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THE ALCOHOL EXCISE cont'd

Tom Hall, NZ Treasury, June 1996

Taxation: The Optimal Excise (Empirics)

The Weighting to be Applied to Individual Drinkers’ Marginal Net Externalities

To estimate the optimal uniform excise, we need to weight the average marginal net externalities of drinkers (at drinkers’ socially-optimal levels of consumption) by their the price derivatives of demand of drinkers. Most empirical studies examine the price elasticity of alcohol or of each beverage, rather than the price derivatives of demand of drinkers by drinking level. However, contrary to the intuitive view that heavy drinkers are insensitive to price, both theory and empirical evidence, albeit mainly from overseas, strongly suggest that heavy drinkers respond to price changes.

From a theoretical viewpoint, a price increase has a greater absolute impact on a heavy than a moderate drinker. Unless the drinker is addicted, this greater absolute impact should elicit a greater response in consumption behaviour.

From an empirical viewpoint, much evidence, albeit largely from overseas, suggests that there are few drinkers who are addicted, in the sense of not reducing drinking in response to price changes, and that heavy drinkers are as responsive as, and possibly more responsive than, moderate drinkers:

- the semi-fixed lognormal distribution of per capita consumption, discussed above (see pages 18-19), implies that drinkers at all consumption levels respond to a variable such as price;

- even small changes in excise have a large effect on heavy drinking, as proxied by death rates from alcoholic cirrhosis;

- United States studies have consistently shown that increases in the price of alcohol can reduce traffic fatalities;

- Cook and Moore review research on how taxes on alcohol affect crime rates. They conclude that taxes on alcohol reduce some types of violent crime; and

- Casswell, Grossman et al., Richardson and Crowley, Wodak, Fingarette and Edwards et al. each survey research on whether heavy or dependent drinkers are responsive to price. Each concludes that they are responsive. Edwards et al., the most comprehensive of these surveys, summarises his findings as follows, "Heavier drinkers as well as lighter drinkers will be ... responsive, and the connection between price and consumption is likely to have its follow-through in a connection between price and population level experience of problems."

Against the findings of the above studies, Manning et al., who explicitly studied the price responsiveness of drinkers by consumption level (using 1983 data), found that light and heavy drinkers are far less price-elastic than moderate drinkers. However, if past moderate consumption is complementary to current heavy consumption, as intuition and economic models of rational addiction suggest, then the strong effect of price on the consumption of moderate drinkers found by Manning et al. in 1983 also lessens the consumption of heavy drinkers over time.

In light of theory and most of the empirical evidence cited above, it is reasonable and indeed possibly conservative to assume that the price elasticity of consumption of absolute alcohol is roughly constant at different levels of average consumption. That is, changes in response to a price change are roughly proportionally to the level of alcohol consumption. This may be because young people tend to be both heavier drinkers and more price-sensitive than older drinkers.

In the section "Externalities at a Population Level" it was noted (see page 19) that in Auckland in 1990-92 the distribution of individuals by average daily drinking levels, among drinkers aged 14 to 65 years was as follows:

If, as suggested, a drinker’s change in alcohol consumption in response to price is roughly proportional to his prior level of alcohol consumption, the "average number of drinks per day" provides the weighting to be applied to the marginal net externality generated by the individuals in each of the "bands of the drinking population". Thus, for example, if the price elasticity of demand for absolute alcohol were, say, 0.5, a 10 percent increase in price would reduce the average consumption of each drinker in the top 5 percent of drinkers by (0.5 x 0.10) x 10.4 = 0.36 drinks per day, and it would reduce the average consumption of each drinker in the bottom 50 percent of drinkers by (0.5 x 0.10) x 0.2 = 0.01 drinks per day. Thus if the weight of each of the bottom 50 percent of drinkers is set at 1 for convenience, the weight of each of the top 5 percent of drinkers is , or 52. This reflects the fact that the top 5 percent of drinkers change their drinking in response to price by 52 times as much as do those in the bottom 50 percent of drinkers. The ratios represent the weight of individuals in the calculation of the weighted-average marginal net externality.

