The Sin Tax

The search for government revenue in fiscally tight times tempts legislators to raise revenue by imposing unusually high excise taxes on cigarettes, liquor, gambling, and so on. This type of charge, often called a "sin tax," appeals to voters who view it as a way of discouraging consumption of certain objectionable products. Yet the temptation to impose sin taxes is one that should be resisted for economic and moral reasons. The consequences of the sin tax are often the very opposite of those intended by its designers. Rather than increasing revenue, the sin tax can reduce it. Rather than discouraging what are regarded as morally questionable behaviors, the sin tax can make them more appealing. Rather than reducing what are perceived to be internal costs of the sin, the sin tax can increase them and expand them to society as a whole.

The sin tax, moreover, fails to consider the crucial distinction between vice and crime. Before we empower the government with what are, effectively, pastoral responsibilities, we ought to consider fundamental issues regarding the interplay between private morality and public policy.

The use of sin taxes and controls on vice generally date back to before the Founding. Puritan New England was awash in laws attempting to control sin, and the means varied from taxes to outright prohibition. These were known as sumptuary laws, defined as the regulation of extravagance in food, dress, tobacco use, and drinking on religious and other grounds (North 1988, 41-61). In 1651, for example, the magistrates and deputies of Massachusetts passed legislation forbidding "the wearing of gold or silver lace, or buttons, or points at their knees, [walking] in great boots; or women of the same rank to wear[ing] tiffany hoods or scarves..." Import taxes were placed on luxury items, including sugar, spice, wine, and tobacco.

Massachusetts and Connecticut passed laws restricting the consumption of the "noxious weed." Also in Massachusetts, shuffleboard was considered a grave danger, because people were spending their time in this vain pursuit instead of working for the community good. But the overly ambitious laws went unenforced, and became relics of a first generation American confidence in the possibilities of the power of statecraft.

Our present era, though hardly akin to Puritan times in its faith in God, is no less anxious to pass laws to enforce minute aspects of behavior. Rather than let these laws go unenforced, as the Puritans eventually did, today we seem to have become even more confident about the ability of the right legislation to overcome intractable desires on the part of the consuming public.

To understand the economic consequences of sin taxes, we must temporarily leave aside the morality or immorality of the good or service being taxed. In economic terms, the sin tax is not categorically different from any tax designed to discourage consumption. These taxes constitute one or both of two major types of government intervention: binary or triangular (Rothbard 1970, 24-202).

In binary intervention, the government deals directly with the individual in society and not with a third party. The income tax is a good example of this. The government, for example, establishes a rule that every individual must give up 30 percent of personal income to the public purse, which then turns it over to those deemed in need.

Sin taxes can be binary. The state can tell every person who smokes, drinks, or engages in other vices that he or she must pay a fixed price for that action to the public purse. The state can mandate all smokers to pay the state $100 per year for the privilege of smoking and $100 per year for moderate drinking. Only two parties are affected in this exchange: the individual taxed, who must bear the burden, and the government, which benefits from increased revenue.

Every dollar taken away from people through this binary approach is one dollar less saved or spent on other pursuits. We know there will never be perfect substitution, that is, where the $100 the smoker pays for the right to smoke will come directly out of the smoking budget. If the person is going to pay the tax to smoke, and thereby sacrifice some of his income, he will use that right to the maximum. More than likely, if the person wanted to give up the habit, he or she would have done so before the tax was forced upon him.

Because it does not tax the act itself, the binary sin tax would make little difference in the amount of sin in which any individual who can pay the tax partakes. Those who do not pay it are forbidden from the sinful practice altogether. But those who can afford to will be likely to retain their present level of sinning, or, having paid a one-time fee for the right, might even increase the habit. Under the binary sin tax, the rich find the sin to be less onerous than do the poor.

If the government is seeking to make people pay for actions deemed socially costly or sinful, it intuitively makes the most sense for these people to be taxed directly for the right to sin. Yet there are very few examples of this binary model of the sin tax. Instead, the modern sin tax usually proposes to go much further. Not only is the consumption itself discouraged by government policy, but all those engaged in feeding the desire to sin, and making the sin available, are also taxed.

