Fat Tax Complications

About four months ago, I gave a talk at a planning meeting of the Institute of Medicine of the National Academies hosted by the CDC.  The title of the meeting was the "Exploring the True Costs of Food."  Health, nutritional, epidemiological, and environmental experts from all the top Universities were there as were representatives from major livestock industries and food and environmental NGOs.  

The implicit objective of the meeting was to determine factors affecting the "true" cost of food.  As an economist, my initial response to such inquiries is "markets already do that."  Except when there are externalities.  Aside from what seemed (at least to me) some slivers of agreement on a few environmental issues, there was remarkably little agreement between some of the economists in the room and the nutrition/health experts on the extent to which obesity and other diet-related diseases represent an externality.  

I won't rehash the whole debate in one post, but I do want to make reference to one issue that I mentioned several times at the meeting.  It is an issue that Robert Murphy discusses in a feature article just released at the Library of Economics and Liberty.  His argument, which relies on work in an American Economic Review article by Bovenberg and Goulder, relates to carbon tax swaps, but it could equally apply to issues like fat taxes.

In short, even if we could agree that obesity and dietary-related diseases represent an externality (and we don't), one would still have to do the really hard work of determining the "optimal" tax.  This hard work is further complicated by the fact that there are myriad distortions in the economy from other taxes, subsidies, and regulations.  Another complicating factor is that an "optimal" tax is not a static measure - it changes constantly with prevailing conditions such that the "optimal" tax at one point in time can actually do more harm than good when market conditions change.  Just look at a plot of corn or soybean prices over the past five year and it is quite clear that market conditions can and do change rapidly.  Moreover (and this is one of the key points of Murphy's article), it can't be taken for granted that the revenues from a fat tax would be subsequently used in ways that generate economic benefits that are often presumed by fat tax advocates.  

Here is the second paragraph of Murphy's article:

Although the thinking underlying the conservative case is correct, there is a potential downside from a carbon tax swap. This negative side effect is rarely mentioned in any but the most technical discussions. It is the "tax interaction effect." A new carbon tax can exacerbate the harms caused by pre-existing taxes, thereby offsetting the potential environmental benefits. What's worse, not only can the tax-interaction effect operate in theory, but also numerical simulations suggest that it might be very large in practice, greatly reducing the "optimal" carbon tax.

and the last:

Proponents of a carbon tax swap deal are right when they claim that the gross harms of a new carbon tax can be partially offset if its receipts are used to reduce other taxes. However, they typically leap from this true claim to the unjustified conclusion that a revenue-neutral carbon tax will be a "win-win" for the economy—by reducing distortions from the tax code as well as providing environmental benefits. On the contrary, it is theoretically possible and empirically likely that a revenue-neutral carbon tax will impose more deadweight loss on the economy, offsetting at least some of the potential environmental benefits. A carbon tax may still be a good policy, but its proponents should first understand the tax-interaction effect before making their case and choosing the tax level.