Tax incidence with strategic firms in the soft drink market

a r t i c l e i n f o JEL classification: H32 L13 Q18 I18 Keywords: Excise tax Ad valorem tax Tax incidence Strategic pricing Differentiated products Soft drinks Because soft drink (SD) consumption is considered to be a contributor to the 'epidemic' of obesity, there is a growing interest in evaluating the impact on SD consumption of alternative tax policies. In this paper, we propose a methodology to evaluate the impact of taxation of a food market taking into account the strategic price response of both manufacturers and retailers. We apply this methodology to the French SD market and simulate the impacts of ad valorem and excise taxes. We find that firms behave differently when facing an ad valorem tax or an excise tax. An excise tax is overshifted to consumer prices while an ad valorem tax is undershifted to consumer prices. We find that an excise tax based on the sugar content of SD is the most effective at reducing SD consumption. Our results also indicate that ignoring strategic pricing by firms leads to misestimations of the impact of taxation by between 15% and 40% depending on the products and the tax implemented. In the short-term, that is, ignoring positive long-term health effects, a €9 cents/l excise tax has a small negative welfare effect (about €1/person/year). According to the World Health Organization, noncommunicable diseases, mainly cardiovascular diseases, cancers, chronic respiratory diseases, and diabetes, cause about 35 million deaths each year, representing about 60% of all deaths. 1 Moreover, up to 80% of the incidences of heart diseases, strokes, and type 2 diabetes and over a third of cancers could be prevented by eliminating shared risk factors, mainly tobacco use, unhealthy diet, physical inactivity, and the harmful use of alcohol. A healthier food diet could be reached by reducing salt levels, eliminating industrially produced trans-fatty acids, decreasing saturated fats, and limiting free sugars. A related consequence of unhealthy diet and physical inactivity is the rise in obesity prevalence. To tackle this public health problem, governments have tried to use public information campaigns with the aim of getting people to change their food habits. These information campaigns may have positive impacts on food consumption (Weiss and Tschirhart, 1994; Snyder, 2007). However, they seem to have not been sufficiently effective at changing behaviour (Cutler et al., 2003), and have failed to reverse the rising trend in obesity, diabetes, and …