Understanding the soda tax proposal

This morning the Council held a hearing to continue their deliberations over the proposed soda tax. Most of the time was dedicated to two panels: one of small business owners, and one of government and healthcare professionals.

(trigger warning: math ahead, but not the scary kind)

Here’s my summary of their first discussion.

The small-business panel was intended to be a wake-up call on the negative effects the soda tax might have on mom-and-pop shops, family-owned restaurants, and craft drink businesses. On the panel were Kara Patt from Timber City Ginger Beer; Taylor Hoang, a restaurant owner and a leader of the Ethnic Business Coalition, and Ryan Hopkins of Burger Boss Drive-in.

Patt described the cost and price structure for her ginger beer products, which she sell directly at farmers markets and also distributes to restaurants, bars and a handful of stores. He product is already sold at a high price — $10 for a 32-ounce can — because the scale of the operation is small. Seattle’s soda tax would add another 56 cents on top of that price. Patt said that without some sort of exemption for small businesses, the new tax would probably put her out of business.

Hoang and Hopkins spoke to the profit margins for soda in their restaurants, and to the role of soda in “combo” offerings to incent sales of other products. They threw around some facts and figures, but in general the financial numbers behind the bulk soda business are kept quiet and it was hard to tell solely from their descriptions just how thin their margins are.  So this afternoon I did the math! Here’s a spreadsheet (excel and PDF)  that lays it out.

Here’s how the soda business works. Retailers buy 5-gallon bags of syrup from a wholesale distributor for a given product (like Coca Cola or Pepsi). The syrup is a 5:1 concentrate, meaning that you add 5 ounces of water to one ounce of syrup to get six ounces of soda. According to Hopkins and Hoang, a 5-gallon bag of syrup costs a restaurant about $40 with volume pricing, which then makes about 30 gallons of soda (240 16-ounce cups).  A single ounce of soda costs them just over one cent (caveat: this is an oversimplified model that just looks at cost of the soda itself and excludes equipment rental and service, delivery charges, cups, lids and straws, and other costs associated with serving soda; we’ll revisit the other costs a little later).

Washington state also taxes syrup at $1 per gallon, which comes out to about one tenth of a cent per ounce of soda.

So let’s put this together. A 16-ounce cup of soda (assume no ice) costs 17 cents for the raw product and 2 cents for the state tax for a total of 19 cents. The proposed Seattle soda tax would be an additional 28 cents, raising the total cost to 47 cents. For every 30 gallons of soda dispensed, it’s $45 of cost of goods and $67 of Seattle soda tax, for a total of $112.

Today, Burger Boss charges $1.99 for that 16-ounce soda that costs it 19 cents (and probably much less with ice), making $432 of profit for every 30 gallons. With the Seattle soda tax, if Burger Boss doesn’t increase its prices its profit would drop to $365.

At Hoang’s restaurant, she charges $1.50 to add a soda and egg roll to a bowl of Pho. Assume it’s 75 cents for the soda, and her profit per soda drops from 56 cents to 28 cents. She said that her restaurant goes through 10 bags of syrup per month; that’s $670 in Seattle soda taxes every month, or $8000 per year off her bottom line.

If they do raise prices to compensate, passing the tax on to their customers, then their volume of sales will go down — also hitting their profit margin.

Soda on its own is a high-margin business, but restaurants and stores carry all the additional costs of selling that product: all the ancillary items I listed above, plus rent, furniture, power, employee costs, advertising, security, insurance, and everything else that goes into running a business. It’s particularly hard on small businesses because they don’t benefit from the economies of scale that larger business see (Burger Boss pays $40 for a 5-gallon bag of syrup, but you can bet McDonalds gets a far better price). So even if soda is a profitable part of the business, most small businesses as a whole operate on thin margins driven by competitive pressures. Adding a significant tax onto soda, causing them to either raise prices or absorb the cost, can easily be the straw that breaks the camel’s back and drives them into the red. It’s very common that across a business’s products, some are high-margin and some are low margin; often a handful of products are the real money-makers, and the others are carried so that the business has the full selection that customers expect (even if they rarely buy them). Soda is a high-margin, high-volume moneymaker that carries the burden for other unprofitable but necessary items on the menu; the corollary, unfortunately, is that if you make soda unprofitable you could screw up the entire business model.

Hoang also contextualized the tax as one more component that the city is adding to what she called “a very challenging business environment” that small businesses are already facing, with the new labor laws, regulatory changes, the increase in the business license tax, the increase in the B&O tax, increasing rent, and increases in food and delivery costs.

Gatt noted that for Timber City Ginger Beer, operating the five 7-keg-capacity tanks they recently acquired would mean paying $140,000 in Seattle soda taxes per year.

