Thursday, September 17, 2009

The "Largest" Unregulated Negative Externality

Most of the significant, and even some of the not too significant, negative externality problems have been identified and regulated in some way. We still debate the proper type and role of regulation, but at least we have made attempts at internalizing the costs of many pollution problems, second hand smoke, drunk driving, noise, and even dog poop. But there is one negative externality that has gone relatively untouched as far as attempts at regulation and that's obesity. Some cities have regulated the use of trans fats in cooking. The next step may be to tax the negative externality causing products, products high in high fructose corn syrup.

The economic argument is pretty straight forward. A negative externality is a cost bestowed on a party who did not participate in the original market transaction. In economics, these costs are referred to as external costs and should be considered a cost of production just like land, labor, and capital. If I decide to drive my gasoline powered car, I incur private costs such as the gas, car maintenance, depreciation, risk of an accident, etc. But I also create an external cost in that the emissions of CO2 and NOx from my tailpipe add to the greenhouse effect and smog. This external cost is an important cost when calculating the social cost of my behavior and if unaccounted for, constitutes a market failure. Obesity also has private and external costs. The existence of external costs means that obesity creates a market failure too.

One way to change my behavior about driving too many miles in my car, is to tax gasoline. The tax should be equal to the damage (external cost) caused by me consuming that gallon of gas. Although the demand for gas, and food for that matter, is fairly inelastic, people may still respond by reducing their consumption.

Yes, like taxes on gasoline, taxes on food are regressive (the poor would pay a larger portion of their income on these taxes) so there are equity concerns. However not all food would be taxed and maybe other income security policies could mitigate some of the distributional issues. However from an efficiency standpoint, taxes on foods and beverages high in sugar make the most economic sense.

Proposed Tax on Sugary Beverages Debated

Published: September 16, 2009

The debate over a tax on sugary soft drinks — billed as a way to fight obesity and provide billions for health care reform — is starting to fizz over.

The tax would apply to soft drinks, energy drinks, sports beverages and many juices and ice teas, but not sugar-free diet drinks.

President Obama has said it is worth considering. The chief executive of Coca-Cola calls the idea outrageous, while skeptics point to political obstacles and question how much of an impact it would really have on consumers.

But a team of prominent doctors, scientists and policy makers says it could be a powerful weapon in efforts to reduce obesity, in the same way that cigarette taxes have helped curb smoking.

The group, which includes the New York City health commissioner, Thomas Farley, and Joseph W. Thompson, Arkansas surgeon general, estimates that a tax of a penny an ounce on sugary beverages would raise $14.9 billion in its first year, which could be spent on health care initiatives. The tax would apply to soft drinks, energy drinks, sports beverages and many juices and iced teas — but not sugar-free diet drinks.

The group’s review of research on the topic, appearing in The New England Journal of Medicine, was released on Wednesday, the same day that Senator Max Baucus, the Montana Democrat, made public his health care reform plan, with an estimated cost of $774 billion over 10 years. The Baucus plan would be paid for by an array of taxes and fees on high-end group insurance plans, drug and medical device makers, and other sources, with no mention of any tax on sugary beverages.

The scientific paper found that a beverage tax might not only raise revenue but have significant health effects, lowering consumption of soda and other sweet drinks enough to lead to a small weight loss and reduced health risks among many Americans.

The study cited research on price elasticity for soft drinks that has shown that for every 10 percent rise in price, consumption declines 8 to 10 percent.

John Sicher, the publisher of Beverage Digest, a trade publication, said that a two-liter bottle of soda sells for about $1.35. At 67.6 ounces, if the full tax was passed on to consumers, that would add 50 percent to the price. A 12-can case, which sells today for about $3.20, could rise by $1.44, a 45 percent increase.

“A one cent per ounce tax would create serious problems and potentially adversely impact sales for the American beverage industry,” Mr. Sicher said.

The proposed tax faces a formidable hurdle in Congress, where several members have voiced strong opposition and few if any have said more than that they would be willing to consider it.

The soft drink industry has adamantly resisted the notion that its products are responsible for a national increase in obesity or that a tax would help curb the problem.

And even a supporter of a beverage tax said it was not clear if it would have a direct effect on the waistlines of Americans.

“I think we should be satisfied that soda taxes would be having a modest effect on consumption but would generate billions of dollars that could be used to mount public health campaigns,” said Michael Jacobson, executive director of the Center for Science in the Public Interest, an advocacy group that favors such a tax.

He said that if the tax was levied on the manufacturers of the sugary drinks they might be able to spread the cost among many of their products, from chips to granola bars to diet sodas, which would keep sugary drink users from feeling the full impact.

Nonetheless, discussion of the tax has the beverage industry on the defensive.

Muhtar Kent, the chief executive of Coca-Cola, was asked about the tax on Monday during an appearance at the Rotary Club of Atlanta and he responded by calling it “outrageous.”

“I have never seen it work where a government tells people what to eat and what to drink,” Mr. Kent said, according to a report by Bloomberg News. “It if worked, the Soviet Union would still be around.”

