Kate Smith

Business owner-managers are central to the debate on how to tax capital income. We develop a dynamic model of business ownership to quantify the efficiency and equity gains from capital tax reforms. We model a rich set of tax instruments to allow for the differential taxation of returns to marginal investments and returns in excess of these, and allow for a range of responses to tax — including entry, exit, investment, incorporation and income shifting. We allow for observed and unobserved heterogeneity to account for the wide heterogeneity in business activities, and exploit tax changes to help identify the model parameters. We show that reforms that reduce effective tax rates on marginal investments while increasing those on excess returns can increase owner-managed business investment and raise revenue in a progressive manner. Through implementable reforms to capital gains taxation and the tax base, policymakers can reap the benefits of higher capital tax rates on excess returns (reduced income shifting and greater equity), while avoiding any negative effects on investment and business entry.

This paper studies the design of sin taxes when firms exercise market power. We outline an optimal tax framework that highlights how market power impacts the efficiency and redistributive properties of sin taxation, and quantify these effects in an application to sugar sweetened beverage taxation. We estimate a detailed model of demand and supply for the UK drinks market, which we embed in our tax design framework to solve for optimal sugar sweetened beverage tax policy. Positive price-cost margins on sugar sweetened drinks create allocative distortions, which act to lower the optimal rate compared with a perfectly competitive setting. However, since profits accrue to the rich, this is partially mitigated under social preferences for equity. Overall, ignoring market power when setting the optimal sugar sweetened beverage tax rate leads to welfare gains that are 40% below those at the optimum. We show that moving from a single tax rate on sugar sweetened beverages (common in practice) to a multi-rate system can result in further substantial welfare gains, with much of these gains realized by instead taxing sugar content directly.

Coverage: Prospect | The Times | The Guardian

We use newly linked tax records to show that the large responses of UK company owner-managers to personal taxes are due to intertemporal income shifting and not to reductions in real business activity. Around half of this shifting is short-term and helps prevent volatile incomes being taxed more heavily under progressive personal taxes. The remainder reflects systemic profit retention over long periods to take advantage of lower tax rates, including preferential treatment of capital gains. We find no evidence that this tax-induced retention increases business investment. It does, however, substantially reduce the tax revenue raised from high income business owners.

Coverage: The Times | The Telegraph | The Scotsman

We evaluate the impact of a price floor for alcohol introduced in Scotland in 2018, using a difference-in-differences strategy with England as a control group. We show that the policy led to the largest reductions in alcohol units purchased among the heaviest drinkers — the group who, at the margin, are likely to create the largest externalities from drinking. The price floor is well targeted at heavy drinkers because they buy a much greater fraction of their units from cheap products and switched away from these products strongly, with only limited substitution towards more expensive products. We show that if the marginal external cost of drinking is at least moderately higher for heavy than lighter drinkers, then a price floor outperforms an ethanol tax. However, more flexible tax systems can achieve similar reductions in externalities to the price floor, but avoid the large transfers from public funds to the alcohol industry that arise under the floor.

Coverage: BBC | Sky News | The Guardian | The National

The COVID-19 pandemic has led to significant changes in where people work, eat and socialise. We use novel data on the food and non-alcoholic drink purchases from stores, takeaways, restaurants and other outlets to quantify the impact of the pandemic on the diets of a large, representative panel of British households. We find that a substantial and persistent increase in calories consumed at home more than offset reductions in calories eaten out. By May 2020 (towards the end of the UK’s first national lockdown), total calories were, on average, 15% above normal levels, and they remained higher than normal for the rest of 2020. All socioeconomic groups increased their calorie purchases, with the largest rises for the highest SES households and the smallest for retired ones. Our findings suggest that the COVID-19 pandemic and the associated changes in people’s lifestyles have exacerbated the challenges of improving population diet and reducing obesity levels.

Coverage: VoxEU

We document that within-individual variation in food choices is substantial and has potentially important consequences for nutrition, and hence well-being. We develop an approach that allows us to study the determinants of this within-individual variation within an economic framework and allow for across-individual preference heterogeneity. We show that around one-fifth of within-individual fluctuations in diet quality is explained by standard economic variables (prices and budgets), along with advertising and weather. The residual fluctuations are important and are larger for lower income and younger people, and individuals who state they are impulsive. We propose a two-selves model of food purchase behavior to structurally interpret these empirical patterns. We use nonparametric revealed preference techniques to show that this model rationalizes our food purchase data.

Coverage: VoxEU

We study optimal corrective taxation in the alcohol market. Consumption generates negative externalities that are non-linear in the total amount of alcohol consumed. If tastes for products are heterogeneous and correlated with marginal externalities, then varying tax rates on different products can lead to welfare gains. We study this problem in an optimal tax framework and empirically for the UK alcohol market. We find heavy drinkers have systematically different patterns of alcohol demands and that welfare gains from optimally varying rates are higher the more concentrated externalities are amongst heavy drinkers.

