Sugar (tax), no please1

In this article, we examine the legal implications of the Grattan Institute proposal for the introduction of a “sugary drinks tax”.2

What you need to know

  • There is little likelihood that a sugary drinks tax will be introduced in the short term.
  • However, given the trend to healthier consumption of food and beverages in developed countries (including the adoption, or proposed adoption, of a sugary drinks or similar tax in over 20 countries), there is a real medium term risk for sugary beverage manufacturers.

What you might do

  • Consider further or expedited research and development into reduced sugar variants of popular products, artificially sweetened alternatives and new products that might sit outside the regime.
  • Consider potential opportunities for strategic merger and acquisition activity to broaden or diversify product ranges.
  • As there appears to be a weak link between tax collections and improvements in obesity outcomes and little analysis of the relatively high deadweight costs, consider commissioning analysis of these issues, as well as modelling of both the direct and indirect costs if a tax were to be introduced along the lines proposed.

What has been proposed?

The Grattan Institute proposal envisages an excise tax of 40 cents per 100 grams of sugar in a sugar sweetened beverage (SSB).3 The SSBs to which it is proposed to apply are non-alcoholic, water based drinks with added sugar, including soft drinks, flavoured mineral waters, energy drinks, cordials, fruit juices with added sugars and iced teas.4 The definition would not cover all beverages that are sugar sweetened (eg. flavoured milks), that have similar levels of sugar (eg. pure juices) or that use artificial sweeteners.

As a so-called "sugar content tax", it is imposed on the level of sugar in the affected SSBs. This differs from the sugar tax proposal that the Greens took to the election which envisaged a 20% ad valorem tax on the retail price of water based beverages, where they contain more than 5 grams of sugar.5 It is argued that a sugar content tax is more effective at reducing sugar consumption, as an ad valorem tax can be avoided by substituting with cheaper products that may have similar levels of sugar.6

Interestingly, while the Grattan Institute recognises that there could be benefits in applying the tax proceeds to healthy eating programs, unlike some of the equivalent regimes in foreign countries, it does not propose that the tax be hypothecated to such programs.7

What are the mooted benefits?

The Grattan Institute points to studies which indicate that the tax would most likely be passed on in full by SSB manufacturers.8 It is suggested, for instance, that this would lead to an 80 cent price rise for an average two litre bottle of soft drink.9 Further, based on other research that suggests that demand for SSBs is elastic (ie. price sensitive), the proposed tax is anticipated to lead to a 15% reduction in sales of affected SSBs.10

In terms of revenue, the Grattan Institute modelling suggests it would raise some $500m to partly offset the community costs of obesity which are estimated at $5.3bn, albeit over 40% of which relates to reduced income taxes based on lower employment rates among obese people and the assumption that there is a causal relationship with their obesity.11

However, despite the above, the Grattan Institute concedes that the proposal would only have a "modest" impact on obesity levels in Australia. This is quantified in the Grattan Paper as a reduction of obesity from 28% of the population currently, to 26% (a drop of just 2%).12

What are the negatives?

The Grattan Institute has proposed an excise tax because of its simplicity and the existing legislative and administrative machinery.13 Nevertheless, it recognises that there would be implementation costs estimated at $7m, as well as ongoing costs of a further $7m per year.14 In our view, this underestimates the likely direct costs. This is because many SSB manufacturers do not produce alcoholic products and so are not currently exposed to the excise system, and will therefore have to establish appropriate accounting and administrative systems to comply. Moreover, as indicated above, the proposal is that the tax will apply to some but not all sweet beverages. There will be an inevitable degree of ongoing complexity, on top of the existing complexity arising from the GST treatment of food products.

The Grattan Institute recognises that the tax will be regressive, given that SSBs represent a higher proportion of the family budget for low income families most at risk of obesity, than more well off families.15 However, it argues that such households will be easily able to substitute to free tap water or other untaxed beverages to avoid the tax.16

When Ken Henry, then Treasury Secretary, led a review of the Australian tax system in 2010, the report included an examination of taxes designed to enhance social and policy outcomes, particularly on tobacco and alcohol, and noted that they raise significant externalities in that they increase costs for consumers who are not at risk.17 In the specific context of a "fat tax", it was observed that:

"[w]hile obesity does involve significant health and productivity costs, the relationship between these costs and the consumption of particular products is complex. The risk of obesity is affected by lifestyle, such as diet and physical activity, as well as inherited and social influences".18

The Grattan Institute does not model the deadweight cost of their tax, but notes that "assuming a marginal excess burden of 25 cents for each dollar of tax raised, would result in a deadweight loss of $750m".19 The quantification is based on tax raised of $3bn, but applied rateably to their proposal would still suggest a significant economic cost of $125m.

The Grattan Institute also downplays the industry impact. It suggests that SSB manufacturers will simply switch between taxed and untaxed products (e.g. CCA would switch from Coke to Mount Franklin water).20 In terms of sugar producers, the suggestion is that decreased domestic sales will lead to an increase in exports with minimal price variances.21 However, much of this analysis appears to be a matter of conjecture.

Will it become law one day?

While the National Party has been quick to dismiss the proposal (perhaps understandable given their constituency base in rural Queensland), Treasurer Scott Morrison and Health Minister Sussan Ley were not as definitive, albeit indicating that a sugar tax was not a current priority for the government.22

Opposition Treasurer, Chris Bowen, has indicated that the Labor party does not support the proposal, but the Greens have called for a Parliamentary inquiry and may proceed to introduce their own private members bill.23

Our assessment

The response from our politicians to the Grattan Institute proposal suggests there is little likelihood that a SSB tax would be introduced in the short term. The groups who would be most affected by the introduction of an SSB tax are high consumers from low socio-economic communities, rural sugar cane farmers and manufacturing workers employed within the SSB sector and associated industries (e.g. packaging, distribution). These are among the very same groups that the major parties are trying to reach out to in the current political climate.

However, given that some 14 countries (or, in some cases, states within a country) have already adopted some form of sugar tax, and a further 8 are proposing to do so,24 there is a real medium term risk for SSB manufacturers. Accordingly, there is some urgency for such companies to develop strategies to address the risk. Other manufacturers of high sugar and high fat content products should also keep a watching brief as, in the longer term, there will likely be calls for a broader “fat tax”.

An area that appears to be worthy of additional analysis is the apparently weak link between tax collections and improvements in obesity outcomes, as well as the relatively high deadweight costs. It will be important to have credible research to support any positioning in this regard. Companies likely to be affected should also seek to commission the modelling of both the direct and indirect costs if an SSB were to be introduced along the lines proposed. This will be particularly useful if the Greens get their way and a Parliamentary inquiry into SSBs is established. The press coverage received by some groups called before the recent Senate inquiries into corporate tax avoidance and the banking sector illustrates the impact of not being properly prepared.

And, given the writing is arguably on the wall, further research and development is warranted as to reduced sugar variants of popular products, artificially sweetened alternatives and new products that might sit outside the regime.

The proposal may also present opportunities for the well prepared. In particular, we predict that the introduction of a SSB tax would result in inevitable industry consolidation, generating opportunities for strategic merger and acquisition activity.