«April 2010 University of Adelaide SA 5005 AUSTRALIA WINE ECONOMICS RESEARCH CENTRE The Wine Economics Research Centre ...»
Wine Economics Research Centre
Working Paper No. 0610
Special Taxation of Alcoholic Beverages to
Correct Market Failures
University of Adelaide
SA 5005 AUSTRALIA
WINE ECONOMICS RESEARCH CENTRE
The Wine Economics Research Centre was established in 2010 by the School of
Economics and the Wine 2030 Research Network of the University of Adelaide,
having been previously a program in the University's Centre for International Economic Studies.
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WINE ECONOMICS RESEARCH CENTREWORKING PAPER NO. 0610 Special Taxation of Alcoholic Beverages to Correct Market Failures John Freebairn Department of Economics The University of Melbourne Parkville Vic. 3010 email@example.com April 2010 Revision of a paper presented at the AARES/AAWE Workshop on The World’s Wine Markets by 2030, Adelaide Convention Centre, 8-9 February 2010. With the usual caveats, I am grateful for the comments of Kym Anderson on an early draft.
Abstract In most countries, including Australia, special excise and other taxes are imposed on beer, wine and spirits. This paper reviews the market failure arguments for special taxation of alcoholic beverages, evaluates the pros and cons of different externality correction taxes in terms of the tax base and tax rate, and uses the results to suggest reform of the special taxation of alcohol in Australia. A common specific tax per litre of alcohol by volume across the different beverages levied on a consumption base at the wholesale level, and indexed by a wage index, is proposed.
1. Introduction Special and relatively high levels of commodity taxation are levied on beer, wine and spirits in most countries, including Australia. They are in addition to the general income, consumption and asset taxes. Initially the rationale for the special taxes on alcohol, and on tobacco, included the dual characteristics of “sin taxes” and the relative ease and low cost of tax collection. Subsequent and additional arguments have included assertions of a relatively low distorting and deadweight cost of taxation on these products because of the relatively low elasticity of demand and because of a complementary relationship in consumption between alcohol with untaxed leisure and home-produced goods and services, but many other products have similar characteristics. Another set of reasons for relatively high rates of taxation of alcohol is as one form of government intervention to correct market failures of too much consumption from a society efficiency perspective. Potential market failures include external costs associated with road accidents, crime and health care expenditures, imperfect information about the longer term effects and habitual effects of excessive consumption of alcohol, and time inconsistency of individual decisions on the purchase of alcoholic beverages.
Using Australia as an illustration, this article reviews the market failure arguments for special taxation of alcoholic beverages, and it considers options in the choice of the tax base and rates of market failure correction Pigovian taxes. Some of the merits of special taxes relative to other forms of government intervention such as information provision and regulations are canvassed. With the taxes being a long lived policy intervention, the analysis is undertaken in a long run equilibrium context.
There is an extensive literature, both in economics and in health care, which directly or indirectly discusses specific taxes of alcoholic beverages and other forms of government intervention to achieve better social outcomes. In the Australian context, recent papers include the economic analyses of Richardson and Crowley (2000) and Clarke (2008), Collins and Lapsley (2008) provide detailed estimates of the costs of alcohol abuse (along with those for tobacco and illicit drugs), the Preventive Health Taskforce (2009) consider the broader set of government intervention instruments to reduce alcohol abuse, and Cnossen (2009) evaluates the excise taxes and the wine equalisation tax. Papers prepared for the Mirrlees Review of the UK taxation system, particularly by Crawford et al. (2008), and commentaries on this paper, review the international literature on excise taxes, including on alcohol. This paper pays special attention to the heterogeneity of consumers in terms of alcohol consumption levels and associated external costs, and in particular a paper by Pogue and Sgontz (1989).
Another set of literature provides estimates of key parameters, including of the elasticities of demand for alcoholic beverages, which are important to the discussion, for example the survey by Fogarty (2008). This paper draws on this and other literature, it notes some areas of controversy at the conceptual level as well as at the empirical level, and it derives principles for the choice of a tax base and rate for special taxation of alcoholic beverages to correct market failures.
The rest of the paper is organised as follows. Section 2 sets out the current set of special taxes on different alcoholic beverages. Section 3 discusses the market failure arguments for government intervention to reduce alcohol consumption to raise efficiency. Some of the options for the design of special taxes on alcoholic beverages, and the challenges in choosing between these options, are canvassed in Section 4.
Both Sections 3 and 4 include some comparisons of the tax instrument with other policy interventions, such as information provision and education, regulations, and investment in primary health care. A final Section 5 draws together the main implications for reforming the special taxation of alcohol in Australia.
2. Special Taxes on Alcohol in Australia Excise taxes are levied on beer and potable spirits and a wine equalisation tax is levied on wine. Table 1 provides details of the current set of special taxes on beer, wine and spirits in Australia in terms of the tax base and tax rate.
Source: Swan, W. and Tanner, L., (2009), Budget Paper Strategy and Outlook:
Budget Paper No. 1, 2009-10, Commonwealth of Australia, Canberra.
Table 1 shows a very different set of special taxes on the different alcohol beverages.
