Taxes on tobacco, alcohol and gambling: Contradictory objectives that are hard to attain

Montreal, Wednesday, January 22, 2014 – At the end of 2013, Finance Minister Nicolas Marceau announced a deficit of $2.5 billion for 2013 and $1.75 billion in 2014-15. In order to achieve a balanced budget, the temptation might be to increase taxes on certain products deemed to be harmful like alcohol or tobacco. But in fact, far from being the miracle solution to budgetary and public health problems, sin taxes often have unwanted consequences, according to a new Economic Note published today.

Sin taxes are sometimes justified by establishing dedicated financing for specific programs. However, the funds collected are sometimes repurposed to pay for government expenditures other than those that justified the creation of the taxes. Quebec’s Olympic tobacco tax is a case in point. In 1976, the government doubled the tobacco tax in order to allow the Régie des installations olympiques (RIO) to reimburse the debt accumulated in the building of the stadium.

“This increase was justified by the fact that from that point on, 48% of the tax had to be paid to the Fonds spécial olympique (FSO). And yet, we calculated that between 1976 and 2006, the period during which the FSO was in operation, only 18.4% of the revenue from the tobacco tax was transferred to the FSO,” explains Jean-François Minardi, the author of the study.

One of the justifications for setting up these taxes is the modification of consumer behaviour. Numerous studies have shown, however, that after an initial reduction, the level of consumption of products like tobacco generally reaches a threshold beyond which remaining users will tend not to modify their behaviour any further. The case of Quebec provides a good example of this, as the prevalence of tobacco use has hovered around 24% since 2003 despite the fact that the price of cigarettes has doubled during this same period.

Another unintended consequence of sin taxes is that when the tax level becomes too high, tax receipts start to fall. Sin taxes in general cannot increase government revenue all while simultaneously contributing to the reduction of the consumption of the targeted products.

The tobacco tax is a particularly regressive tax that hits the poor four times harder than it hits the wealthy, among other things because the rate of tobacco use among the poorest people is 50% higher than among the wealthiest. For this reason, an additional hike in tobacco taxes, which already account for 63% of the average price of a pack of cigarettes in Quebec, would impact low-income people in particular. “Rather than continuing to raise these taxes, governments would be better off themselves practising the virtue of thrift in order to balance their budgets,” concludes Jean-François Minardi.

The Economic Note entitled “The Unintended Consequences of Taxes on Tobacco, Alcohol and Gambling” was prepared by Jean-François Minardi, in collaboration with Francis Pouliot, both public policy analysts at the Montreal Economic Institute. This publication is available on our website.

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The Montreal Economic Institute is an independent, non-partisan, not-for-profit research and educational organization. Through its studies and its conferences, the MEI stimulates debate on public policies in Quebec and across Canada by proposing wealth-creating reforms based on market mechanisms.

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