Proposed sugar tax may be less effective than expected | KPMG | ZA

Unorthodox economics: why the proposed sugar tax on SSBs may be less effective than expected

Proposed sugar tax may be less effective than expected

Price can affect consumers’ enjoyment of a product because it is a signal of quality, while healthier alternatives, like 100% fruit juices, remain out of reach for many low-income consumers.

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In a previous article , we explained that a proposed tax on sugar sweetened beverages (SSBs) might not encourage the consumption of healthier alternatives. In particular, low-income consumers might not view SSBs and healthy alternatives¬ as viable substitutes in light of large price differences that persist even following the implementation of the proposed tax of 2.29c per gram of added sugar in SSBs. 

The extent to which the beverage industry passes on such a tax to consumers is a central consideration in this debate. Previously, we have raised the issue that smaller players in the domestic beverage industry may be less able to absorb the tax than larger players.  Even if the tax is fully passed through, there are a number of factors that affect whether consumers will substitute away from SSBs. In this article, with reference to economic concepts, we explore how factors such as brand loyalty, conspicuous consumption and income effects might dampen initial expectations of the effectiveness of the sugar tax, particularly for low-income consumers, who might be disproportionate bearers of the tax in South Africa.

Could popular branded soft drinks become premiumised?

For certain branded SSBs that are perceived as aspirational, cognitive biases like the ‘snob effect’ might counter the extent to which consumers search for substitutes in response to tax-induced price increases. 

This effect suggests that consumers who associate certain branded SSBs with an aspirational lifestyle might develop greater brand loyalty and become less likely to change their purchasing behaviour in favour of healthier alternatives. 

We can also understand this outcome by referring to the so-called ‘Veblen effect’. When the price of a ‘Veblen good’ rises, some consumers conspicuously consume more of the good as they perceive it as having higher quality, and possibly enhancing their social capital. Marketers frequently rely on this behavioural trait, framing products as ‘premium’ in advertising campaigns. 

A main driver of the Veblen effect results from consumers’ perceptions of a link between quality, price and derived enjoyment, or utility, from the consumption of a good. This is a contradiction of orthodox economic theory, which predicts that higher prices do not influence our enjoyment of a product and would lead to a reduction, rather than an increase, in market demand for a good. In practice, however, prices could influence our enjoyment, as a study performed at Stanford University in 2008 illustrated. It found a correlation between the prices of wine, consumers’ perceptions of the wine’s intrinsic quality and their actual enjoyment of the wine. In other words, price can affect consumers’ enjoyment of a product because it is a signal of quality. 

The profile of Veblen goods, or goods with snob effects, where price, quality and consumer enjoyment are positively linked, will vary depending on a host of contextual drivers. Thus, whether we consider goods in a developed country context, where the majority of studies originate, or in a developing country context like South Africa, will have strong implications for what is considered an aspirational good. It is important to consider the possibility that a tax, in the instance of certain popular branded SSBs, could yield a premiumisation effect for some groups of consumers. Certain branded SSBs may benefit from this forced premiumisation, meeting the requirements of aspirational products for some low-income consumers in South Africa. These effects would need to be considered and accounted for by policymakers in their assessment of the expected effectiveness of the tax. If these effects are large, then the sugar tax might not be an effective driver of healthier behaviour. 

Not to be underestimated: The interplay of substitution and income effects

Another important economic effect to take into consideration is the influence of the so-called income effect. While we do not predict that this effect will completely reverse the expectation that a tax-induced increase in the price of SSBs may reduce consumption, the expected decline in consumption may be substantially dampened for certain products.  

First, to understand the influence of so-called income effects, we provide a quick overview of two main effects in orthodox demand theory. 

Following a price increase, two effects come into play, 1) substitution effects and 2) income effects. 

The former entails that consumers will reduce their consumption of a good whose price has increased and substitute for suitable alternatives, whose relative prices are now comparatively lower. According to the substitution effect, a higher price means reduced consumption of the good in question. 

Income effects occur as the price increase negatively affects the discretionary income of consumers and as a result changes their consumption behaviours. In the instance of most goods (termed ‘normal goods’ in economic theory), consumption will decrease when discretionary income falls (for example, due to price increases). In the instance of ‘inferior goods’, however, consumption will increase when discretionary income falls. Thus, consumers of inferior goods are inclined to ‘trade up’ to higher priced goods, as soon as they can afford them. Certain forms of public transport and some staple foods are examples of inferior goods.

In the case of inferior goods, the substitution effect typically dominates the income effect of a price rise, and therefore still results in an overall decrease in consumption, as anticipated. However, the crux of the analysis is that the tax-induced decline in the consumption of ‘inferior goods’ will typically be lower than for normal goods – an outcome that would be particularly pronounced for very low-income consumers. It is important that analysts and policymakers consider that there are different price elasticities for different product categories to capture these effects. 

Are some SSBs ‘inferior goods’ in South Africa?

For those South African households that view certain SSBs as ‘inferior goods’, the income effect would dampen any substitution effects. Particularly, for consumers with limited disposable income for food purchases, who could make up a large proportion of SSB consumers, cheaper SSBs might be inferior goods. This is particularly true so long as healthier alternatives, like 100% fruit juices, remain out of reach for many low-income consumers. 

Expect the unexpected: conspicuous consumption and income effects can produce paradoxical outcomes for the proposed SSB tax

In summary, if either: 

  1. a significant number of consumers are influenced by branding or pricing as an indication of quality and enjoyment for certain SSBs, and/or
  2. the income effect dampens the substitution effect for a significant proportion of lower income consumers for certain ‘inferior’ SSBs,

…then a tax aimed at encouraging substitution of SSBs for healthier products might be less effective than expected.

It is plausible that, for some low-income consumers in South Africa, brand loyalty, conspicuous consumption and income effects might be large, depending on the types of SSBs in question. The size of these effects is relevant for understanding the overall effectiveness of the sugar tax relative to other policy interventions. If the tax is ineffective in influencing health outcomes among those most at risk, it is merely a stealth tax.

The outcomes of the proposed sugar tax are relevant in light of the upcoming submissions on Government’s Policy Paper, which are due on 22 August 2016.  

Authors

Maura Feddersen, Kathryn Lloyd (Economists in Financial Risk Management, KPMG South Africa) and Lullu Krugel (Chief Economist and Director at KPMG).

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