The Economics of Vice Tax

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A vice tax is an indirect form of taxation applicable to sold called vice goods like alcohol, tobacco and to a certain extent gasoline. The tax is included in the purchase price for these goods and paid by the retailer, rather than the customer directly, hence an indirect taxation.

It may come as a surprise to realize that goods are very heavily taxed - sometimes in excess of 50% of the actual price. It is a bizarre phenomenon that products can have such an artificially high value and yet survive in the marketplace, although the economic explanation for this is clear.

One major problem with vice taxes is that they are indirectly regressive, that is to say they affect poorer segments of the population more than the richer segments. This is as a result of increased alcohol consumption and abuse in less affluent people than richer people. Also it is a social fact that smoking is more prevalent amongst poorer communities. Even if this wasn't the case, vice tax would still be regressive when considered as a portion of income.

So how does the government, and governments across the world get away with levying such high taxes in this way? Easily. There is a blatant moral justification: for example, smoking is bad for you, therefore we'll increase tax on tobacco to dissuade people from smoking. The same is true of alcohol and gasoline, and like it or not we all feel that this is justifiable. Furthermore, smoking is addictive.

If you're a smoker, you'd have to pay the price if cigarettes were $20 a packet to feed your addiction. A lot of smokers would try to give up, but with addiction it's not always that easy, and many would still buy cigarettes at this price. It all boils down to these goods being what is known economically as demand inelastic, that is to say raising the price per unit won't have a major impact on sales.

In fact in examples of demand inelasticity, gradual price increases actually increase total revenue. The lack of alternatives means that people simply have no other choice but to pay the price inclusive of tax, regardless of how high it goes. In economic terms, this form of taxation is a wise move, and this has proven to be the case with many governments reaping in a vast amount of income from these goods year on year.