However, there are different numbers of individuals in the five percentage groupings. The weights of the groupings are as follows:

The figures on the right-hand side of the equation are the weights of each individual in each percentile range multiplied by the number of individuals in the range. They are therefore the weights of the five percentile-ranges of drinkers, and may be used to calculate the weighted-average marginal net externality. It is convenient to normalise these weights to add to one:

For example, the weighting of the top 10 percent of drinkers (weight of 0.341 + 0.151 = 0.492) is almost as great as that of the bottom 90 percent of drinkers (weight of 0.246 + 0.197 + 0.065 = 0.508). This reflects the fact that the top 10 percent of drinkers consume 49.2 percent of total alcohol consumption. If the marginal net externality of alcohol consumption by the top 10 percent of drinkers were $10 per person, and of the bottom 90 percent were $1 per person, the weighted-average marginal net externality would be (0.492 x $10) + (0.508 x $1) = $5.43.

 The Current Excise Compared with the Optimal Excise

To determine whether the weighted-average marginal net externality at drinkers’ optimal levels of consumption (the optimal uniform excise) is likely to be more or less than the average net externality at drinkers’ present levels of consumption (the current excise), I examine the pattern of marginal net externalities, weighted by drinkers’ price derivatives of demand.

The discussion of externalities earlier in this paper provides the requisite information about the pattern of marginal net externalities, weighted by drinkers’ price derivatives of demand. Marginal net externalities are composed of two elements, namely marginal negative externalities and marginal positive externalities:

To estimate whether the optimal excise is more or less than the current excise, we need to determine the relative importance of these two types of marginal externality - the first implying an excise probably significantly greater than the current excise, and the second implying a subsidy to alcohol. The weighting calculations in the preceding section of this paper allow us to do this.

First, consider the CHD positive marginal externality. Those who generate a marginal positive externality by drinking are those who drink less than about one drink per day on average (the level at which additional drinking potentially reduces CHD), would otherwise suffer from CHD and do not binge-drink. Since these drinkers change their consumption very little following price changes compared with heavy drinkers, they have a very small weighting (at most about 6 percent) in the calculation of the weighted-average marginal net externality of alcohol consumption (i.e., the optimal excise). Therefore the only significant influence on the weighted-average marginal net externalities is the distribution of marginal negative externalities.

Secondly, consider marginal negative externalities. These are a convex increasing function of alcohol consumption, measured in absolute dollars as illustrated in diagram 1 (see page 16) by the vertical distance between marginal internal cost and expected total marginal cost. This necessarily implies (as a mathematical consequence) that, at a given consumption level, the average negative externality is less (in absolute dollars) than the average marginal negative externality, which is in turn less than the weighted-average marginal negative externality, since the large negative marginal externalities of heavy drinkers have a considerably greater weight than the small marginal negative externalities of light to moderate drinkers. Therefore at a given consumption level, the average negative (and hence net) externality is less, probably considerably, than the weighted-average marginal negative (and hence net) externality.

A conservative estimate (see page 13) of the annual net external cost associated with alcohol consumption in New Zealand is a range $432 million to $713 million (in March quarter 1996 dollars). The alcohol excise currently raises about $570 million annually. Therefore the current excise on a drink is similar to the average net externality associated with a drink at current consumption-levels. As the preceding paragraph shows, this is less, probably considerably, than the weighted-average marginal negative externality at current consumption levels. This means that the current excise is too low. An increase in the excise towards the weighted-average marginal net externality at the optimal consumption level, which is also more than the current excise (the comparison of t_low and t* on diagram 5 on page 27 illustrates this for a "weighted-average" representative individual) will increase aggregate welfare. In short, this analysis suggests that the current excise is too low and current consumption is too high to maximise society’s welfare.

