stakeholders, including consumers and firms. This approach will take time and would ideally require collaboration with other companies such as Givaudan and Sensient technologies. However, its outcome would be effective in the long run, as it would improve the health of Newfoundland and Labradorians. If the policies implemented by the government are successful in reducing sugary beverage consumption to the socially optimal level, then the government would achieve its goal of encouraging consumers to switch to healthier beverages, resulting in long term health gains for the province. References Newfoundland and Labrador says soft drink tax coming in 2022 will be Canada's first | CTV News1 Sugar Sweetened Beverage Tax - Finance (gov.nl.ca) Sugar-Sweetened Beverage Reduction Policies: Progress and Promise | Annual Review of Public Health (annualreviews.org)2 Legislation on Making Better Beverage Choices Being Introduced in the House of Assembly - News Releases (gov.nl.ca) FINAL Report – Proposed SUgar Sweetened Beverage tax in Newfoundland and labrador: a Review of the business and economic implications (canadianbeverage.ca) Canada: New “sweetened beverage tax” enacted - KPMG United States (home.kpmg) Newfoundland and Labrador introduces legislation to create sugar sweetened beverage tax - Retail Council of Canada The soda tax may not be popular, but here's the thing: it will save lives | CBC News Public Health Concerns | The Nutrition Source | Harvard T.H. Chan School of Public Health