A specific tax per unit of alcohol by volume applies to beer and spirits, but even then the first 1.15 per cent is exempt in the case of beer and the rate varies by container size (or for draft versus other beer) and by alcohol content. An ad valorem wholesale sales tax is applied to wine, and then with a significant zero rate threshold per winery in excess of $1.7 million wholesale value per year1. The excise tax rates are indexed to the CPI, and adjusted every six months.
The tax rate per unit of alcohol is highest for potable spirits and mixed drinks, slightly lower for brandy, lower again for beer, and in the case of beer, the rate is lower for low strength beer and it is much lower for draft beer relative to beer sold in bottles and cans. The effective tax rate per litre of alcohol by volume in wine is relatively low for low value wine, but relatively high for high value wine when compared with the other beverages. The reasons for this diverse pattern of different tax bases and tax rates, and then the different effective tax burdens, on different alcoholic beverages and different places of sale owes more to ad hoc responses to producer lobby groups by the political process over time than to any logical arguments, and in particular those canvassed in the rest of the paper.
For all alcohol beverages, the special taxes apply to an Australian consumption or destination base. That is, imports, with the exception of duty free allowances for international travellers, as well as domestic production consumed domestically are taxed, and exports are exempt.
In 2007-08 the special taxes on alcohol are estimated to have collected $3.3 billion, with $1862 million from excise on beer, $774 million from excise on other beverages and $661 million from the wine equalisation tax (Swan and Tanner, 2009). In practice A commonly stated rationale for the WET rebate is to support wine cellar door sales as a part of a regional development strategy. But, there is no rationale to support wine sales but not other regional activities such as food purveyors and other regional tourist operators.
the taxes are collected at the manufacturer level, but most of the economic incidence is passed forward to consumers as higher retail prices2.
3. Market Failure and the Case for Intervention This section follows a textbook taxonomy to assess the arguments for government intervention to reduce the alcohol consumption decisions of individuals to achieve a more socially efficient outcome. As a benchmark, it starts with the simple case of no market failure where private decisions correspond with efficient levels of alcohol consumption. It then considers different market failure arguments to achieve social efficiency, and the implied changes to private purchase decisions.
a. A Competitive Private Market In modern economies, including Australia, private sector competitive markets, supported with government monitored secure property rights, use prices determined by supply and demand to choose the mix and quantities produced and consumed of products which have private good properties of rival consumption and low costs of exclusion, and also the choice of production methods. These products include the different alcoholic beverages, foods, housing, clothing, recreation and so forth. Other forms of government intervention which directly and indirectly influence market outcomes from the supply side of the market for alcohol, including various forms of assistance to the agricultural sector, regulations and standards on the production of alcohol products, and anti-monopoly monitoring and intervention of businesses along the supply chain, can be important, but they are not considered here.
A competitive market for a particular alcohol product or the aggregate product category alcohol is shown in Figure 1. The demand curve D represents the marginal private benefits (MPB) of the alcohol product to consumers. It represents consumer valuation of the social, recreational, taste and other sensations gained and it deducts any costs of alcohol consumption. Well informed and far-sighted rational individuals will take into consideration not just current period benefits and costs to them, but also In the appropriate long run context, a 100 per cent pass forward assumption is used by ABS in its analyses of the distribution of the tax burden (ABS, 2007) and by Warren et al. (2005). For beer and wine, the underlying logic is constant returns to scale production technology and mark-up on marginal cost pricing associated with a number of oligopoly models. In the case of wine, one plausible model is a competitive or monopolistic competitive model and a highly elastic export demand function.
any longer term costs associated with alcohol consumption, including risks to future health and employability. This forward looking decision making framework is best represented in the Becker and Murphy (1988) model of rational addiction.
There is considerable econometric evidence that the market demand curve for individual alcoholic beverages, and for alcohol as an aggregate, is price sensitive (see, for example, the review study by Fogarty, 2008). Although there is a wide range of reported estimates of the own price elasticities of demand for the broad categories of beer, wine and spirits, and for alcoholic beverages as an aggregate, almost all are significantly negative, and most are in the inelastic zone. There is more variation of estimates of the cross-price elasticities among the different alcoholic beverages across the different studies, with many not being statistically different from zero.
The supply curve in a competitive market represents the marginal private cost (MPC) of producing the product, including the opportunity cost of labour, capital, materials, land, water and other natural resources. In the context of the production of alcohol, rather than a competitive model, the wine industry likely is better described as a monopolistic competitive industry (many producers of differentiated products and low costs of entry and exit), and the beer and potable spirits industries as a differentiated oligopoly (a few producers and high costs of entry and exit). Then, the industry supply curve will be above the MPC. However, given the characteristics of a mature product, and one or both of intense competition among the producers of highly substitutable products and the intense scrutiny of monopolistic behaviour by the ACCC, the difference between the market supply curve and a MPC curve likely is not large both absolutely and relative to the same comparison for other industries in the economy.
Figure 1: A competitive market for alcohol
If we make further assumptions that the demand or MPB curve also corresponds to the marginal social benefit (MSB) curve, and the supply or MPC curve corresponds to the marginal social cost (MSC) curve, the market solution depicted in Figure 1 corresponds also to the most efficient level of consumption of alcohol from a society perspective.