Executive Summary Of Reviewing the Sale Of Liquor Act: Tax and Pricing Consequences

Report prepared for the New Zealand Law Commission. Filed 30 June, 2009. The Executive Summary was reproduced in the Law Commission’s report Alcohol in Our Lives, p.172-175.

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Keywords: Health;

            – on the whole, much alcohol consumption is benign or even socially beneficial, but some generates very great social harm;
            – this harm may be reduced by various interventions, but their effectiveness is limited because of the need to allow consumption which is benign and socially beneficial;
            – a specific tax on alcohol is a means of reducing the harm through internalisation of an external cost (the efficiency gain), and compensating those who suffer harm from others’ drinking (the equity gain). However neither objective can be precisely attained.
            – the New Zealand system of an excise duty on absolute alcohol has much to commend it. However more attention could be given to the minimum purchase price of absolute alcohol

1. The Policy Framework

The Sale of Liquor Act 1989 was based on the premise that most consumption of liquor was benign or even beneficial but that some was extremely harmful in comparison to most products. Rather than control everything, which had been the broad practice before 1989, the aim was to target consumption which was markedly harmful.

It involved a marked liberalisation of the supply of liquor, moving from ‘quantity licencing’ (the number of outlets) to quality licensing (anyone could set up an outlet, providing they met certain quality standards). At the same time there were associated measures to reduce certain kinds of harm, including more vigorous pursuit of drink-driving.

The Sale of Liquor Act was one of the most successful social reform of its times, vastly improving access to liquor for moderate drinkers, transforming and enlivening inner cities with a plethora of small bars and restaurants. There is no evidence that harm rose – indeed the downward trend of absolute consumption per adult continued across the reform period.

In recent years there has been some evidence of rising harm in some areas including
            – increasing teenage drinking;
            – increased evidence of binge drinking;
            – new forms of alcohol;
            – evidence of the magnitude of the social harm from alcohol, which is substantial.

2. The Harm From Alcohol

There have been two major attempts to provide estimates of the social costs of alcohol misuse. While their exact estimates may be challenged, each brings together the existing available data on social harm and assign values them. They show that there is substantial harm caused by the misuse of alcohol.

The harm can be divided into three components.
            – the additional costs to the public purse;
            – the material (or ‘tangible’) costs which are borne by the private sector;
            – the human (or ‘intangible’) costs covering the loss of quality of life and early mortality.

A major issue is the degree to which these costs are ‘internalised’, that is, taken into account by the person who purchases or imbibes.

External costs are a major justification for excise duty on alcohol, insofar as the drinker fails to take them directly into account when they make the consumption decision.

3. Rational and Irrational Drinkers

What costs are included in a drinker’s decision is an empirical matter. Economists’ default position assumes ‘rational economic man’ who takes into consideration all the costs of a consumption which impact on him but none of the costs which impact on others.

Some economists treat the notion of rational economic man as a useful analytic device for want of a better hypothesis; others treat the notion as a fundamental economic assumption which may not be challenged. The difference leads to a major difference as to what is or is not included in social costs.

There is hardly any direct evidence that ‘rational economic man’ is a realistic account of how humans make decisions. In recent years an alternative framework has begun to evolve around ‘behavioural economics’ which is characterised by close attention to psychology’s research and theories. It is much less an a priori approach than that upon which rational economic man is based.

Relevant to this report is ‘time inconsistent’ decision making, which is the notion that even without any new information a person may regret a decision which earlier had been made rationally. The time inconsistency arises because the discounting of decisions through time differs from that which is assumed for rational economic man. It leads to the conclusion that drinkers who suffer from it will retrospectively welcome a tax on their consumption since it limits the excessive drinking which subsequently they will regret. That means some consumption is not (subsequently) valued by the consumer, and therefore is an externality and a contributor to social costs.

4. The Case For Taxing Alcohol

It is clear from the evidence that alcohol consumption causes considerable harm which is not always taken into consideration when individuals make decisions to imbibe. Public policy has introduced a range of interventions which aim, one way or another, to internalise the decision, so that the drinker takes into consideration more of the harm which the drinking causes.

In practice it has not been possible to eliminate all the social harm by education, private arrangements and statutory and regulatory interventions. It has been a standard practice to use specific taxes on alcohol to deal with the remaining social harm.

There are two channels by which this may work – modification of drinking patterns and compensation for social harm; one is an efficiency gain, the other is an equity gain.

It is generally assumed that the demand for alcohol is largely price inelastic. However, it is believed that the main groups whose consumption is sensitive to changes in prices are
            – the young;
            – binge drinkers;
            – heavy drinkers.

Any reduction in the quantities they drink will reduce social harm to some extent. Thus a specific tax will increase the efficiency of the system. Where there is time inconsistent decision-making the tax will make such drinkers better off in the long run, and that they will welcome it from this perspective. It is assumed that the impact on the quantities drunk by moderate (time consistent) drinkers is zero. Insofar as the tax is not recycled back to them, they may be worse off in real income terms (although even then they may be better off from lower social harm).

It is not possible to state with any precision the exact winners and losers of a specific tax on alcohol, except that non-drinkers will be beneficiaries since irrespective of whether they receive any of the recycled tax revenue, they will pay none of it, and they will (probably) benefit from reductions in personal harm. Since there will be overall reductions in social costs from higher specific taxes, the aggregate gains (including the reductions in social costs) of the winners will be greater than the losses of the losers; there will be a net social gain from the efficiency gains.

There is a strong argument that there is an injustice when non-drinkers and moderate drinkers pay for the harm of others. It could be argued there is justice in specific alcohol tax transferring some of the burden of these costs from the non-drinkers and moderate drinkers to the drinkers who are generating the harm. Such compensation improves the equity of the system.

5. The Taxation Implications for New Zealand

When the price of alcohol goes up, many people have the option of maintaining their absolute alcohol consumption for the same cost, by reducing the quality of what they drink. However drinkers on the cheapest form of absolute alcohol do not have the option of reducing the quality of their consumption following a price hike. Some of the most harmful drinking occurs in these circumstances. Insofar as the aim is to use taxation to regulate absolute alcohol consumption with the objective of reducing harm, attention should be paid to the price of absolute alcohol levels, particularly where they are cheapest.

The New Zealand alcohol taxation regime is particularly suitable for this purpose since it is levied on the basis of absolute alcohol content.

There is a general acceptance that the aggregate revenue from the excise duty should at least cover the fiscal costs. The compensation principle suggests it might also cover the social cost to the non-drinker. In practice it is likely that the cost recovery would not be complete and that some harm would not be compensated – even crudely – through the tax system.

An alternative approach arises from the focus on modifying drinking patterns. Taxing Harm recommended that the excise duty should be set to target some minimum price of absolute alcohol.

In summary the two gains from a specific tax on alcohol – the efficiency gain from moderating harmful drinking, and the equity gain from compensating for the harm – give slightly different recommendations for the level of an excise duty on absolute alcohol. It seems likely that, whether the purpose is to ensure the minimum price of absolute alcohol discourages harmful drinking or whether the purpose is to adequately compensate for the harm, the current excise duty is too low.

Tax rates need always to be set with the possibility of avoidance in mind.

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