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May 21, 2009
News Analysis: Pop Goes the Soda Tax
Joseph J. Thorndike

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So lawmakers are thinking about using a soda tax to help pay for healthcare reform. They should think again. History suggests that soda taxes are not popular. Or fair. Or durable.

More generally, they are a poor choice for anyone looking to fund a vital -- and presumably permanent -- social program. Excise taxes are inherently unreliable. They are subject to attack and revision by political opponents, who will lobby long and hard against them. Entitlements need a more resilient fiscal foundation.

The nation's first soda tax appeared in 1917, when Congress imposed taxes on the ingredients used in many bottled beverages. In 1919 lawmakers took a more direct approach, imposing a manufacturer's tax on bottled beverages and a retail tax on fountain sales.

The two-tiered 1919 tax was a war levy -- despite its passage some three months after the armistice ended World War I. In May 1918 President Woodrow Wilson asked Congress for additional money to fight the war, but lawmakers took their time developing a bill. In the meantime, peace overtook their efforts. So, too, did Prohibition, which blew a big hole in the budget by slashing projected revenue from alcohol taxes.

Over the course of the war, lawmakers transformed the nascent income tax from a modest levy to a revenue workhorse. Individuals and corporations faced higher rates and lower exemptions, as well as a new tax on "excess" profits.

But income taxes were not sufficient, prompting lawmakers to adopt a wide range of excise taxes. Some were paid by manufacturers -- including the makers of cars, tennis rackets, firearms, cameras, hunting knives, chewing gum, candy, and cosmetics -- and some were on private club dues and a host of other goods and services. Others were collected at the retail level.

Many retail taxes were designed to tax "luxury," and they applied only to items priced above a certain level. Umbrellas, for instance, were subject to a 10 percent retail tax only if they cost more than $4 (roughly $55 in current dollars). Picture frames were taxed when they exceeded $10. Men's hats were taxed if above $5, but women's hats only if they cost more than $15.

Tax experts were not impressed by this blend of moral and fiscal imperatives. Excise taxes could be expected to raise money or discourage consumption, observed economists Roy and Gladys Blakey, but rarely could they do both. "The two results are not likely to be achieved in the same bill," they explained, "because if the rates are high enough to accomplish the latter, not as much revenue will be produced as if the rates were lower."

Soda Tax

The soda tax suffered from the same problem. It, too, traded on the notion of luxury, or at least non-necessity. Congress decreed a two-part tax: a 10 percent manufacturer's tax on bottled soda; and a 1-cent retail tax for every 10 cents charged by soda fountains for soft drinks, egg creams, ginger beer, ice cream, and similar treats. (Ice cream was inexplicably included in the "beverage" category, lending credence to the old saying that the past is a foreign country.)

The Blakeys did not approve of the soda tax. "The tax is not high enough to discourage wasteful or unnecessary consumption nor will it bring in much revenue to the government," they wrote. The retail tax also promised to be an administrative nightmare. "It will prove a most annoying measure from the taxpayer's point of view," the Blakeys predicted, "and will be difficult of collection, because there is no way of finding out whether these pennies are properly put aside for Uncle Sam or get into the pockets of the dispenser of sundaes."

The Blakeys were right. From the moment of its enactment, the soda tax was the object of special scorn. Critics complained that it was annoying. "After today, the little old nickel or dime, which not long ago purchased you a foaming drink with ice cream, crushed fruit, flavored syrup and everything, becomes en passé with the man at the soda fountain," observed the Los Angeles Times. "Coco-cola and the other thirst quenchers which have remained at the 5-cent price will now sell for 6 -- Uncle Sam gets the penny."

Like almost every other excise, the tax was also complicated. Definitional issues confused patrons and vendors alike. "The law says cold malted milk is a beverage and subject to tax," the Times pointed out, but "hot malted milk is a food and is exempt." Coffee and tea were exempt, according to federal officials, but what about iced versions of both drinks? Inquiring soda jerks wanted to know.

Pie, a staple of most soda fountains, was not taxable. "But when one gets an aristocratic impulse and orders it a la mode, that is with ice cream served with it, it gets in the taxable list," the Times noted. "Now comes the question, shall the boy behind the counter charge the tax on the basis of 15 cents, the price of pie a la mode, or just on the 5 cents that is added for the ice cream?"

Trivial (and tongue in cheek), to be sure. But such questions were indicative of the derision that greeted the tax on its debut.

Opposition Mounts

Predictably, drugstore owners organized a new Soda Fountain Association to lobby for repeal. The tax was complex and cumbersome, they insisted. It was also patently unfair. Fountain owners pointed out that drinks served in their establishments were subject to tax, while identical drinks served in a hotel were exempt.

The Bureau of Internal Revenue, eager to forestall a tidal wave of tax avoidance, issued guidance. Tax was due on items sold for consumption in or near the vending establishment. "The purchaser cannot escape the tax by stepping outside of the place where sold to consume his soft drink or ice cream," the agency intoned. Similarly, ice cream served in cones was taxable (since the cone implied imminent consumption). But ice cream sold in boxes, as well as soda sold in pitchers, was presumed to be destined for home use and was therefore exempt.

Eventually, the soda tax succumbed to its critics, and Congress repealed it in 1922. At its peak the previous year, it had raised approximately $58 million, with about half coming from the retail levy. This figure represented slightly more than 1 percent of total federal revenues. It was not enough money to sway lawmakers besieged by angry consumers, retailers, and manufacturers.

Ten years later, lawmakers returned to the soda tax. They were desperate for revenue to cope with a Depression-wracked economy. But this time the tax lasted just two years, before Congress decided to repeal it in the Revenue Act of 1934. Notably, the 1934 act was passed in a fiscal climate only slightly less desperate than the one prevailing two years earlier. But lawmakers were again swayed by the appeal of soft drink manufacturers, who insisted that the tax was complex, costly, and only marginally productive (it raised between $4 million and $5 million annually in its encore appearance). The tax, Congress concluded, was more trouble than it was worth.

Today's Tax

The soda tax under consideration today is different than its predecessors. Among other things, it wouldn't tax ice cream. (Although arguably it should, given the rationale offered for it.)

Today's tax derives its claim to fairness from the tradition of taxing sin, not luxury. It has more in common with the revenue history of alcohol and tobacco than with any previous efforts to tax soda and sarsaparilla.

But if lawmakers think they can successfully add a new sin tax to the revenue system, then all I can say is good luck. The only sin taxes of any significance that have survived for any length of time are the two we know and love: taxes on booze and smokes. Those levies benefit from a degree of historical legitimacy that will not transfer readily to a new tax on indulgent eating.

Poll data suggesting popular support for soda taxes seem dubious. As Kevin Drum, a blogger for Mother Jones magazine, has pointed out, support for a soda tax drops precipitously when people are reminded that it will be regressive. In general, Americans react poorly to social engineering of the moralistic sort. Even more so when it lacks a reasonable claim to fairness.

Today's soda tax seeks legitimacy in the notion that it would raise money while also discouraging harmful behavior. But only a few sin taxes can actually manage to do both. Lawmakers will not have the luxury of taxing an addictive vice -- a feature of alcohol and tobacco that has made associated taxes effective revenue tools. If it is going to raise enough money to make a difference to the healthcare debate, the soda tax will have to be set low enough to discourage only the most casual drinkers.

Healthcare reform is important. It deserves a better funding source than some misbegotten sin tax that is sure to raise the ire of taxpayers and manufacturers alike. Even if, by some miracle, advocates of the soda tax won the fight to enact it, they would have to refight that battle every year. Better to choose a battle that, once won, will actually stay won.