About a week ago, Denmark introduced a new tax on fat in foods, in an effort to improve the health of Danes. The general idea is consistent with the sort of thing that environmental economists often recommend for other bad things, like pollution (e.g. a carbon tax). But is it sensible in this case? I have my doubts.

My daughter is currently living in Denmark and struggling a bit with the high cost of living there. So a further cost increase is the last thing she wants.

The system involves a tax of 16 kroner ($A3.00) per kilogram of saturated fat. Economists recognise two effects of this sort of tax: (a) it makes fatty foods more expensive relative to other goods, so people change how they allocate their income between alternative purchases (a “substitution effect”), and (b) as a result of having to pay the tax, people have less disposable income, and this leads to a reduction in their consumption of all goods, including of fatty foods (an “income effect”). Both result in less consumption of the good that’s being taxed, although the substitution effect is far more important in practice.

So the idea sounds OK, but it’s worth asking, would the approach really work in this case? The effectiveness of such a tax depends mainly on how responsive people are to the prices of the goods in question. It’s well known that responsiveness to price (which economists refer to as “price elasticity”) varies a lot between different goods.

Consumer demand for fat in foods strikes me as the sort of thing that is unlikely to be responsive to price. My reasoning includes that:

• Fat is only one ingredient of a food, so changes in the cost of fat would have a less than proportionate effect on the cost of the food as a whole.
• In developed countries, food is only a small proportion of our total expenditure. If its price goes up a bit, it would be possible to cope without greatly altering one’s consumption patterns.
• People already know that fat is bad for them, but they still choose to buy fatty foods, basically because they taste good. I would not have thought that a modest increase in prices would change that much.

There is some empirical evidence to support my feeling that increasing the price of fat won’t change behaviour much. For example, Chouinard et al. (2007) find that a tax on milk in the USA in order to reduce fat consumption would have to be enormous to have much impact. For example, they say that “a 50 percent tax only lowers fat intake by 3 percent.” That’s a 50 percent tax on the milk as a whole, not just the fat component. Whole milk is about 3.3 percent fat. By my rough calculation, a 50 percent tax on milk would be about 10 times bigger than the new Danish tax, for a really small impact.

Similarly, Brownell et al. (2009) also concluded that moderate sized taxes on soft drinks basically have no impact on consumption.

Although it wouldn’t change behaviour much, these taxes would collect plenty of revenue. Indeed, if revenue collection was the aim, fat might be the ideal target for a tax, specifically because people would keep buying it, even with the tax.

This means that there is potentially an important negative consequence of the tax: it would have a disproportionately large impact on people with low incomes. They spend a larger proportion of their income on food, so the tax would have a larger proportional impact on them. Actually it might have a larger absolute impact on them, because the incidence of obesity is higher among low income groups, so presumably they spend more on fat. Chouinard et al. (2007) argued that “these fat taxes are unattractive because they are extremely regressive, and the elderly and poor suffer much greater welfare losses from the taxes than do younger and richer consumers.”

Ineffective and regressive doesn’t sound like a good tax to me.

A third problem is the specific way that this tax is designed. Apparently, the level of the tax is based on the amount of fat used in making the product, rather than the amount in the end product. If that’s true, it seems ridiculous. If the point is to improve health, why would you want to tax fat that people aren’t actually eating?

Finally, I would imagine that the system would have quite high transaction costs, such as costs of administration, reporting, monitoring, enforcement, learning, and so on. If the system would really work, they could be worth bearing, but probably not in this case.

On a more positive note, it may be that revenue from the tax could be used for other purposes that would contribute to improved health outcomes, such as research or health education. I suspect that this is the most likely route for the system to generate worthwhile benefits, although, of course, governments could use the existing tax collection system to invest in those things and thereby avoid the regressive nature of this tax.

David Pannell, The University of Western Australia

Further reading

Hayley H. Chouinard, David E. Davis, Jeffrey T. LaFrance, and Jeffrey M. Perloff (2007) “Fat Taxes: Big Money for Small Change”, Forum for Health Economics and Policy 10(2): Article 2. http://www.bepress.com/fhep/10/2/2

Kelly D. Brownell, Ph.D., Thomas Farley, M.D., M.P.H., Walter C. Willett, M.D., Dr.P.H., Barry M. Popkin, Ph.D., Frank J. Chaloupka, Ph.D., Joseph W. Thompson, M.D., M.P.H., and David S. Ludwig, M.D., Ph.D. (2009). The Public Health and Economic Benefits of Taxing Sugar-Sweetened Beverages, New England Journal of Medicine 361:1599-1605.