At the possible cost of labouring the point, I repeat the chain of logic leading to the conclusion that although the majority of drinkers drink less than about one drink per day (the level at which additional drinking potentially reduces CHD), they are likely to be of negligible importance in calculating the optimal uniform excise:

the optimal uniform excise is equal to the weighted-average across drinkers of their marginal net externalities of alcohol consumption at drinkers’ socially-optimal consumption levels, the weights being the price derivatives of demand of drinkers. That is, the more a price change affects an individual’s absolute consumption and the more a given change in his absolute consumption affects the net externalities he generates, then the more important is that individual in the calculation of the optimal excise;

since drinkers at all consumption levels change their consumption roughly proportionately, each light drinker has a lesser weighting by far than each heavy drinker, since he drinks less than the heavy drinker by far;

empirics tell us what proportion of drinkers drink up to about one drink per day and would otherwise suffer from CHD, and what the approximate weighting of each of these drinkers is in the calculation of the optimal excise. We can calculate that those who drink up to one drink per day and would otherwise suffer from CHD should in aggregate have a weighting in the calculation of the optimal excise of at most about 6 percent; and

a weighting of at most 6 percent implies that individuals for whom drinking reduces CHD are likely to be almost irrelevant to the calculation of the weighted-average marginal net externality, which is equal to the optimal uniform excise.

Caveats

The following caveats should be borne in mind in considering the analysis proposed above:

- the analysis assumes that if consumption of alcohol changes, products without significant externalities would be substituted for alcohol. If products such as tobacco or illicit drugs were substituted for alcohol, the net external benefit of reducing alcohol consumption would be diminished. On the other hand, cannabis is often consumed with alcohol: if it were complementary to alcohol, reduced alcohol consumption may reduce consumption of cannabis. However, there is almost no research on substitutes for and complements with alcohol. My subjective judgement is that it is unlikely that substitutes for alcohol would generate negative externalities on the scale that alcohol does;

- the hypothesis that light, medium and heavy drinkers have the same price elasticity of demand for absolute alcohol is only an inference - albeit a reasonable one - mainly from currently-available empirical studies of the effect of price changes on various types of damage from alcohol use. Future empirical studies which directly examine the elasticity of absolute alcohol consumption of drinkers at various drinking levels could refine our knowledge. If light drinkers were more sensitive or heavy drinkers less sensitive than this paper assumes, then the CHD benefit becomes more important and the high marginal costs of the drinking of heavy drinkers less important, than this paper states. However, there is much evidence relating the price of alcohol to overall consumption and damage levels: the proportionality of the price derivative of demand to consumption levels is unlikely to be significantly incorrect; and

- if the excise increased, avoidance may well also increase: this, rather than the level of weighted marginal net externalities, is likely to be the binding constraint on optimal excise-increases. This is an argument against raising the excise, rather than in support of lowering it. Avoidance is discussed in more detail below (see page 39).

These caveats, particularly the problem of avoidance, cast doubt on the conclusion that the excise should be increased. On the other hand, the assumptions used in this paper to estimate the externalities associated with alcohol consumption are conservative: less conservative assumptions would reinforce the conclusion that, in the absence of avoidance, the excise should be increased. On balance, even though there is doubt that the excise should be increased, the weight of evidence clearly indicates that it should not be reduced.

Taxation: General Conclusion

In the presence of externalities a uniform excise tax can increase welfare. The optimal uniform excise is equal to the weighted-average across drinkers of their marginal net externalities of alcohol consumption at drinkers’ socially-optimal levels of consumption, the weights being the price derivatives of demand of drinkers at various levels of net externalities.

We do not have the information to estimate the optimal excise. However, we do have the information which will allow us to determine whether the optimal uniform excise is higher or lower than the current excise. To determine this, we need to know:

- the weighting to be applied to each drinkers’ marginal net externality of alcohol consumption; and the distribution across drinkers of their marginal net externalities of alcohol consumption; and

- the distribution across drinkers of their marginal net externalities of alcohol consumption.

With regard to weighting, in light of theory and most of the empirical evidence it is reasonable and indeed possibly conservative to assume that the price elasticity of consumption of absolute alcohol is roughly constant at different levels of average consumption. That is, changes in response to a price change are roughly proportionally to the level of alcohol consumption. Therefore the weighting to be given to the marginal net externality of heavy drinkers is far greater than to that of light drinkers.

The distribution across drinkers of their marginal net externalities of alcohol consumption is a combination of the distribution of its two elements: marginal positive externalities and marginal negative externalities.

