A Natural Experiment for Philadelphia’s Soda Tax

City of Philadelphia - Philly Bev Tax - Modified from: https://beta.phila.gov/media/20170403100453/PhillyBevTax-Breakdown-1024x512.png - Source: https://beta.phila.gov/posts/mayor/2017-04-03-philly-beverage-tax-where-the-money-goes/

The city of Philadelphia's controversial soda tax is providing a lot of material for serious scientists to evaluate the effects of arbitrarily imposing a tax on the distribution of a range of naturally and artificially-sweetened beverages. Since we're near the end of the tax's first year of being in effect, we thought we'd focus upon one of the more interesting findings to date.

Consumers are primarily the ones paying the tax

Thanks to the quirks of geography and development, some parts of the terminals at Philadephia's international airport fall within Philadelphia's city limits while other parts do not, which means that Philadelphia's Beverage Tax is imposed in some parts of the airport while not in others. Cornell University's John Cawley recognized that situation would make for a natural experiment for assessing some of the impact of the tax, where they collected data for soda sales at the airport in the period of December 2016 through February 2017, which provides a window into how both prices and sales changed as the tax went into effect on 1 Janaury 2017. Here's a summary of the research's findings:

The research, co-written with Barton Willage, a doctoral candidate in economics, and David Frisvold of the University of Iowa, appeared Oct. 25 in JAMA: The Journal of the American Medical Association.

Philadelphia’s tax of 1.5 cents per ounce on sugar-sweetened beverages is one of several passed by cities throughout the United States. The goal is to increase prices and dissuade people from drinking soda to benefit their health. These taxes have been controversial; Cook County, Illinois, recently repealed its tax, which had only been in place a few months.

The Philadelphia tax (and one in Berkeley, California) are levied not on consumers but on distributors. That’s because lawmakers are trying to change consumers’ behavior but want, for political reasons, to avoid taxing consumers directly. So they levy the tax farther up the supply chain, said Cawley, who is co-director of Cornell’s Institute on Health Economics, Health Behaviors and Disparities.

Until now, it has been unclear just how much of Philadelphia’s tax on distributors would be passed on to consumers in the form of higher retail prices. Distributors could just pay it themselves to avoid a decrease in sales, Cawley said. “Or producers like Coke and Pepsi could say, ‘We’re not going to let cities use this tax to decrease our sales; we’re going to bear the brunt of it. We’ll just sell our soda cheaper to distributors, and that’s how we’ll keep retail prices the same,’” he said.

But in Philadelphia, just 36 days after the tax went into effect, stores raised their retail soda prices by a whopping 93 percent of the tax. “I was surprised by how much of the Philadelphia tax was passed on to consumers in such a short period time,” said Cawley.

And some untaxed airport stores, technically located in Tinicum, Pennsylvania, also raised their prices by exactly the amount of the tax after the taxed stores did, the study found. “It was impossible to predict in advance whether the untaxed side of the airport would limit the pass-through of the tax on the Philadelphia side, or whether the untaxed side would take advantage of Philadelphia’s tax to raise prices themselves,” says Cawley.

The 93 percent “pass-through” to Philadelphia consumers was significantly higher than occurred in Berkeley, California; previous research (including some by Cawley and Frisvold) showed that only 43 to 69 percent of the Berkeley tax was passed on to soda drinkers there.

This finding is highly significant because although Philadelphia directly imposes the tax on beverage distributors in the city (the de jure incidence of the tax), in reality, the tax is predominantly falling upon consumers, who are the ones who are primarily paying the tax (this is the de facto incidence of the tax).

The true incidence of the tax matters because it potentially affects the legality of the tax and how it is imposed. The imposition of a similar soda tax in Chicago was largely derailed because courts in that state recognized the de facto nature of the tax, while courts in Pennsylvania have so far dismissed the real world incidence of the tax in upholding Philadelphia's soda tax. Pennsylvania's state supreme court has not yet announced whether it will hear an appeal of the case.

Meanwhile, the pass-through of 93% of Philadelphia's soda tax to consumers at Philadelphia's International Airport falls on the high side of our own observations throughout 2017, where overall, we've found that two-thirds of Philadelphia's soda tax is being passed through to consumers.

Confounding factors for soda prices on the Tinicum-side of the airport

We should however recognize that the market represented by Philadelphia's International Airport is not generally representative of the market for beverages in the city, where the airport cannot be considered to provide a genuinely free market for competition. For example, the city of Philadelphia, which manages the airport, is able to severely restrict the number of vendors that may do business at the airport.

Restricting the ability of outside vendors to freely enter into the market represented by Philadelphia's international airport allows the approved vendors who sell soft drinks outside of Philadelphia's city limits at the airport to hike the prices of the sweetened beverages they sell without the potential penalty of losing business to competitors charging lower prices, with the vendors and their employees pocketing the difference thanks to their city-granted, monopoly-like business privilege.

On average, in December 2016 before the tax was implemented, the mean price per ounce of cola was 12.37 cents on the untaxed side and 12.53 cents per ounce in the taxed side. By February 2017, that price had increased to 12.93 on the untaxed side and 13.92 on the taxed side. Thus, the price had risen significantly more on the taxed side.

The investigators calculated that overall, 55.3 percent of the tax was passed along to consumers. In the taxed stores, however, 93 percent of the tax was passed to consumers by February.

One might query why the stores in the untaxed part of the airport also raised prices? Probably because they could, and it would simply add to their profits.

That would make logical sense, but there's more to the story, where the common conflating factor of the intervention of Philadelphia's city government is also at work. Here, the role of the city in jacking up prices for consumers at parts of the airport outside of the city's limits was confirmed by the mayor's office.

Mike Dunn, a spokesman for Mayor Kenney, said Friday that vendors on the Tinicum side who have raised their prices since Jan. 1 did so for a different reason. Three out of the 37 vendors in Tinicum received permission to change prices this year, Dunn said, and all did so as part of a voluntary program that allowed them to raise all prices by 10 percent in exchange for paying their employees more.

All airport merchants will be required to pay a minimum hourly wage of $12.10 when they enter new concession contracts, Dunn said, but three vendors on the Tinicum side elected to begin early.

That dynamic adds an interesting wrinkle to Cawley's initial research findings, one where he should already have the detailed data indicating the amount of prices changes of soda at all airport locations to be able to resolve, where it should be easy to identify the vendors that increased their soda prices by the 10% that was blessed by the mayor's office. How soda prices changed at the remaining vendors will then give us an ideal of the extent to which those other vendors took advantage of the opportunity to gouge their customers within the closed market of the Philadelphia International Airport during the first two months of the tax going into effect.

It's a question to which we don't yet know the answer that will be exciting to find out, hopefully in 2018!