In the triangular model of taxation, the government goes beyond taxing only the individual who actually commits the sin; the government also taxes the production and distribution of the good or service in anticipation that the higher costs will be borne by both the consumer and the producer. This is the most common form of sin tax. Three parties are affected in the forced transaction: the producer, distributor, the consumer, and the receiver of revenue.

Several effects logically flow from this triangular arrangement. The higher tax raises the costs of producing and distributing the good or service. If the producer or distributor intends to generate the same level of sales, he or she must cut back on other areas of the business. For example, if the government taxes beer sold in supermarkets, if the store loses sales and profits, it will then have to cut back on other expenditures in inventory or wages. And if beer sales, for instance, are a substantial part of revenue, it is conceivable that this tax could lead to a cut in employment itself.

If this same sin tax is levied at all points along the structure of production-on the hops producers, the beer makers, the beer distributors-jobs will probably be lost at every step of the production and distribution process. A good example is the luxury tax placed on yachts. The people most hurt by this type of tax are not the well-off consumers so much as the middle-class manufacturers and retailers of the luxury item.

If the costs of production, distribution, and consumption get too high, the effect will be to create "informal" or "underground" markets for goods and services. The term "informal" refers to a good or service that is legal yet distributed through channels that are officially unapproved (de Soto 1989). This informal effect is something that must be considered in all forms of interventionism, but it is a particular problem for sin taxes. Precisely because the good or service being taxed is less socially approved than other goods or services, unscrupulous individuals are likely to take over the job of supplying the consumers with what they want.

Canada's experience with cigarette taxes provides a poignant case. Throughout the '80s and early '90s, Canadian and American smugglers met at the border, many driving in snowmobiles so as to avoid customs agents. Violence and gunplay increased. Apparently most of the cigarettes being brought into Canada in underground markets were actually manufactured in Canada, exported to the United States, and brought back into the country by disreputable elements. The same wholesalers have been known to buy back the cigarettes and sell them again.

In the official market, a case of cigarettes, which is 50 cartons, sold at an official price $2,500. But in the informal market, smugglers pay only $700. They then sell it back in the underground at a price of $1,500. As much as 80 percent of Canada's export market ends up back in Canada. That means an enormous amount of fast profits high enough to lead people to take exorbitant risks. In three months, from November 1993 to January 1994, 125 people were arrested for possession of bootleg cigarettes (Chicago Tribune, Feb. 4, 1994).

In this case, the informal-market cigarettes were sold to the public in rented warehouses and homes at a rate approximately half the price of the official market. Complicating matters, the Indian reservations in Canada are exempt from the law. In February 1994, this led to an actual shoot-out between the Indians and the government. At last, the Canadian government gave in and cut cigarette taxes in half. That put to an instantaneous end the more egregious aspects of informalism in the Canadian cigarette market.

American cigarette taxes, at about 56 cents per pack, are among the lowest in the world (compared with the United Kingdom at $2.52, Canada at $3.01, and Denmark at $3.68). The effect of the sin tax cannot be measured or predicted by its percentage of the overall retail price of the good or service. It must be measured by the way consumers respond to price changes, which differs from person to person. If demand is low, a high tax will have less startling effects in terms of creating underground markets. People will just give up the habit. On the other hand, if people would rather fight than switch, the social consequences of even a small tax are to induce informal entrepreneurs into the market. History suggests that the demand for tobacco and liquor in the United States is probably very intense. Even relatively small changes in the tobacco tax at the state level have resulted in large-scaled interstate smuggling (Ekelund and Thornton 1993).

As sensible as the reduction of the tax seems, anti-smoking groups in the United States immediately denounced the Canadian government for the change. These people had high hopes that the problems associated with Canada's high taxes were solely due to the discrepancy with the United States, a discrepancy that could only be remedied by vastly increasing the American tobacco tax. The Clinton administration has proposed raising the tax to 75 cents per pack (Washington Post, Jan. 12, 1994).

"Canada has been our greatest role model in demonstrating the effectiveness of tobacco taxes in preventing disease and premature death," said Cliff Douglas of the American Cancer Society. "We're using the Canadian data and experience heavily in our effort to persuade the United States Congress to follow suit by substantially raising federal tobacco taxes here" (Chicago Tribune, Feb. 4, 1994).

Such policy would only make matters worse. Rather than ending the social chaos, it would merely export it to the United States. Tobacco would come across the borders at cheap prices one way or the other. Massive police power would have been expended to prevent leakage on both our Southern and Northern borders. Even that would not have prevented the inevitable growth of the underground.