The industry began to coordinate its response in June when it created an organization called Americans Against Food Taxes.

On its Web site,, the group calls itself “a coalition of concerned citizens” opposed to “the government’s proposed tax hike on food and beverages,” including soda and juice drinks. Calls to a media contact listed on the site reach the American Beverage Association, an industry organization whose board is made up of top executives from the major soft drink manufacturers.

Americans Against Food Taxes bought a full-page ad last Sunday in The Washington Post. It was fashioned as an open letter to Congress, saying “Don’t tax our groceries.” It has also been running commercials on cable networks, including CNN, MSNBC and Fox News, according to Kevin W. Keane, senior vice president for public affairs at the beverage association.

Mr. Keane said that the association was heading the antitax group and that the beverage industry was paying for its activities.

He took exception to any efforts to single out sugary drinks in the fight against obesity.

“When it comes to losing weight, all calories count, regardless of the food source,” Mr. Keane said. “The bottom line is that the tax isn’t going to make anybody healthier. It’s not going to make a dent in a problem as complex and serious as obesity, and we’re certainly not going to solve the complexities of the health care system with a tax on soda pop.”

Talk of a soda tax is just the latest headache for an industry that has been struggling with flat or declining sales for many products, from sodas to bottled water.

Across the country, many schools have removed soda vending machines saying they should not be plying children with sugary drinks.

Last month, the American Heart Association urged people to reduce their intake of sugary foods and beverages to lower the risk of conditions like obesity and high blood pressure — singling out soft drinks as a prime culprit.

Even President Obama has voiced a cautious openness to the tax.

“I actually think it’s an idea that we should be exploring,” he said, in a recent interview in Men’s Health magazine. “There’s no doubt that our kids drink way too much soda. And every study that’s been done about obesity shows that there is as high a correlation between increased soda consumption and obesity as just about anything else.”

But Mr. Obama acknowledged that there would be significant resistance to such a tax.

Kelly D. Brownell, the lead author of the study and director of the Rudd Center for Food Policy and Obesity at Yale, said in an interview that a penny-an-ounce tax would have an immediate and powerful impact on the nation’s elevated obesity rate.

He said that a tax was justified in part because conditions like obesity and diabetes are often treated with public funds through programs like Medicaid and Medicare. Revenue from the tax could help pay for such care.

Acknowledging how difficult it would be to get a tax through Congress, he said state or local governments could take the first step.

That would follow tobacco, which has been heavily taxed by states in an effort to reduce smoking and defray the costs of smoking-related illnesses.

Representative Bill Pascrell Jr., a Democrat from northern New Jersey, who supports a soda tax said that House lawmakers had considered including it as part of their health reform bill but decided it was too divisive. “It didn’t look like we had the votes,” he said.


  1. "But there is one negative externality that has gone relatively untouched as far as attempts at regulation and that's obesity... ...Obesity also has private and external costs. The existence of external costs means that obesity creates a market failure too."

    I have been trying to find opinions about the negative externalities related to obesity. Your articles says they exist but don't specify what they are.

    The most commonly cited negative externality of obesity is increased medical costs. With private insurance, this is not actually a market failure because higher premiums are charged to obese policy holders. You can argue that since people who are covered by medicare/medicaid don't pay extra if they are obese, that this creates a negative externality as taxpayers must pay for the increased medical costs. However, this externalty is actually caused by the medicare/medicaid system, not by obesity.

    Do you have any other ideas on why obesity constitutes a negative externality.

  2. Here are a couple of research papers:

    1. Correction above: w16467
      and also w11303 and

  3. This comment has been removed by the author.

  4. Strictly speaking, I don't see how sugary drinks are in fact an externality. My consumption of soda does not cost you anything. In other words, I can drink as much soda as I want but this really will not affect your safety, increase the likelihood you will get sick, diminish your productivity, etc. The only argument I could see you making here for soda being an externality is that if it increases the likelihood of my getting a communicable disease, then you are more likely to get sick, and this will diminish your productivity.

    The real cause of obesity, as the previous poster pointed out, is the fact that people are insured in such a way that they have zero incentive to avoid sugary drinks b/c their premiums will not increase no matter how much healthcare they consume.

    1. Thanks for the comment. As for the direct and external costs of obesity, I recommend this article:

      As for the causes of obesity, there are many including the moral hazard effect resulting from health insurance ( However, correctly pricing health care for the obese is tricky. If you increase the price of health care for those who are obese, does this change weight related behavior or just result in a decrease in the quantity demanded of health care? If the later, then the health effects related to obesity will likely result in costlier patients who forego health care until they get a serious, much more expensive, weight related complication. Might it not be on net a lower cost option for society to provide lower cost health care that encourages weight loss, weight management, and treatment for weight related diseases when they are less expensive?

  5. Also, apparently obesity is contagious!

  6. Excellent insight and links.


  7. Thanks so much for a great post. I'd like to know more about these topics and hope that I can receive more insight into this topic.
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