A sugar tax wouldn't just be paid by the manufacturers

There is a very common misperception in the public about who pays the cost of excise taxes (taxes on the sale of goods or services). In most respects, it actually does not matter whether a tax is levied on the sellers (producers) or buyers of the product or service - the tax will be shared between both the sellers and the buyers.

As one recent example of this misconception, see this comment by Gwen in the NZ Herald Rants and Raves yesterday:

After reading the item in the Herald about introducing a sugar tax, I think surely the manufacturers are to blame, and therefore they should be paying a sugar tax, not the taxpayers who already have plenty of tax costs. Come on manufacturers, take a sugar pill and reduce sugar in all your products. Life is so sweet.

Unfortunately, if a sugar tax was introduced there is no way to ensure that it would only affect manufacturers. To see why consider the diagram below, which represents the market for some sugary food product (for simplicity, we'll assume that the sellers in this market are the manufacturers). With no tax, the market operates in equilibrium with the price P0 and the quantity of sugary food products traded is Q0.

Now say that the government introduces a tax - we'll assume it is what we call a 'specific tax', which is a constant per-unit amount (e.g. $1 per sugary food product). Let's say the government levies this tax on the manufacturer - the manufacturer must pay this tax to the government. The effect of this is like increasing the costs of supplying the market (because in addition to their usual costs of production, the manufacturer must now pay a tax for every unit of sugary food product they produce). To represent this on our market diagram, we create a new curve (S+tax), which represents the costs of supply (S) plus the cost to the manufacturer of the tax. In effect the S+tax curve is vertically above the supply (S) curve by exactly the per-unit dollar value of the tax.

With this new tax in place, the manufacturer will increase the price that they charge customers for the sugary food product, to PC. This is the new (higher) price that consumers pay for the product. The manufacturers receive that price, but then must pay the tax to the government, and the quantity of the good that is traded falls to Qt (note that this is likely to be the point of the sugar tax - to reduce consumption). The effective price that the manufacturer receives (after deducting the tax) is the lower price PP. The difference between PC and PP is the per-unit value of the tax. However, the important point here is that, even though the manufacturer is the one paying the tax to the government, the consumers pay part of the tax (the difference between PC and P0), and the manufacturers pay part of the tax (the difference between P0 and PP). It isn't possible to mandate that the manufacturers face the burden of the tax alone. In the diagram above, the manufacturers and the consumers have roughly equal shares of the tax burden.

In fact, it might be worse. There are some that argue that sugary products are addictive. If this were the case, we would expect demand to be relatively inelastic (demand would not respond much to price, because addicts will continue to buy roughly the same amount even if prices rise a lot), which leads to a demand curve that is relatively steep, as in the diagram below. Now think about the share of the tax burdens in this case. Notice that the price for consumers (PC) has increased significantly over P0, while the price for manufacturers (PP) has barely changed. The burden of the tax falls mostly on the consumers! And to make matters worse, the quantity of the sugary food product traded barely changes at all (falling from Q0 to Qt).

So while a sugar tax might be effective in reducing consumption, if sugary products are indeed addictive it would take a large sugar tax to have an effect on obesity and health (unless people switch from sugary food products to fatty food products instead!). Note that large excise taxes are what we currently apply to tobacco.

Finally, what happens if the tax is levied on consumers instead of manufacturers? To do this you would have to find some way of making the consumer pay the tax directly (rather than having it collected by the seller). One way is to require consumers to buy a time-limited licence (or some other document) allowing them to purchase a stated number of units of sugary food products. They buy this licence from the government (which is their tax payment), then take the licence to a seller to buy the product. Sellers would only be legally allowed to sell to licence-holders, and only the quantity that the licence permits. In diagrammatic form, it looks like the market below.

As before, with no tax the market operates in equilibrium with the price P0 and the quantity of sugary food products traded is Q0. With the tax, the net benefit of purchasing is lower for the consumer - this is similar to a decrease in demand. We represent this with a new curve (D-tax), which represents the benefits to consumer of the sugary food product (D) minus the cost of the tax (or licence to purchase). In effect the D-tax curve is vertically below the demand (D) curve by exactly the per-unit dollar value of the tax.

Note that the effects of the tax look identical to those in the first diagram in this post. The consumers pay a higher effective price (PC, which is made up of the PP they pay to the manufacturer, plus the amount paid to the government), the manufacturers receive a lower price (PP), and the government pockets the difference in prices. Quantity traded falls from Q0 to Qt.

However, we don't typically see taxes on consumers (rather than producers) because they are more difficult and costly to collect. It is relatively easy and cost-effective to collect taxes from sellers, because there are fewer of them (than buyers), and because they have to advertise where they are (otherwise buyers couldn't find them) it is easy for the tax collectors to find them.

Having said that, if you wanted to really increase the cost of sugary food products to consumers, making them buy a licence to purchase at a local government office before they can go to the store and buy a Snickers bar is certainly going to make many of them reconsider!