A tax is a signal: theory and evidence

We propose a theoretical model in which uninformed consumers update their beliefs about the health effects of sugar in soft drinks through two sequential policies: an information campaign and a sugar tax. The information campaign is modeled as a costless signal (cheap talk), while the tax policy is modeled as a costly signal. While the information campaign conveys only partial information, we show that the tax policy can generate a fully revealing equilibrium, thereby transmitting accurate information to consumers. Our empirical analysis supports the theoretical predictions. Exploiting the announcement (on March 16, 2016) of the tiered structure of the UK Soft Drinks Industry Levy, we provide evidence consistent with the tax policy functioning as an effective signaling device. Immediately after the tax announcement and before implementation, both the purchased volumes and the sugar content of taxed soft drinks declined, while purchases of exempted sugar-sweetened beverages remained unchanged. In contrast, the preceding information campaign had a similar effect across all soft drinks, regardless of their sugar content.