Market Failure of Sugar Sweatened Beverages Essay

MONTPELIER, Vt. (AP) — A Vermont House committee voted Wednesday to advance legislation calling for a penny-an-ounce tax on sugar-sweetened beverages. The House Health Care Committee voted 7-2, with two members absent, for the tax bill that would raise an estimated $27 million to support state health programs. Supporters say it will also discourage consumption of products that are big contributors to obesity. “We have an obesity epidemic and the scientific data is clear that sugar-sweetened beverages have a unique place in contributing to this epidemic,” said Rep.

George Till, D-Jericho, a doctor and member of the Health Care Committee. He said reliable studies have shown the tax would “substantially reduce the average 44 gallons a year of sugar-sweetened beverages we drink in Vermont. ” The measure faces an uncertain future. Gov. Peter Shumlin has gone on record opposing the tax, saying it would send shoppers to neighboring states. That argument is being pushed hard by retailers and a beverage industry group that has been buying full-page newspaper ads and has launched a full-court press lobbying effort to block the tax.

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We don’t believe we should be singled out as an industry and a heavy tax placed on our products,” said David LaRose, a manager with the Coca-Cola Bottling Co. of Northern New England. He said the beverage industry already has been taking steps to reduce the beverages’ role in increasing obesity, pulling high-sugar drinks from schools, offering a broader range of low- and no-sugar products and promoting school athletic programs. The tax would be levied on distributors, rather than paid on retail sales like a sales tax.

LaRose said companies would respond by spreading the cost of the tax across their full range of products, so any price signal that might prompt a consumer to choose bottled water over a Coke would be lost. The House Health Care and Ways and Means committees have been hearing from a range of witnesses, including economists, health professionals and beverage industry executives. One witness told the House Health Care Committee that Vermont has had an unhappy history as a sales tax state located next to New Hampshire, which has no sales tax.

Art Woolf, an associate professor of economics at the University of Vermont, said eastern Vermont and western New Hampshire had equally large retail sectors up through the 1960s. Vermont passed a 3 percent sales tax in 1969, which since then has been raised in stages to 6 percent. Meanwhile, data from 2007 show that retail activity on the New Hampshire side of the Connecticut River was now outstripping that on the Vermont side by 40 percent, Woolf said.

When the production or consumption of a good/service has an effect on some third party an externality is occurring. The presence of externalities in a free market indicates that the market isn’t functioning in the most efficient manner, and a Market Failure is occurring. Producing a good/service has a Marginal Private Cost (MPC) and a Marginal Social Cost (MSC). The MPC includes the cost to a firm to produce a good/service. The MSC includes the cost to produce a good/service plus or minus the costs of any externalities.

Like production, consumption has a marginal Private Benefit (MPB) and a Marginal Social Benefit (MSB); representing, the benefit a consumer receives from consuming a good/service and the benefit a consumer receives from consuming a good/service plus or minus any benefit gain or lost by some externality, respectfully. The Market is functioning at its optimal efficiency where MSC=MSB. Sugar-sweetened beverages (SSB) are described as a main contributor to obesity, an epidemic that cost much to the health sector. The production of SSB poses what is term a negative externality of production.

This specific externality occurs when the production of a good/service has a negative effect on some third party that adds additional cost to society. Figure 1 shows the market for SSB. The MSC and MPC are represented by the positively sloped lines while the MSB is represented by the negatively sloped line. Because there is additional cost to society for producing SSB that is not included in the private cost MSC>MPC by that of the cost of the externality. Consequently an excess of Q1 is supplied at a low P1 price, an amount that is greater than the socially efficient level where Q* is supplied at a P* price.

The shaded triangle represents the society welfare loss due to the Market Failure. Figure 1 Market failure of SSB market (not drawn to scale) In the event of market failure the government intervenes. One such intervention is the use of Specific indirect taxes (SIT). SIT is a fix amount of tax that is imposed by the government upon a product. The penny-an-ounce tax demonstrates the governments’ efforts to internalize the externality and cause the market to function at the socially efficient manner.

The SIT has the effect of increasing the price of SSB; as such producers have to supply less as there is an increase in cost of factor of production, and consumers consume less as some may be discouraged by high prices. Figure 2 shows how SIT affects the SSB Market Failure. MPC is shifted upward by the amount of the SIT, where a total of Qtax is supplied at a higher price of Ptax closer to the social efficient level where Q* is supplied at P* price. There is less welfare loss indicated by the shaded triangle Figure 2 SSB market after taxed imposed (not drawn to scale)

Additionally SIT gains government much revenue, 27 million was estimated to be raised by the penny-an-ounce tax which can be used to correct the market failure e. g. by supporting state health programs. Those opposing the tax argue that the tax burden will be levied upon distributers which will see them distributing the extra cost of production across all their products, negating the very purpose of the tax and additionally cause consumer to seek lower prices in different states. Price elasticity of demand (PED) is a measure of the change in demand for a good as price changes. SSB has a very high PED.

This sees the demand for SSB being more responsive to price than the supply of SSB. Consequently the demand curve is more sloped than the supply curve. Figure 3 shows how PED determine who hold more tax burden. The demand curve is very negatively sloped while Supply moderately positively sloped. The tax shifts the supply curve upward by the amount of the tax to S1 + tax where Q1 is supplied at P1 price. The market is in a state of equilibrium where Q* is supplies at P* price. The government receives CYP1X revenue where a major CYP*Z is burdened upon the producer and a minor P*ZP1X burdened upon the consumer.

Figure 3 Market of SSB indicating who hold most tax burden (not drawn to scale) Those opposing the tax were correct about who more of the tax burden is levied upon. However, instead of distributing the added cost of the tax across several products and risking a drop in demand for those products, producers are more likely to decrease production of taxed products to the social efficient level ultimately seeing the success of the penny-an-ounce tax. Finally, I caution the government to prepare for long term effects e. g. unemployment that this tax may cause. Words: 748

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