Council member O’Brien was unapologetic on the impact on small businesses, explaining that he didn’t want to put anyone out of business, but that the entire point of the tax is to raise the price of the product so that people consume less. “We’re increasing the price of your product by 56 cents, and to be frank, that’s our intent. We want it to be a noticeable increase not to put you out of business, not to say that no one in this city can drink sugary beverages, because that’s not going to happen, but we do want to start to tip the scales so that people are choosing healthy alternatives. And we’d love for them to choose healthy alternatives right in your store. And we’d like to help your store through other programs so that you have fruits and vegetables available for folks to turn to.”

O’Brien got strong support from the second panel, which included Dr. Jim Krieger of Healthy Food America, Dr. Jennifer Falbe of UC Berkeley School of Health, and Dr. Bessie Young of University of Washington. Young listed some eyebrow-raising statistics: consuming 1-2 sugary drinks per day is associated with a 58% increase in chronic kidney disease, 26% increase in diabetes, and a 12% increase in hypertension.  In King County, 35% of adults are overweight, 7% have diabetes, 22% are obese, and 26% have hypertension.  63% of adults in King County drink sweetened beverages. The figures for children aged 6-18 are equally sobering: 27% have daily consumption of a soda, 12% are overweight, 9% are obese, and 78% don’t meet the daily exercise requirement. According to Young, kids who drink 1-2 sugary drinks a day have a 60% increased risk of obesity within 15 months.

Kriegler noted that research shows taxes on sweetened beverages are indeed an effective means of reducing consumption. However, when Council member Burgess asked him what the research shows about adding in “diet” sodas to the tax program, he received an unexpected answer: Kriegler said that the research on the health effects of diet beverages are mixed, but including them in the tax limits the convenient alternatives to sweetened beverages and actually results in a smaller reduction in consumption and thus reduced positive health effects — so he recommended not taxing diet sodas. That sets up a difficult choice: the Racial Equity Toolkit analysis shows that the tax will have a disproportionate effect on poor and underserved communities if it is levied just on sugary drinks, but it will be less effective if it’s spread to a wider array of drinks.

Also on the second panel was Marisa Waxman, Revenue Commissioner for the City of Philadelphia. Last year her city passed a 1.5 cent per ounce tax on wholesale sales of both sugary and “diet” beverages, which went into effect at the beginning of the year. They expect a 27% price increase and a 27% decline in sales to accompany it, and so far she says they are tracking fairly closely — though it will be several more months before they have enough data to fully understand the impact. Implementing the tax cost $1.8 million the first year, and is expected to cost an additional $1 million in subsequent years. They look to bring in around $91 million in annual revenues from the tax.

Several adjustments to the tax were suggested today, including:

  • taxing other products with added sugar, such as candy bars, ice cream and sugared cereals. Burgess liked that idea, but explained that the trick is knowing how much sugar is added. He noted that the FDA’s new nutrition labels planned to be rolled out next year have a separate line for added sugars, but the Republicans in Congress are currently trying to roll that back.
  • exempting naturally occurring sugar.
  • exempting small businesses.
  • exempting businesses that make their own product and sell it directly to consumers rather than going through a distributor (which would exempt Timber City’s sales at farmers markets, but not their distribution to stores, restaurants and bars).
  • Offsetting the tax by introducing a “healthy beverage tax credit” on the wholesale purchase of healthy drinks to resell in retail stores and restaurants.

In the Council’s first discussion of the tax, there was disagreement about what programs the tax revenues should be applied to. This time Council member Juarez continued her push that substantial revenues should go into increasing access to healthy food, especially in the several neighborhoods that today don’t have a grocery store or even a convenience store that offers fresh produce. Juarez also had an excellent rant about people who think farmers markets are a legitimate option for people in underserved neighborhoods to get access to healthy, fresh food, pointing out that the Seattle version of a farmer’s market offers organic kale, wine, specialty food and artisan cheese — not where you would expect a mom with two kids in tow to choose to get staple foods to serve at home.

If there was tension today among the Council members (there was clearly tension between the Council and the small business owners) it related to whether the soda tax is primarily viewed as a revenue source or as a public health intervention. If it’s about revenues, then the debate over which programs take priority will be front and center. If it’s a public health initiative, then there will likely be less effort to carve out exceptions to protect small businesses.

Burgess wrapped up today’s discussion by noting that his committee will take up the bill again on Friday May 26th, and then again on May 31. He also said that he and his colleagues are already developing a set of amendments, many of which are likely to form an alternative version of the soda tax legislation. He expected the new version to be available before next Friday’s meeting.