Social engineering through the tax system is nothing new. Both Tory and Labour chancellors have become excited at the prospect of initiatives to encourage spending in one area and discourage it in another.
George Osborne is the latest to give it a try. In Wednesday’s budget the chancellor said he wanted to save the nation from an obesity crisis with a tax on fizzy drinks. He said he was convinced that his levy of up to 24p on a litre of fizzy pop would reduce consumption and reap a tax dividend for the exchequer. The independent forecasters at the Office for Budget Responsibility agreed. Without a change in behaviour, Osborne would be more than £900m a year better off, but the likely deterrent effect of a higher price would reduce this to £520m.
The current chancellor is following a path well trodden by predecessors. Gordon Brown – when in No 11 and No 10 Downing Street – was famous for it. Tax credits were designed to overcome the poverty trap and act as an incentive to work; solar panel subsidies were aimed at reducing global warming; reductions in capital gains tax on assets held for more than 10 years encouraged long-term investment.
In some cases, the effect was clear-cut. Solar panel sales have added around eight terawatts to the national grid since subsidies were introduced in 2010. Such was their success that Osborne pulled the plug and almost killed the industry in the process.
This situation can be avoided if the subsidy is pitched at a level that generates the desired take-up, but the Treasury often makes estimates of how much a subsidy will cost and gets its maths horribly mangled.
The success of tax credits was less clear-cut, but undoubtedly people on benefits found the income top-up made work worthwhile. The initial cost was £9bn. That was in 2003; by 2009 it had ballooned to £27bn and the next year hit £30bn as the collapse in UK average earnings meant claimants qualified for more of the credits.
Critics said the Treasury had failed to envisage the unintended consequences of the scheme, which they said was used by employers to subsidise wage costs rather than reduce profits. Osborne joined the critics last year, but was forced to reverse a near-£4bn cut in tax credits after it was made clear that employers were unwilling to fill the gap with higher wages.
The International Monetary Fund and the Organisation for Economic Cooperation and Development have both argued that tax incentives can change behaviour for the better. One bugbear is that high taxes on incomes, relative to taxes on wealth, across the developed world increasingly punish those who draw their income from work and reward those who draw their income from selling assets.
They have called for governments to begin reversing the tax incentives or risk discouraging workers from making the investments needed to improve skills and adopt new ways of working.
Kate Smith, a senior research economist at the Institute for Fiscal Studies, says that from an economist’s point of view, subsidies work in the same way as taxes to encourage or discourage behaviour, but in practice can produce very different results.
The sugar tax is like the excise duties the UK currently levies on alcohol and cigarettes. Smith says: “There are different types of goods and services that have wider costs to society the consumer doesn’t pay for when they make a purchase. One way we might make up for this market failure is by imposing a tax that brings into line these external costs of consuming the good or service.”
But like tax credits, it can be complicated. Smith says the incentive can work for some people and act as a punishment for others. “Take the instance of an already obese person who buys a fizzy drink with lots of sugar and a marathon runner. There are external costs of the obese person buying the drink in terms of health costs for the NHS, but not the marathon runner. So is it fair to tax both in the same way?”
Then there is the prospect of sugar addicts getting their fix from other products, such as cakes, which have neither the sugar tax or even VAT applied to them. If they want a sugary drink, then a caramel latte, which is excluded from the tax, will probably have more sugar than a can of Coca-Cola.
Osborne made it clear last year that the evidence was against a sugar tax reducing obesity significantly. Smith says studies by some US states back up his scepticism: consumers switched to untaxed sugary drinks and the consumption of sugar remained stable.
“You are taxing a product for which there are quite close substitutes,” Smith says, which makes it difficult to estimate the impact.
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