Yet on one level, the reaction of anti-smoking groups is perfectly understandable. Once having committed themselves to a policy of interventionism through a triangular sin tax, it makes sense to attempt to remedy the market imbalances through a policy of further interventionism. When successful, this pattern creates ever increasing levels of statist power, which can only end in a complete state takeover of the industry in question (Mises 1949). Yet even that would not solve the problem. From an economic perspective, it is far better to leave the market alone, allow a policy of non-discrimination in taxes, and let the market allocated goods and services, sinful or not.

When the Canadian government threw up its hands and lowered the tobacco tax, it did not admit that the real reason had to do with the violence and social chaos it caused. It said the change was in the interest of raising more revenue, a perfectly understandable rationale as well. If a good portion of the market went underground, the state would indeed lose substantial revenue.

This raises another peculiar aspect of the sin tax. It is contradictory at its very heart. At some point in the "revenue curve," the tax will tend to reduce rather than increase government income, especially when people choose informal means of getting the desired product. When that occurs, it defeats a major purpose of the sin tax in raising revenue in the first place. On the other hand, increasing revenue might actually require propaganda to induce people to continue consuming. But that would defeat the moralists' reasons for imposing the tax in the first place.

The urge to lower the tax to capture underground revenue demonstrates that the state is willing to undertake policies to keep the revenue flowing in. This shows that the state has an inherent interest in having people continue the supposedly sinful behavior. If people stopped smoking altogether, the state would be denied even more revenue than it lost when they moved to the underground. The original purpose of the tax was not only to raise revenue; a crucial political purpose was to discourage the behavior in question. Under a sin tax, the state finds itself in the peculiar and contradictory position of professing to discourage certain behaviors while relying on their continuance as a source of revenue.

The politicians and bureaucrats charged with drawing up and enforcing the policy are caught in a moral hazard. What if it costs less to pay the advertising budgets of liquor and tobacco companies than to lose revenue from lost sales? In other words, it might eventually be beneficial to the government to actively promote the product it is taxing.

This moral hazard is also evident when the state monopolizes the distribution of alcohol within its own boundaries. The policy can be a tremendous source of revenue. But for that very reason, the state finds itself in the bind of discouraging alcohol consumption on the surface, but underneath it, hoping that the behavior will continue as a rich source of government funds.

This moral hazard is especially dangerous for the poor, who spend a disproportionate amount of their income on products deemed sinful under a consumption tax. It takes money from their pockets when they buy the goods for which they have a strong demand, and leaves less for them to spend on their rent, food, clothing, and the like. The supposed virtue of the consumption tax is that it hits every consumer of the good equally. Yet the poor are the ones that can least afford the tax, are the ones most in need of discretionary income, and are therefore the ones hit hardest. This is neither good statecraft nor good economic policy. And it is not compatible with the demands of justice.

When government imposes high costs on a good that consumers desire, consumers will attempt to find ways to feed their personal desires at low cost. This propensity will make any form of sin tax backfire in terms of its overall impact on sin itself. This is due to the "more-bang-for-the-buck" principle. If cigarettes are taxed at a high rate, some consumers might turn to cigarettes that have a higher nicotine content, including those that are unfiltered. If wine is taxed excessively, wines of higher alcohol potency become more desirable than those of lower potency. In the same manner, taxation on soft drugs inadvertently promotes harder drug use, since, as the principle says, people seek out more-bang-for-the-buck, especially when a noticeable part of that buck is going to pay the sin tax (Thornton 1991, 89-138).

The sin tax and monopolization of the provision of sin (as in the alcohol example) are the halfway house to total prohibition. For that reason, it is impossible not to notice the parallels between the recent Canadian experience and the American era of Prohibition, which lasted from 1919 to 1933. The entire country became engulfed in a crime wave, while statistics reveal little if any difference in actual alcohol consumption. The worst elements of society -- those willing to take enormous risks with the law -- made handsome profits, while the peaceful users of these supposedly sinful products paid high prices for their goods. The Prohibition era ended up making a mockery of the law. Even otherwise law-abiding people were dragged by their desire for the "sinful" product into underground markets, lessening their overall respect for the government and authority in general.