First, consider the CHD positive marginal externality. Those who drink up to on average up to about one drink per day and would otherwise suffer from CHD have a weighting in the calculation of weighted-average marginal externalities of at most 6 percent. The CHD benefit is unlikely to be of such a size that, with a weighting of less than 6 percent, it significantly affects the calculation of the weighted-average marginal net externality.

Secondly, consider marginal negative externalities. These are a convex increasing function of alcohol consumption, measured in absolute dollars. This necessarily implies (as a mathematical consequence) that, at a given consumption level, the average negative externality is less (in absolute dollars) than the average marginal negative externality, which is in turn less than the weighted-average marginal negative externality. Therefore at current consumption-levels, the average negative (and hence net) externality is less than the weighted-average marginal negative (and hence net) externality.

The current excise on a drink is similar to the average net externality associated with a drink at current consumption-levels. As the preceding paragraph shows, this is less, probably considerably, than the weighted-average marginal negative externality at current consumption levels. This means that the current excise is too low. An increase in the excise towards the weighted-average marginal net externality at the optimal consumption level, which is also more than the current excise (the comparison of t_low and t* on diagram 5 on page 27 illustrates this for a "weighted-average" representative individual) will increase aggregate welfare. In short, this analysis suggests that the current excise is too low and current consumption is too high to maximise society’s welfare.

Various caveats, notably the likely increase of avoidance if the excise increased, make this conclusion less than certain. However, the weight of evidence clearly indicates that it should not be reduced.

Taxation: Other Issues

Excise as a Generator of Revenue

This paper argues that an excise on alcohol can increase efficiency. Even if it did not do so, reducing the excise would not necessarily increase society’s welfare, since, given a new, lower fixed revenue requirement and the option of reducing other taxes, the welfare gain from reducing other taxes may exceed the gain from reducing the excise on alcohol. That is, the optimal excise in the presence of other distorting taxes is higher than that implied by the analysis of the optimal excise considered alone. Welfare is maximised when the various tax instruments are adjusted so that their marginal cost per dollar of revenue raised is equal.

Equity

A standard equity criterion for tax is that those with higher incomes should pay more tax. However, while equity is inevitably subjective, it is arguable that this equity criterion is of minor importance in considering an excise on alcohol:

- arguably, a more important equity consideration is that non-drinkers should not pay for costs generated by drinkers. This applies not only in monetary terms - it is inequitable that family members should be subject to violence caused or aggravated by alcohol;

- even if government has a particular equity aim, there is no reason why each individual tax, rather than the tax and expenditure system as a whole, should conform to that equity aim; and

- indirect taxes in general are a clumsy tool for redistribution.

Since most drinkers drink small amounts, reducing excise taxation benefits them to a small extent. Given a fixed government revenue-requirement, the cost to them of the consequential increase in other taxes could, depending on which other tax rate is increased, exceed the benefit to them of the reduced excise. To put the same point in a different way, if taxes are being reduced, most drinkers could gain more by reducing taxes other than the alcohol excise. For example, abolishing the excise reduces revenue by the same amount as reducing GST by about 1.6 percent. Since the distribution of alcohol consumption is very skewed, a large majority even among drinkers would probably be financially better off if GST were reduced: those who would pay less tax are concentrated among the comparatively few heavy drinkers.

The increase in negative externalities associated with a abolishing the alcohol excise would further worsen the welfare of non-drinkers and the large number of light drinkers. For example, the increased use of health resources, particularly by drinkers, would result in either fewer non-alcohol-related health services or higher taxes to pay for more health services.

Excise as a an Insurance Premium

Another perspective on whether an excise on alcohol increases efficiency is to think of it as an insurance premium. Insurance premiums collectively finance uncertain risks. Although insurers try to match the premium they charge as nearly as possible to the cost of the risk, each individual’s premium will not (except coincidentally) match the actual cost incurred as a result of the risk associated with that individual.

An excise on alcohol is, in a sense, an insurance premium paid by drinkers for the costs they generate which the insurer - government in its role as the funder of health and other services - will pay. Government’s ability to impose an excise allows it to partially overcome the information problem which it and private insurers have in identifying who is at risk of generating costs associated with alcohol use: the "premium" drinkers pay increases with each drink. If there were no excise, taxpayers in general would pay the costs generated by alcohol. A question may now be asked: is payment by taxpayers, or by drinkers in accordance with their level of drinking, for the costs generated by alcohol use likely to provide greater incentives for socially-optimal levels of alcohol consumption? To ask the question is to answer it.

