Practicalities defeat 'Fat tax'

Denmark introduced the worlds first 'Fat Tax' just over a year ago. It was covered in this blog and got one of the highest number of hits of any post to date.

Now Denmark is scrapping the tax. They say its because it has cost jobs, caused people to go into Germany to shop and inflated prices.

Well taxes do raise price! That's the point. This is a disappointing move as it represents a victory political expediency over economic policy.

It would be nice to find out how much the tax changed behaviour, especially in areas a long way from the German border.

If there is an important lesson to learn it is that a country acting alone can disadvantage itself. This has often be said of acting on carbon emissions and pollution. If you impose higher costs on domestic firms in a market with few barriers to international movement then the result maybe that firms move. So perhaps the answer is a European Fat Tax; good luck convincing David Cameron on that one.

The Daily Mail report the story here

When regulation is necessary

Governments have tried everything to reduce smoking. 

They have used the best method available to such a market failure - tax and forced the price up to many times the actual cost of production. The problem is that this addictive good has very inelastic demand and so the effect on existing smokers is small.

Two primary methods of moving the demand curve to the left have been tried:

Education has failed. Everyone knows that smoking is bad for them, but they have failed to understand the full extent of the damage they do to themselves yet young smokers continue to take up the habit.

Banning advertising has not worked either.

However all these measures have reduced smoking and it is much less of a problem than it was in the 1960's when almost everyone smoked.

So what can governments do when they are faced with the failure of policy to correct this market failure? Unusually the best answer is more regulation. Normally the best solution to market failure is some sort of tradeable permit, then tax, but not with smoking.

The latest attempt is the banning of distinctive packaging. This has been introduced by Australia where all cigarette packets are now olive green with nasty pictures on them. The idea is to deny brand loyalty and make them unattractive.

Of course the tobacco companies claim its not going to work and even claim it is unfair. But these were the same companies who claimed smoking didn't cause cancer when they had evidence that it did, so lets not take too much notice of them.

The Telegraph report the new scheme here

Poor consumption decisions lead to poor health

Today there is news that in the UK deaths from liver disease has risen by 20%. Is this a surprise? Yes, because in the rest of Europe deaths from the same cause have fallen by 20%!

The cause of liver failure is usuall either drinking too much, being overweight or having a poor diet. Of course hepatitis, which is an infection, can also cause liver failure.

From our point of view this is another example of market failure. It is caused by consumers failing to take into account the full information available about the goods they consume.

There are three different failures identified here, but all have a similar cause. Lack of information, or demerit goods, are over-consumed compared to optimal levels.

In the case of alcohol there is already a high tax, but a minimum price per unit of alcohol will soon be considered by the government in an attempt to reduce binge drinking. As for poor diet and over-eating the question about how to tackle this remains unresolved.

What is certain is that more education will help in all three cases and stories like the one in The Guardian below needs to be taken seriously.

The Guardian story is here

Regulating demerit goods

Merit goods are technically 'lack of information goods', where consumers do not have all the information necessary to make a decision on consumption, or ignore information that is relevant.

Demerit goods, such as tobacco, are similarly lack of information goods. Where they are present in the market an inefficient allocation of resources will occur as consumers maximise perceived private benefits weighted against private costs.

They consume to the point where Marginal Private Benefit equals Marginal Private Cost. With demerit goods Marginal Private Cost understates the true costs of consumption and so the market fails.

One way to correct this is through price. A tax will raise private costs and reduce consumption. But what if the harm done by the good is so great that the optimal level of consumption is zero? Then regulation must be used to ban the good or service.

In Australia it has long been recognised that ultraviolet radiation causes skin cancer. It appears that sunbeds cause a much greater amount of harm than natural sunlight, but consumers do not consider the full information on harmful effects and continue to use sunbeds.  Therefore Australian governments are starting the process of banning sunbeds.

As with all policy choices there are costs of acting. There is no guarantee that it will work for a while as second hand sun beds are traded and who knows if there will be a trade in illegal sunbeds from states that do not act? Of course zero may not be the optimal level of consumption of sunbeds, for example some people suffer from a lack of vitamin D and need them to correct this. All regulation is a guess and can be a sledgehammer to crack a walnut.

The Age report on progress in Victoria to ban sunbeds here

When adjusting prices does not work

Markets do not always allocate resources efficiently. One such market failure is in the area of demerit goods such as tobacco.

