The Goods and Services Tax Council’s decision to impose a 28% sin tax on digital gaming on the full face value has received widespread criticism. The criticisms are mainly premised on the ground that skill-based digital gaming cannot be equated for tax purposes with chance-based gambling. While there may be force in that argument, especially in view of a recent decision by the Karnataka High Court in All India Gaming Federation vs The State of Karnataka, these criticisms somewhat overlook the deeper problems with levying a sin tax.
Often referred to as a Pigouvian tax, named after a leading British economist, Arthur C. Pigou, a sin tax has traditionally been justified as furthering the government’s legitimate interest in discouraging socially objectionable human behaviour or practices that produce negative spillover costs on third parties while simultaneously raising tax revenues. Arguably, the government has a duty to protect the mental health of individuals, especially adolescents, exposed to certain kinds of digital gaming and increase social welfare. However, this is not as straightforward a justification as it seems.
Firstly, past experience on levy and collection of sin tax on alcoholic beverages and tobacco products reveals that the sin and its after-effects may not reduce drastically as a result of the tax. This is because addictive human behaviour and practices are demand inelastic — the offtake is insensitive to price fluctuations triggered by an increase in the tax rate. The purpose of a sin tax could then be self-defeating: the government’s success at deterring sinners would inevitably imply a failure in raising tax revenues and vice-versa.
Secondly, unlike tobacco products or alcoholic beverages, it is difficult to clearly identify the negative externalities produced by online gaming addiction. The negative externalities caused by a specific individual at a given point in time cannot be clearly measured. In the absence of an objective assessment of relevant factors, such a tax would end up creating a tax burden on all online gamers equally without making any rational distinction between those who act responsibly and those who do not. Unlike income tax that conforms to the ability to pay principle, a sin tax is regressive in nature because it imposes a disproportionate burden on lower-income groups that are subject to the same rate of tax as high-income groups. This flies in the face of long-standing principles of horizontal and vertical equity in taxation.
Thirdly, a sin tax may become a devious tool to collect additional revenue on the pretext of correcting socially objectionable human behaviour or practices. Worse, the acquired long-term revenue interests of the government may often come into conflict with the underlying purpose of the tax, which is to stop the sin and its negative spillover costs. The tax, then, loses its character as a public health or a good governance measure.
Finally, there is ample research to suggest that a sin tax often leads to negative, unintended consequences. The digital gaming industry is expected to become a 10-billion-dollar industry in the next five years. The tax could overburden an otherwise booming online gaming industry and could lead to the loss of thousands of jobs. Furthermore, the tax could spur the growth of black-market transactions for the targeted sin as people would devise means to evade the tax. Over the last decade, the government lost thousands of crores in tax revenues to illicit goods in the tobacco and alcohol industries.
For the government, a sin tax comes across as an easy and popular solution: it affects only a minuscule size of the population who are addicted to online gaming and would rarely invite a voter backlash. But taxation is not necessarily an optimal solution. The government should instead devise innovative alternatives outside taxation to discourage the negative social effects of online gaming addiction.