Tax does not just raise money. It changes behaviour
When most people think of tax, they think of the government taking money. But economists think about tax differently. Taxes don’t just raise revenue. They change incentives. And when incentives change, behaviour changes too.
This is why tax is so politically controversial. People respond to it.
1. The basic idea: incentives
An incentive is something that pushes you toward or away from an action. When the price of something rises, people tend to buy less of it. A tax raises the price, so it usually reduces consumption.
Economists call this the behavioural effect of tax.
A classic example is smoking. When cigarette taxes rise, the price rises, and fewer people smoke. This is partly why governments use taxes not just to fund public services, but to discourage harmful behaviour.
2. The “Beard tax” example
One of the funniest examples in economic history is the beard tax. In Russia, Tsar Peter the Great introduced a tax on beards in the late 1600s to encourage men to shave and look more “modern”.
This shows the point perfectly. The purpose was not mainly to raise money. It was to change social behaviour.
People responded in predictable ways. Some shaved to avoid paying. Some paid because they valued having a beard. That is literally consumer choice.
3. Jaffa cakes and the power of tax definitions
Another great example is Jaffa cakes. In the UK, cakes are zero rated for VAT (meaning no VAT), but biscuits are taxed. So the classification matters.
Jaffa cakes were legally argued to be cakes rather than biscuits, partly because they go hard when stale like cakes, not soft like biscuits. This sounds silly, but economically it matters because VAT affects prices, and prices affect demand.
The wider point is that tax rules influence business behaviour. Firms have incentives to label products in tax efficient ways. Small definitions can change millions in revenue.
4. The “fat tax” and sugar tax
The UK sugar tax (soft drinks industry levy) is another example where the goal is to change behaviour. It pushes firms to reduce sugar content and pushes consumers away from high sugar drinks.
This is an example of a corrective tax. Economists call it a Pigouvian tax, meaning a tax aimed at correcting negative externalities.
A negative externality is when your actions create costs for others. For example, sugary drinks increase health costs, which puts pressure on the NHS. So the tax is designed to reduce that social cost.
5. Why taxes sometimes have “unintended consequences”
A key economic idea is that people respond to incentives, sometimes in unexpected ways. If taxes make something expensive, consumers can substitute toward alternatives.
For example, if you tax sugary drinks, people might switch to cheaper sugary foods, or they might just switch brands. If you tax cigarettes, people might move toward vapes.
Economists call this substitution. When something becomes expensive, we substitute to something else. Tax policy has to consider this.
Final thought
Tax is one of the strongest tools governments have, not just for raising money but for shaping behaviour. It can reduce smoking, change what companies produce, and even influence whether men keep beards. Once you understand that tax changes incentives, you start seeing economics everywhere, even in Jaffa cakes.
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