The analogy between the sin tax and prohibition is an especially valid one from an economic point of view. Each policy represents a different point on the same continuum. One can imagine a tax on liquor -- say, $100 per bottle -- that would create the same level of social and economic chaos as an outright prohibition. When the retail costs of a good become higher than the costs of production plus the usual rate of profit, underground entrepreneurs are driven to provide the good or service in illicit markets. For this reason, the economic lessons we learn from prohibition -- that economic motives are among the most powerful that afflict the human mind, and when making policy are perilous to ignore -- also applies to even marginal taxes on consumption of particular products. Such taxes tempt people to find a way around the law.

We find that any sin tax – whether a direct binary tax or a triangular tax that hits buyer and seller – is harmful in a number of ways.

Whatever economic or social benefits one can dream up from the sin tax, we must also realize that the decision to tax must be weighed against the social benefits for reducing the behavior by slow and deliberate persuasion and voluntary action. When it comes to public policy, the preferred method of discouraging sin should fall under the category of alternative institutions, especially family, church, and school.

Paulist priest James Gillis, the renowned editor of Catholic World, strongly opposed the use of alcohol. At the same time, he was greatly upset by the passage of the prohibitionist Volstead Act. "It is my own conviction... that the prohibition law was the greatest blow ever given to the temperance movement," he wrote. "Before prohibition, the people at large were becoming more and more sober. Total abstinence had become the practice, not of a few, but of millions... Under the Volstead Law, drinking became a popular sport. The passage of the law was a psychological blunder, and a moral calamity... The only way to make the country sober is to persuade individual citizens, one by one, to be sober" (Finley 1958, 182).

The sin tax is one of the few taxes presumed to have an overt moral justification. We have to say "overt" because other taxes imply certain covert moral categories. For example, our nation taxes the return on capital at a higher rate than income that flows from pure wages and salaries. This "capital gains tax" implies there is something less morally legitimate about making money through risk and investment than there is from taking home pre-set wages and salaries.

There is a moral assumption underlying the inheritance tax as well. It taxes money passed from one generation to another at a high rate. That too implies that inheriting money is no more legitimate than "earning" money, a conclusion which is inescapable given the explicit egalitarian origins of the inheritance tax (it was high on Marx's list of priorities).

When the state treats a certain behavior as sinful and thus taxable, it assumes certain moral categories. It says that the taxed behaviors are less morally justifiable than other forms of behaviors, and therefore more justifiably taxed. The moral reasoning behind such a tax is clearly evident. Punishing wrong doers is among the usual lists of powers appropriate to government. What is not obvious is why the central state puts itself in the business of determining the sinfulness of certain behavior given that the taxed sins are not directly invasive of other peoples' rights.

Compare smoking and drinking, for example, with crimes against person or property. When the state declares drinking and smoking to be sins vulnerable to added levels of taxation, it also admits that these behaviors are less objectionable than theft or murder. We don't, for example, have anything like a murder tax or a theft tax. When a citizen steals something from another person, he is not taxed; he is tried and convicted as a criminal. Neither are the sins being taxed considered violations of the civil code. Instead, the state simply taxes the behavior in an attempt to raise revenue and discourage the behavior (these are, as noted earlier, logically incompatible goals).

This is not to say that the behaviors targeted by the sin tax are "victimless crimes," as many civil libertarians might be inclined to say. That phrase confuses more than it clarifies. All actions have consequences outside the individual. A person who drinks excessively victimizes his family to the extent that liquor distracts from his family life. A smoker who contracts cancer imposes sometimes terrible burdens on his family. Even sins with no identifiable earthly victims are sometimes objectionable when judged by the eternal law. There is no such thing as an action without consequence. It is possible that certain behaviors that are not direct attacks on property or person are in need of a correction, not best addressed by civil authority (see St. Thomas Aquinas, Summa Theologica, I-II Q. 100, A. 9).

The question often comes down to the means of discouraging sin, not whether the sin itself is harmful. We must be careful not to confuse opposition to sin taxes with moral relativism. Rather the question is: Do we want to charge politicians and bureaucrats with sanctioning sins in areas that are morally ambiguous? Or should this task be left to community, family, church, and tradition -- social institutions that are often more trustworthy in determining the limits of non-violent behavior?

