Column
Designing Alcohol Taxes: Evidence From The UK Market
Rationale
Governments have long used taxation to correct for the socially costly alcohol-related harm, but as the external cost of alcohol harm varies across alcohol users, a single tax rate is not optimal.
This column argues that variation in preferences for different products and in price responsiveness across heavy and light alcohol users provides scope to improve welfare by varying tax rates across alcohol products. The proposed framework is well suited to addressing other sources of external costs, such as obesity.
Conclusions
In this column, we have argued that we can exploit variation in consumers’ preferences for different products to improve the design of corrective taxes. We focus on an application to alcohol taxation, but the framework that we develop is well suited to other applications in which there are external costs of consumption that vary across people. For example, concern about obesity and the excess consumption of sugar has led to growing interest in sugar taxes.
We have focused on how to design such taxes when there is variation in the marginal externality of consumption. In order to do this, we have abstracted both from re-distributional concerns and supply side considerations. Kaplow (2012) shows that under certain assumptions, the income tax system can be adjusted to perfectly offset the re-distributional effects of corrective taxes. Nonetheless, in order to know what adjustments to the income tax system are necessary, we would need to work out the distributional effects of the optimal taxes we recover. We assume that taxes are fully passed on to consumer prices. If the patterns of pass-through vary across products, then this could change the optimal rates across products. We leave for future research the incorporation of imperfect competition between firms into the optimal corrective tax model described here.
Finally, we note that taxation is only one instrument available to governments to correct for the problems of excess alcohol consumption. Regulation is another popular tool, for example, governments can prohibit the sale of alcohol at certain times, or impose restrictions on the upstream market for alcohol. The interaction of these various policies is another topic for future research.”