Tuesday, December 20, 2011

Pigou and Potato Chips

Frances Woolley has presented an interesting question which we have examined in depth before. She has presented an exam question regarding the externalities of obesity framed in terms of a potato chip tax.

Frances states:

"Pigouvian taxes" are imposed to make people take into account the full impacts of their actions. The classic example is a carbon tax. Whenever people produce or consume carbon-based fuels they harm other people, from those who breathe in exhaust fumes to future generations affected by climate change. A carbon tax makes people recognize the full cost of their consumption and production choices, thus creates incentives for people to change their behaviour. 

The potato chip example, however, is different: the chip eater in the exam question isn't harming other people. The bad skin, weight gain, and depression is experienced by the chip eater himself. It is not obvious that a Pigouvian tax is needed to make chip eaters take into account the harms that they causing - why not just tell people that potato chips cause bad skin, and if people think the chips are worth the zits, let them munch away? They're only harming themselves.

Now let me rephrase her issues a bit. Perhaps as in the US we may have a slightly different economic framework than Canada but I believe we have a parallel.

First, as we have demonstrated many times, obesity in the US will cost us $350B this year alone of our $2.5T health care costs. How is this paid for, well Medicare, Medicaid, and insurance. Namely we are all taxed equally for the costs of a few.

Second, we have a country where over 60% have a BMI in excess of 25 and well over 40% are outright obese. Frankly I wonder who is "hungry" with all these fat people but I leave that question to the side.

Third, we know that obesity is the prime driver for Type 2 Diabetes, well in excess of 95% is a result of weight, and Type 2 Diabetes causes many sequellae from neuropathy, nephropathy, retinopathy, cardiomyopathy and the like. We can draw a straight line from caloric consumption to costs. This is unlike the carbon claim of Woolley where I would argue the nexus is tenuous at best.

Thus as to her assumptions as above:

1) I disagree with the first regarding carbon. The line is broken by hypothesis and not fact connecting cause and effect.

2) The line between a calories and a cost is well established. We can actually say what every excess calorie costs. Not bad for an engineer! But that is nothing more than what Chem Es do for a living. We know what the cost of every 0.1 above 25.0 costs society. The issue then is do we tax the input or the output to cover their externalities, namely their added costs. Namely, do we tax the food or the person's weight?

I believe that Frances may have missed an interesting example if she had carried it a bit further. We have substantial data on disease incidence by BMI level and we have costs with each disease. I have gone through this analysis a few years ago in the large regarding health care costs. Perhaps the "devil is in the details" but that is where economists perhaps should seek truth if not just the facts.

Perhaps also this may just be one of my hot buttons. Frances has an interesting point but I believe that it requires more depth. This was a point which I had a strong disagreement with Greg Mankiw for he is a proponent of a Pigou tax on gasoline but opposes a Pigou tax on carbs. My opposition of the Pigou tax on gasoline is driven by the fact that demand is inelastic. Namely if workers have to drive to their place of employment the tax is not a disincentive but merely another way for the Government to take funds out of the economy. On the other hand a carb tax is used in a much more elastic environment, just look at cigarette taxes, and the funds become not only a disincentive but a cost balancing means.

Thus my argument with Frances is that this is an interesting but complex problem with the data available to actually perform a detailed analysis. In addition it is a pressing problem for many countries, for it is not just acne but the development of one of the most pandemic disease epidemics known. In fact the main problem with Type 2 Diabetes and the sequellae is that they can be managed for a long time per patient but at an ever growing cost per patient per year. In contrast lung cancer just kills you off before you become too much of a burden!