A classic statement regarding non-violent forms of social behavior which are nonetheless frowned upon was made by John Stuart Mill in his famous tract On Liberty (1859, 22):

There can be little doubt that John Stuart Mill had thought himself to be stating a straightforward case for keeping private behavior private. He did this by introducing strict limits on the ability of social and state agents to exercise coercive control over private moral behavior. His views became enormously influential, as Tom Beauchamp points out (1975, 236).

This is an effort worthy of praise, especially in our time when the limits of government power and responsibility are disregarded as merely an old-fashioned concern. Mill's theory serves as a useful check to the ambition of the Leviathan state. The central state need not be involved in affairs that are harmless and purely private. In myriad ways, government policy today goes well beyond the limits Mill outlined for us. The sin tax is only one of many readily available examples.

Yet even by Mill's own formulation, the case is less clear than it would first appear. His statement contains two formulations of what appears to be the same principle: that there ought to be a distinction between behavior that is permissible to control and behavior which is not. In the negative formulation, private behavior (that which concerns a single individual) should be kept private and should not be the concern of the state. But in the positive formulation, any action which harms others or even concerns others can be socially regulated.

As Ernest Nagel points out (1968, 269), this allows Mill himself much latitude in interpretation. He opposed the prohibition or restriction of alcohol as an infringement of liberty -- a consistent application of his negative formulation. But Mill himself took tremendous latitude in his positive formulation. He believed the state was justified in compelling parents to educate their young, forbidding marriage between people who could not afford it, and allowing people to escape contracts that last too great a length of time. Such behaviors have an obvious effect on others. Thus Mill himself found his rule to be too ambivalent to apply in a consistently libertarian manner.

Another problem with the "victimless crime" theory against taxing or prosecuting peaceful individual behavior, like smoking and drinking, is that it disregards potential victims like other family members, to which we have moral obligations that extend well beyond a purely contractual level. While as autonomous individuals we may have legal rights to engage in certain behaviors like excessive indulgence in drink, we have no moral right given the implied obligations to family and community. It is simply not enough to claim that a legal right should equal a moral right to engage in sin.

Indeed we have no moral right to abuse drugs, abuse alcohol, to burn our lungs out with cigarettes, or to gamble God-given resources away. We have responsibilities not to do these things. The real issue has little to do with our rights so much as it has to do with the agency of enforcement. Who or what will be charged with the moral instruction and enforcement required to keep sinful behavior to a minimum, or at least restrict its social consequences?

Governments always act on moral premises of some sort. Punishing crimes against person and property are acts of moral sanction. But when we allow the central government to determine and enforce a broader vision of sin and vice, and by implication goodness and virtue, we set ourselves up for certain dangers. We sanction what I have elsewhere called the Pastoral State (Detroit News, Oct. 17, 1993). The pastor has certain responsibilities to look out for the well being of the flock of faithful. The pastor must be available for spiritual counseling when people come for help, and must even be willing at select moments to intervene when people have not asked for help for manifest problems in their lives, problems which they deny and whose reality they seek to ignore. The pastor must guide the moral direction of the community of faith, not only to help people discover and fulfill their earthly responsibilities to others and achieve peace within themselves, but also to prepare for eternity.

The theory of the Pastoral State is that the state -- or in the case of the United States, the federal government -- ought to assume these pastoral responsibilities vis-a-vis the citizenry. The nature of the state being coercive, one common way for it to do this is through compulsion such as prohibition or the sin tax. Once the Pastoral State takes its place in the life of the nation, the state invariably begins to broaden the definition of sin. It enters the world of sex and sexuality without much difficulty, as it has done recently with condom campaigns and public funding for abortion and birth control.

Given the nature of politics, the Pastoral State ends up developing a comprehensive vision of what does or does not constitute legitimate behavior. This plan may or may not fit with the citizens' own views of what constitutes sin. But because the state has that power, it may exercise it with impunity, overriding contrary moral objections. Those who demand that the state punish petty sins are taking a dangerous tack by assuming that state power will always be used to promote their own particular view of right and wrong. It does not always do that.

A government that can tax liquor higher than water can on the same grounds prohibit liquor altogether, as well as caffeine, fatty foods, and slothfulness. It is a small but logical step for the state to institute a central plan governing all our behavior, even excluding behavior considered to be religious. Therein lies the danger of entrusting the state to guide behavior whose consequences are necessarily restricted and minimal.