Base for the Excise

The base for an excise on alcohol should be the agent generating net externalities: ethyl alcohol.

The sections "Description of Externalities: Negative Externalities" and "Description of Externalities: Positive Externalities" (see pages 7 and 8) argued that both negative and, probably, positive externalities relate to consumption of absolute alcohol, irrespective of the beverage (beer, wine, spirits). This implies that the excise rate should be equal per unit of alcohol across the beverages. At present the excise tax on spirits is about twice the rate on beer and wine, on a per unit of absolute alcohol basis. An increase in excise on beer and wine and a reduction in that on spirits, so that the excise rate on all beverages were equalised and overall revenue were unchanged, would increase overall welfare.

Another possible variation in excise rates would be to tax more lightly alcohol sold in situations which are likely to generate less damage (for example, restaurants compared with taverns).

However, to avoid lobbying and an excise régime dependent on meagre empirical evidence, perhaps provided by the sector seeking advantage, a régime which differentiates among the beverages or situations of sale would be justified only by a consensus of the relevant experts that there are large differences in the generation of externalities among the beverages or situations of sale. Until such solid evidence is available, the excise rate should be set equally per unit of absolute alcohol.

Indexation

The question arises of whether the level of the excise should change over time. The level over time should equal the weighted-average marginal net external cost of alcohol consumption (at drinkers’ socially-optimal consumption levels) over time. Since this in general probably increases at a rate similar to the rate of consumer-price inflation, the alcohol excise should be indexed accordingly. To not inflation-index the excise would:

- depart from the principle that the excise should equal the weighted-average marginal net externality of alcohol consumption;

- cause uncertainty to government and the industry over the timing and size of possible ad hoc changes to the excise;

- amount to an arbitrary reduction in the excise, depending on the rate of inflation;

- encourage the industry and consumers to engage in precautionary behaviour (such as excess stocking of alcohol) when second-guessing possible excise changes; and

- encourage the industry to engage in lobbying to prevent excise increases.

Indexation also makes the excise regime more transparent, since changes in the real rates of excise require a discretionary decision by government.

However, over time:

- information quantifying the externalities associated with alcohol use may improve;

- inflation of the costs associated with the damage from alcohol use (for example, medical costs) may diverge from the CPI; and

- changing demographics and social attitudes may alter the type and extent of damage associated with a given level of drinking in society. For example, if light drinking (without binge drinking), but not heavy drinking, increased, the optimal excise would be lower than otherwise, since the weighting of the CHD benefit in the calculation of the weighted-average marginal net externality of drinking (at drinkers’ socially-optimal consumption levels) would increase. (However, this is unlikely to happen: since the distribution of per capita alcohol consumption is to some extent fixed, an increase in drinking among light drinkers who are suffering or will suffer from CHD, and hence in the marginal CHD benefit from a lower excise, is likely to be accompanied by an increase in the consumption of all other drinkers, and hence in the negative marginal externalities they generate.)

It would therefore be desirable from time to time to review the level and indexation of the excise.

Avoidance

The higher the excise, the greater the incentive to avoid it. The main means of avoidance is home production. At present there are about 4000-5000 home stills and possibly up to 10 percent of beer is home-brewed. A 1995 survey of drinking in New Zealand suggests that about 3 percent of absolute alcohol consumed is home-produced.

A tax on malt and/or hops would stop avoidance of excise on beer. However, this would be problematic since:

- neither malt nor hops is directly related to alcohol content. An assumed - and inevitably inaccurate - estimate of alcohol content would be used in setting the level of excise;

- it would tax uses of these ingredients other than beer, for example confectionary (malt) and insomnia remedies (hops); and

- taxing hops would discriminate against bitter beer, which uses more hops.

 Taxing home-made wine is impractical.