Demerit goods are more accurately described as 'lack of information goods'. Consumers do not fully appreciate the costs and benefits of consumption and so the demand curve for the product is further to the right than it would be to achieve an efficient allocation of resources.

The usual response to this type of market failure is to tax the good. This raises the price and so reduces consumption. However sometimes this does not work to the extent desired. For example with tobacco consumers are addicted and the PED is very inelastic. Educating the population on the dangers is therefore another option and that can include graphic pictures of the harm that tobacco does.

One area of great concern is the diet of the nation. We eat too much overall and or diets include too much fat and salt. This is very concerning because of the health impacts which will shorten life expectancy and impose heavy costs on the NHS.

Taxing fat and salt is difficult, mainly because of the very many products involved. In addition any tax on food would be highly regressive as food takes up a higher proportion of the income of poor households. So far education has not been that effective. Therefore resorting to warning people at the point of sale and trying to get them to more fully consider the information about the product may help.

People know that fat is bad for them in too great a quantity (as are too may calories, salt etc). What they don't know is how much of each is in modern processed food. For some time there has been a call for a uniform method of labelling food to show the content. Each retailer and manufacturer disagreed on the format (some prefer traffic lights others % of daily maximums etc).

Now there is agreement on a uniform system that combines all of the approaches. The move has to be accompanied with education which allows people to understand the dangers of exceeding the recommended daily amounts. But if successful then the demand for high fat and salt goods will shift to the left.

Unfortunately this is only going to be a voluntary scheme so it falls short of 'Regulation'. It is, however, a good example of where adjusting prices is not enough and an example of an alternative policy to reduce market failure. But will it work?

The BBC covers the story here

Lack of information goods - Pensions

A market can only work efficiently if both sides of the market (buyers and sellers) have all the information they need. Therefore a common market failure is where one side of the market has insufficient information or places too little value on that information.

Pensions are an excellent example. Many people do not save enough for retirement because they do not fully understand the benefits. This makes them look on pensions as too expensive and they decide not to 'consume' that service.

The problem with pensions is that the benefits are a long way into the future when you are in your 20's. When you realise that you need a pension it is too late to build up one you are satisfied with.

So the solution is to make pensions more attractive. Until now the government has given a tax incentive to those contributing to pension schemes. All contributions are 'tax free' saving 20% of the cost and up to 40% for higher rate tax payers.

Despite this generous incentive the number of people in private pension schemes has dropped below 3 million for the first time. (There are around 5 million in public sector schemes.) With 29 million people in work this means around 21 million workers in the UK have no private pension.

Of course the state will pay everyone an old age pension and there is a state earnings related pension, but this may not be enough to let people live comfortably. If that happens the government will end up paying out more benefits in other forms and with an ageing population they can't afford that.

So a new scheme is being introduced. All employers will have to offer a workplace pension and all workers will have to opt out of their workplace schemes. It is hoped that the effort of having to do so will mean many people will get a private pension by default.

This is an example of regulation and looks like being more successful than the market solution of tax rebates (although that remains too).

The Independent reports the scheme here

Imperfect information - the case of payday lenders

In recent years there has been a boom in the business of lending people small amounts for short periods. These have become known as 'payday lenders'.

They specialise in allowing people to meet their bills between today and the next time they are paid. It seems an easy way to manage personal cash flow. Added to this the small loans are easy to arrange and the borrower can choose the term of the loan.

So what is the problem? Do the borrowers actually fully understand what they are doing? The interest rates are potentially 16,000% (although that is very unusual) and always much higher than borrowing from a bank or even a cash advance on a credit card.

The industry is, according to many, under-regulated. Are people being properly informed about what they are buying? This lack of information market failure can lead to disastrous consequences where consumers make bad choices, in this case buying more services than are optimal. The financial services industry has many other examples of this, such as payment protection insurance and endowment policies.

The attached article makes the concerns of many clear. People may well start taking out loans each month or week out of habit and believe they are managing their finances. In fact they will be compounding mismanagement of their finances and in the end they will reach the limit of their ability to borrow but with higher and more expensive debt.

Another worry is that this is just another example of 'sub-prime lending'. This was the cause of the credit crunch when banks extended mortgages to those who were in weak and unreliable financial circumstances. Maybe the lenders think this is safer, lower amounts and faster repayments so default on the scale of 2007/8 is impossible? But where is the moral justification for this? Lending to people not able to fully understand their product and endorsing behaviour that is unsustainable.

This does need sorting!

The Guardian covers the story here