To entrust the state with sweeping social responsibilities is to forget the crucial distinction between society and state. As Richard John Neuhaus (1984, 118-19) has written:

There is one sense in which the Pastoral State is more invasive of others' sovereignty than even the strictest pastor. Unlike the case of the sin tax, the pastor never proposed to make money off other peoples' sin. When this occurred at the time of the Reformation (trafficking in indulgences), it was soundly and rightly denounced as a corrupt act. The enforcer of right, and sanctioner of goodness, should not at the same time be profiting from occurrence of sin. The priest should not profit from the penance of his parishioners.

The modern state, however, profits from the sins it chooses to tax. At one level, the law intends to produce this situation: the more citizens "sin" (e.g., smoke and drink), the more money goes into government coffers. This is a corruption of the idea of the pastor, whether this occurs in the Middle Ages or in a modern democracy.

It is a mistake to entrust the modern state with the enforcement of certain moral codes of behavior that extend beyond obvious crimes against person and property. When government is allowed to go beyond these limits and enforce a wider array of moral issues, it will substitute its own form of morality for traditional morality. A government program like recycling, for example, could be deemed more morally worthy than traditional virtues like fidelity in marriage. Obeying securities regulations could be seen as the very heart of virtue, whereas teaching children at home seen as a vice. The government's sense of morality, especially when it is influenced by excessive power, is often at war with traditional standards and common sense.

It is also more prudent to allow such enforcement to travel the normal channels of community and society. As F.A. Hayek (1973, 35-54) made clear, there can be no way for the government to define all the rules that tacitly govern the conduct of our moral lives. It lacks even that crucial information of what constitutes virtuous and sinful behavior; it has less knowledge within its purview than society owns and uses in the aggregate.

At the same time, contrary to Mill, it is not enough to say that private sins are not harmful and therefore in need of no correction; contrary to the modern state, we do not need coercion to punish and prod the population on every aspect of behavior. We also need strong and vibrant familial, religious, and communitarian means for dealing with non-violent behaviors that nonetheless have some public consequences. This is far preferable to allowing the federal government to enter spheres of life into which it has no business and from which it may be very difficult to remove.

Ludwig von Mises (1966, 733-34) aptly identified the contradiction of the state's temptation to enter private life on behalf of society.

If we cannot have the central state control our private lives for these reasons, nor leave the moral and cultural battles of our day to private conscience alone, what is the answer? For this we turn to the Catholic tradition, and in particular the social thought of Pope John Paul II. In his brilliant treatise on economics and social teaching, Centesimus Annus, the pope reiterates the traditional principle of subsidiarity. This principle uses an Aristotelian frame-of-mind to consider which social institutions should deal with problems in culture, economy, and society.

The pope states the subsidiarity principle as follows: "a community of a higher order should not interfere in the internal life of a community of a lower order, depriving the latter of its functions, but rather should support it in the case of need and help to coordinate its activity with the activities of the rest of society, always with a view to the common good" (1989, par. 48).

This principle establishes a social hierarchy for dealing with the kinds of problems the sin tax purports to address. Lower levels like the individual and family are the preferred moral center of society. Only when those institutions fail is the church or community to step in with a substitute function. Only after the lowest levels are tried and failed does government and society at large begin to play a role, and so on up the social hierarchy. Only in the case of extreme failure should the central state be called up to correct what are essentially individual moral failings, and then only when such intervention would promote the common good.

These are stringent requirements. The sin tax -- promoted primarily as a fiscal last resort -- does not qualify as a legitimate intervention under the principle of subsidiarity. In short, the sin tax fails from both an economic and a moral point of view. That doesn't mean society should be any less rigorous in its efforts to reduce the incidence of alcohol, tobacco, and drug use, or the other behaviors rightly classified as sins. It does mean that our responsibilities to evangelize should not be transferred to the government to become the modern equivalent of failed sumptuary laws. The federal government and even governments at lower levels have not proven themselves worthy of the task.

Robert A. Sirico is president and co-founder of the Acton Institute for the Study of Religion and Liberty. Holding a master’s degree in Divinity from the Catholic University of America, Father Sirico is the author of numerous journal and newspaper articles on public policy, economics, and theology. He is also a full-time parish priest, a member of the Mount Pelerin Society, and an international lecturer on economics and religion.