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We provide new evidence on retailers’ pricing and advertising of store brands in the UK grocery markets. We analyse a simple Hotelling model in which retailers and manufacturers endogenously advertise their respective brands; we account for the impact of advertising on retailer–manufacturer bargaining and downstream competition. The model predicts that retailers advertise their store brands less when advertising is more rivalrous. We present empirical evidence consistent with this prediction. According to our model, aggregate consumer surplus can be higher with store brands than when they are absent from the market.

| WORKING PAPER | POLICY SUMMARY |

Improving diet quality has been a target of public health policy. Governments have encouraged consumers to make healthier food choices and firms to reformulate food products. Evaluation of such policies has focused on the impact on consumer behaviour; firm behaviour has been less well studied. We show that the recent decline in dietary salt intake in the UK was entirely attributable to product reformulation; consumer switching between products worked in the opposite direction and led to a slight increase in grocery salt intensity. These findings point to the important role that firms can play in achieving public policy goals.

| WORKING PAPER | POLICY SUMMARY |

Over the Great Recession UK households reduced real food expenditure. We show that they were able to maintain the number of calories that they purchased, and the nutritional quality of these calories, by adjusting their shopping behaviour. We document the mechanisms that households used. We motivate our analysis with a model of shopping behaviour in which households adjust shopping effort and the characteristics of their shopping basket in response to economic shocks. We use detailed longitudinal data and focus on within household changes in basket characteristics and proxies for shopping effort.

Coverage: The Times | VoxEU | Economics Observatory

We study consumer spending dynamics during the first infection wave of the COVID-19 pandemic using household scanner data covering fast-moving consumer goods in the United Kingdom. We document a large spike in spending for storable products, such as food staples and household supplies, in the days before lockdown. Demand increases were concentrated in 30 of 138 product categories, e.g. soap, soup, canned goods and dried pasta. Households in all socioeconomic groups exhibit unusually high demand pre-lockdown, but there is a clear gradient, with the largest demand spikes for wealthier households. Although stories of people purchasing extreme amounts received a lot of attention, higher aggregate demand was mainly driven by more households than usual choosing to buy storable products, with only small increases in average quantities bought on a given trip. Temporary limits on the number of units per transaction, introduced following the demand spike, are therefore unlikely to lead to the avoidance of stock-outs. Given rapidly increasing case numbers in the ongoing second wave, and the spectre of further national lockdowns, our work provides timely evidence for preparing for a future demand spike.

Part of the special issue celebating the 50th Anniversary of the IFS.

Young people in the UK consume far above the maximum recommended levels of added sugar. It is likely that neither they nor their parents fully take account of the future health, social and economic costs of this high sugar consumption. This provides a rationale for policy intervention. The majority of young people’s added sugar consumption occurs in the home, where purchases are typically made by parents. This means that understanding the purchase decisions of adults is important for policy design, even if the policies aim to reduce the consumption of young people. We discuss the merits of popular policies, including taxes, advertising restrictions and restrictions on the availability of specific foods, and we identify promising avenues for future research.

Prepared as the Richard Musgrave Lecture, CESifo, Munich, April 2017.

Corrective taxes have been implemented in a number of countries with the aim of addressing growing concern about the rise in obesity- and diet-related diseases. The rationale is that food consumption imposes costs on the consumer in the future that they do not fully take into account at the point of consumption (‘internalities’). Corrective taxes have the potential to improve welfare by reducing suboptimally high consumption. We review the literature on the size of these internalities and on the optimal corrective tax, which depends on the patterns of internalities, the price responsiveness of consumers, and on redistributive aims.

For a special issue on “The economics of the global food and agriculture system”.

Shocks to world commodity prices and the depreciation of sterling led to a large increase in the price of food in the UK. It also resulted in large changes in the relative prices of different foods. We document these changes, and consider how they affected the composition of households’ shopping baskets. We isolate the impact of changes in relative food prices from variation in preferences using data on purchasing decisions made by a representative panel of British households. We show that changes in relative food prices led to a worsening in the nutritional quality of households’ shopping baskets, though this was partially mitigated by offsetting changes in preferences.

Coverage: FT | The Guardian | VoxEU

The share of pre-tax income flowing to the top of the UK income distribution increased continually and substantially in the three decades leading up to the financial crisis, but has changed little since 2013. Using microdata sampled from UK tax records, we describe the nature of top incomes in the UK and how they are taxed. We show that wage income is the dominant source of pre-tax income, even for highest-income 0.1% of UK adults. But, ‘active’ business income – derived from self-employment or closely-held incorporated businesses – is considerably more important for the top 1% than for those with lower incomes. High-income wage earners work disproportionately in financial services. The high-income self-employed predominantly work in partnerships in professions such as accountancy and legal services. Overall, UK income taxes are progressive: average tax rates rise with income. Taxes on top incomes have been increased since 2010, with the result that the post-tax share of income flowing to the top has fallen. But average tax rates vary significantly within the top and depend on how income is received. Incomes from business ownership and investment are taxed at lower rates than employment income. We discuss options for reforming the taxation of top incomes.