Governmental financing externalities

There have been proposals to tax soda drinks because they make people fat and unhealthy, and thus increase medical costs that are paid for by the government. The advocates of soda taxes claim that the sugary drinks create a negative externality, which the soda drinkers should prevent by paying for their future medical costs via the soda tax. However, these advocates evidently do not understand the economics of externalities.

An external effect, or externality, is an uncompensated impact on others. A negative externality imposes a cost on others. Pollution, for example, that trespasses into others’ property, without compensation to those affected, is a negative externality.

In contrast to a real externality, a physical invasion into others’ domains, a pecuniary externality is an effect on others caused by economic activities that do not physically invade others but affect them by a change in prices or profits. For example, if one company increases market share, the others which lose market share suffer a pecuniary externality. Economic analysis concludes that real externalities should require compensation, while pecuniary externalities should not.

A third type of externality is a governmental financing externality, in which the activity of some people impose a cost on others because they are forced to pay taxes to pay for that activity. That applies to the consumption of unhealthy food when taxpayers pay for the medical costs.

If people fully paid for their medical costs, then drinking unhealthy sodas would not impose an externality. The sugar would make the drinker fat and sick, and he would pay for the medical expenses. It is only because government subsidizes medical expenses with Medicare, Medicaid, and other governmental financing that a cost is imposed on others. So this is an externality caused by government policy.

Thieves impose a real externality when they invade property to steal wealth. Government likewise imposes a real externality when it forcibly extracts wealth from taxpayers. If externalities are bad and should be prevented, then the first policy response should be to abolish taxation except from sources, such as land, that do not suffer negative externalities.

The taxation of land rent obtains wealth which is a surplus, funds left over after paying for the costs of labor and capital goods. After the land-rent tax is in place, even the landowner suffers no externality, since the tax just replaces the mortgage interest he would otherwise have paid.

The argument for the forced extraction of wealth from soda drinkers collapses when one realizes that the tax itself is an externality, and that the governmental financing externality would not exist if we untax labor so that workers can then afford to pay for their own medical costs.

The concept of using taxes to reduce the consumption of unhealthy food, if applied generally, would get bogged down in controversy. For example, there are claims that some sugar substitutes are unhealthy. Some nutritionists claim that eating meat is unhealthy, and most experts agree that eating processed foods such as cookies is unhealthy. Others say these are acceptable in moderation. So a proposal to tax foods made from wheat flour, or with sugar, or too much salt, or sugar substitutes such as aspartame, or meat, or milk products, or too many chemical additives, would be disputed. There are difference in views about supplements such as vitamins, minerals, and enzymes. Controversies among experts in nutrition make economics look good by comparison.

The better proposal is disclosure. Require a logo such as a skull and crossbones for foods for which there is a wide agreement that they are unhealthy. A poison logo would be put on foods such as sugary candy, salty crackers, and fatty bacon. Such disclosure is now being made for fish that may contain mercury and on tobacco products, and there are warnings on some foods that pregnant women should not consume these.

A tax on an externality created by government policy is a perversion of the economic policy of charging for real externalities. As law professor Eugene Volokh has written, the “solution to this problem is to eliminate the government financing that created the ‘externality’ in the first place.” Just as pecuniary externalities have a different moral and economic effect from real ones, so should the policy for governmental financing externalities be to abolish them, not use them as an excuse to impose yet another tax externality.