The only means of taxing home-distilled spirits is to tax stills on purchase. Such a tax would not relate to alcohol production, since a still may produce a large or small volume of spirits. Further, since there are 4000-5000 home stills at present, it is impractical to expect an impost on new stills to effectively tax home-distilled spirits. That horse has already bolted.

In view of these difficulties in combating avoidance, it is difficult to avoid the suspicion that, if the excise significantly increases, so too will avoidance. This, rather than the level of the weighted-average marginal net externalities, may be the binding constraint on optimal excise-increases.

 Non-Economic Perspectives

The perspective of this paper is economic. Other perspectives are those of public health and of morality:

- the public health perspective is that the damage to health from activities such as drinking should be minimised; and

- the moral perspective is more diffuse, but tends to make absolute judgements against drugs such as alcohol or at the least to include internal costs among those of which public policy should take account.

These approaches lead to a higher excise on alcohol than result from an economic analysis. Many economic and public-health policies reveal that policy-makers give some weight to these non-economic perspectives.

 ANNEX

Arguments against an Excise on Alcohol

In recent years various arguments have been made against an excise tax on alcohol. They are set out and commented on below.

Argument: most drinkers of alcohol drink moderately. To tax alcohol is to punish them, whereas the target of policy should be the few alcohol abusers.

Comment: excise is levied on alcohol, not drinkers. Those who drink the most alcohol pay the most tax. 50 percent of drinkers drink only 7 percent of total alcohol consumed and so pay only 7 percent of the total excise: the excise is well-targeted.

Since most drinkers drink small amounts, reducing the alcohol excise would benefit them to a small extent. If Government had a fixed revenue-requirement, the cost to them of the consequential increase in other taxes could, depending on which other tax rate is increased, exceed the benefit to them of the reduced excise. Alternatively, if taxes were being reduced, most drinkers could gain more by reducing taxes other than the alcohol excise. For example, abolishing the excise reduces revenue by the same amount as reducing GST by about 1.6 percent. Since the distribution of alcohol consumption is very skewed, a large majority even among drinkers would probably be financially better off if GST were reduced: those who would pay less tax are concentrated among the comparatively few heavy drinkers.

The increase in negative externalities associated with abolishing the alcohol excise would further worsen the welfare of non-drinkers and the large number of light drinkers. For example, the increased use of health resources, particularly by drinkers, would result in either fewer non-alcohol-related health services for most people or higher taxes to pay for more health services.

The argument assumes that only heavy drinkers cause costs to society. This is wrong. It is not the case that only a few clearly-visible alcohol abusers generate negative externalities. Light to moderate drinkers on average generate negative net externalities, albeit smaller than in the case of heavy drinkers. Because of their large numbers such drinkers may in aggregate generate a larger share of total damage from alcohol than heavy drinkers. In particular, the bulk of problems associated with intoxication occur among light and moderate drinkers.

The argument assumes that it is possible to target measures on heavy drinkers. However, since the drinking habits of individuals tend to be synchronised with those of their social network and society as whole, the drinking behaviour of light and heavier drinkers may be interdependent. This is consistent with the semi-fixed lognormal distribution of alcohol consumption. To the extent that this is so, any course of action which aims to reduce the drinking of heavier drinkers also reduces the drinking of light drinkers, and any course of action which aims to influence only heavy drinkers is likely to prove unsuccessful.

Argument: consuming alcohol reduces CHD for most if not all drinkers. Taxing alcohol reduces this benefit.

Comment: an excise tax affects marginal consumption. Only those who drink about one drink per day or less, who would otherwise suffer from CHD and who do not binge-drink generate a marginal external benefit from additional alcohol consumption. These people have a weighting of at most 6 percent in the calculation of the optimal excise, which is equal to the weighted-average marginal net externality of alcohol consumption, the weights being the price derivatives of demand of drinkers at various externality levels. The reason for the low weighting is that such light drinkers, although a majority of drinkers, drink a very small share of total alcohol consumed and change their consumption very little as a result of price changes.

Since an increase in drinking among light drinkers who are suffering or will suffer CHD is likely to be accompanied by an increase in drinking by other drinkers (see the final paragraph of the preceding "comment"), reducing the excise to reduce CHD is likely to be accompanied by an increase in the negative externalities associated with alcohol consumption. If government wished to reduce CHD, a better-targeted and cheaper policy instrument would be a public campaign to increase fitness, reduce intake of cholesterol, etc.

