Costs and benefits of alcohol, properly done

I previously took BERL to task for its report on the costs of alcohol use in New Zealand.

My colleague Andrea Menclova points me to a previous Treasury analysis of the costs and benefits of alcohol: Felicity Barker, "Consumption Externalities and the Role of Government: The Case of Alcohol". The important difference isn't that there's a ton of health or other benefits from alcohol use; rather, the important difference is that costs that fall on the individual then are netted out: the individual has to weigh those costs as being less than the benefits. What's the conclusion when we do that?

This paper considers the role of government in the case of externalities and, in particular, in the case of alcohol externalities. The purpose of the paper is to assess whether the current level of the alcohol excise can be justified on externality grounds. The paper assesses various mechanisms to address externalities. These mechanisms are institutional solutions, trade in rights to generate externalities, regulatory measures and Pigouvian taxes. The paper assesses these tools in the case of alcohol and concludes that institutional, trade and regulatory solutions are limited in their ability to address the externalities of alcohol. A specific tax can be justified in the case of alcohol. The externalities are large and there is sufficient information on which to base a tax. Given the information constraints the specific tax must be applied uniformly across a rage of units of consumption, rather than to particular individuals. Where an optimal uniform tax is imposed it is reasonable to assume that the amount of revenue collected by the government would be at least as large as the total externality. In 1999/00 the amount of revenue collected from the tax on alcohol was $580 million. This is near the mid-point of the estimated bound of the external tangible costs of alcohol. Thus the current rate of excise tax can be justified on externality grounds.

I like the Barker paper. I could quibble about some details (allowing 5% of production losses to be external costs), but it frames the problem correctly and shows an appropriate amount of worry about the limitations of the method. Barker notes not having accounted for some external costs, like the costs of caring for victims of alcohol-related accidents. But the Barker's self-recognized limitations in underestimating things are dwarfed by BERL's inclusion of costs that should not count.

How much would we cull from the BERL report if we were to do things properly? All costs that are internal to the individual have to be dropped immediately. A quick accounting has those at $2.46 billion in the BERL figures (Table 5.5): foregone labour income and costs of producing and distributing alcohol. That should go. BERL counts $1.6 billion as the monetized value of premature death and intangible health costs: the vast majority of those fall on drinkers. Barker suggests that about 1/3 of victims of drunk driving are people not in the drunk driver's car; car accidents contribute about $500 million to the BERL number. We then can count $167 million in real road crash costs falling on other parties; BERL (properly) adds in a small value for mortality costs from homicide. So $169 million in real external costs from a $1.6 billion line item: So we should cut out $1.4 billion from the $1.6 billion as being costs that fall on drinkers themselves as a first cut estimate. So, $3.9 billion are costs that shouldn't count in a cost-benefit analysis: they're automatically offset by benefits as judged by the drinker.

BERL cites total social costs of $5.3 billion. $3.9 billion of that, 74%, cannot honestly be counted as policy-relevant costs from an economic perspective.