Taxation and Imperfect Information

February 17, 2010

Taxation is offered appropriately as a solution for some market failures—spill-over effects for example. But for other market failures it seems, at best, second best. A New England Journal of Medicine article last year proposed taxing soda because people are unaware of how unhealthy it is (they also threw every other market failure behind the tax).

Several market failures exist with respect to sugar-sweetened beverages. First, because many persons do not fully appreciate the links between consumption of these beverages and health consequences, they make consumption decisions with imperfect information….

Assume that people do not know soda is bad for them. Or maybe they know it is unhealthy but just not how unhealthy. (Assume for argument’s sake. I don’t really think that is the case with most soda drinkers because of calorie labels and the internet and soda having been around a while.) That would certainly be a market failure. The market is not working because people do not know what they are buying; mass fraud. What is the best policy prescription? It seems obvious that if people do not have enough information then a policy that supplies people with information would be best. Like a website. But many jump to taxation as a solution.

It is unclear how one would even devise a non-arbitrary tax to fix a lack of information. The problem of imperfect information is not that people are consuming too much or too little of a product. No one has decided what too little or too much is. In a market one looks at a monetary price, consults their knowledge of other costs associated with the product, and makes a decision. When the state decides to increase the price because people do not know other costs, it does not solve the market failure. The state has just approximated the cost of the product for the entire population.

New York spent a couple hundred thousand on posters, made a disgusting commercial, and still Paterson proposed to tax soda. After New York required calorie labels at food chains the purchase of high-calorie food did not really change—if anything it increased bit. So people probably know the health consequences of soda. But if they do not, it does not justify a tax. At most it justifies a lame public education campaign.



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