Argument: the extent to which alcohol causes illness and, even more, damaging social behaviours, cannot be accurately estimated. Therefore the external costs of alcohol cannot be accurately estimated.

Comment: it is inevitable that causality cannot be exactly determined for some types of damage from alcohol use, particularly damaging social behaviours, associated with alcohol consumption. Indeed, culture, as well as direct pharmacological effects, influences the behaviour of drinkers. However,

- medical experts can and have estimated the extent to which alcohol causes various illnesses; and

- a variety of methodological approaches, such as statistical studies of the incidence of damage associated with alcohol, psychological studies of the social effect of alcohol and pharmacological studies imply causality between alcohol and various social behaviours. At the least, it is highly plausible that alcohol is a contributor to or catalyst for such behaviours.

As an example, suicide is statistically associated with alcohol. Heavy drinking leads to a deterioration of social ties and is associated with depression, a precursor to suicide. Intoxication may reduce an individual’s self-control and thereby trigger a suicidal inclination. Studies which aim to correct for sample selection bias (the problem that drinkers are those who are for other reasons likely to commit suicide) still suggest a link between alcohol and suicide.

Different estimates of the extent of causality underlie the wide range estimated by Devlin et al. as the cost of alcohol in New Zealand (see pages 11-12).

Argument: the excise departs from the principle of imposing broad-base low-rate taxes, such as GST. There is no valid reason for singling out alcohol from other goods or activities that potentially generate externalities.

Comment: if government had perfect information and if the cost of administering excises were zero, it would be efficient to tax and subsidise a wide range of goods in accordance with the marginal net externalities they generate. For most goods the information, administrative and compliance costs of imposing a tax would far exceed the benefits from doing so. Further, variable commodity taxes on many different goods would elicit lobbying from sectors seeking tax concessions or subsidies. The aim of implementing a broad-base low-rate indirect tax is to allocate resources efficiently. However,

- tobacco and alcohol generate unusually-large negative externalities. The information costs of deriving a lower-bound for the optimal excise (as done in this paper) are small compared with the gains from imposing excises on these goods;

- the administrative and compliance costs of imposing an excise tax on tobacco and alcohol are small compared with the costs which would be associated with imposing excises on most goods;

- tobacco and alcohol taxes are well-established and perceived as "special cases". This lessens the risk these excises will encourage other sectors will lobby for tax concessions or subsidies.

Argument: to be an efficient taxing instrument, the marginal rate of tax on each drink should approximate the external costs related to that drink.

Comment: a perfect but infeasible policy should not drive out a imperfect but beneficial and feasible policy.

Argument: some costs of drinking, such as a car crash while drink-driving, are unlikely and will never be generated by most drinkers. It is unreasonable that most drinkers should pay for these costs.

Comment: the optimal uniform excise is equal to the weighted-average expected marginal net externality of alcohol consumption, the weights being the price derivatives of demand of drinkers at different levels of net externalities. There is no requirement that the actual costs imposed by each drinker are matched by excise payments: in a context of uncertainty, efficiency is defined in terms of expected externalities. The analogy of an excise to an insurance premium is instructive: insurance premiums are based on expected costs, as best the insurer can estimate them.

Argument: the excise reduces exports.

Comment: the alcohol excise, like GST, is not imposed on exports. Indeed, it could be argued that the higher the excise, the greater the incentive to produce for export, rather than domestic markets. Artificially fostering a large domestic base from which industries can export tends to create industries which are domestically-oriented and uncompetitive.

Argument: the excise reduces the growth of the local alcohol industry, and in particular the wine industry.

Comment: having an excise lower than is economically efficient would indeed result in larger domestic consumption, some benefits of which would flow to domestic producers and distributors. However, the economically-efficient excise does no more than price alcohol in accordance with the cost to society of its consumption: a lower excise is a subsidy. Any industry sector will to some extent grow if subsidised, by drawing resources such as capital and employment from unsubsidised sectors, but to the detriment of society’s welfare as a whole.

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