Thursday 7 May 2009

Alcohol taxes and effects on producers

Small breweries are rather upset about hints that the excise tax on alcohol will see a big increase after the Law Commission releases its report. They're right to be upset: they'll bear some of the excess burden of the tax increase. But are they really right that such tax increases favour big breweries over small ones? I don't think so.

Why not? The excise tax on alcohol makes up a much smaller portion of the overall price of great beers like those made by Three Boys, Emersons, Renaissance, or Epic than it does for the dreck my students drink. Suppose that these student beers sell for $1 per bottle while good beer sells for $5 per bottle. A doubling of the excise tax from about $0.40 to about $0.80 would, in the limiting case of full pass-through (assuming an inelastic demand curve), increase the price of cheap beer from $1 to $1.40, a 40% increase, while good beers would increase from $5 to $5.40, an 8% increase. If anything, good beer becomes relatively cheaper with an increase in the excise tax. It's absolutely more expensive, but the price ratio between the two beers decreases: instead of being 5X more expensive, it's then a bit less than 4X as expensive.

In general, regulations that increase fixed costs regardless of output help big producers and hurt small guys. In general, regulations that increase per-unit costs regardless of output level do more to hurt big producers. That's why small businesses tend lobby for regulations that reduce fixed costs (like Sunday closing laws) while big businesses tend to lobby for regulations that increase fixed costs (like coal scrubbers on power plants).

Over on the Beer Blog, a member of the Society of Beer Advocates (though not speaking for them) argues
In this country you have the big two. We know who they are. Even morons waving around hand-wringing think-of-the-children legislation like yourself know who they are. These big two don't care about alcohol. They don't care about excise tax. They make product, not beer. They have a captive and uneducated market (I mean that literally - they don't know any better, not that they are stupid) who will continue to drink their product no matter what. This is great for them. It's great for you, Geoff. It's murder for the small brewers in this country, and it's murder for what you, in your stupid and misguided way, claim to be trying to achieve.
For an excise tax increase to have this effect, it has to be the case that demand elasticity (the percentage change in quantity demanded given a percentage change in price) at the low end is very very small relative to demand elasticity at the high end of the market. There has to be a smaller response to a 40% price increase at the bottom end of the scale than there is to an 8% increase at the top end. I don't buy it.

Another argument I've heard is that the big guys can absorb the price increase more easily than the niche producers by further denigrating their product quality. But if the big guys can make more money by making the bottles or the beer even thinner, why haven't they done it already? Are they just being generous by not taking on that profit opportunity prior to the tax increase? They may well make some marginal changes to re-optimize on the quality/price front after the imposition of the fixed charge, but it would be pretty surprising if they had much scope for change at the bottom end. The argument from the craft brewers tends to be that these beers are about as bad as they can get already. It may be more expensive for the craft brewers to re-optimize, but they've more scope to do it. I'd still reckon they've less need to though: I have a hard time believing that demand is that responsive to an 8% price increase for the higher quality beers.

I'm not a fan of the proposed increases or of the report forming the basis for arguments favouring the tax increase. There are plenty of good arguments against the tax. I'm not convinced the small brewers have a good one here, but if they've any data on relative demand elasticities, I'm all ears.

In related news, the hubub surrounding the Palmer press conference in which he telegraphed the Law Commission's intentions apparently has led our big supermarket chains to start engaging in price fixing on alcohol. Some folks thought the supermarkets were using alcohol as a loss-leader and wanted regulation to stop such behaviour; I tended to figure that buying in exceptionally large volume explained price differences between supermarkets and some liquor outlets. The Hospitality Association has argued for banning of the use of loss leaders (or just getting alcohol out of supermarkets entirely) - anything to raise your rivals' costs with the patina of social responsibility, eh?

But no matter. The problem, such as it was, is now solved. Matt Nolan, who's sat on his hands about the BERL report, weighs in here and here. Brad Taylor usefully points to Yandle (the young Sith apprentice learns well); Walker (who only supports antitrust legislation when it could have a big effect on his budget set) weighs in as well. I've little further to add.


  1. Little further to add? Nothing to feel bad about; your arguments this week have been pretty much unanswerable. Depressingly, it's up to the politicians now.

  2. "(who only supports antitrust legislation when it could have a big effect on his budget set)"

    You can think of a better reason for supporting antitrust!!!

  3. bk: depressingly indeed. Politicians don't seem to respond to solid arguments too often. Much easier to label any heretic who dares to disagree with the health promotion consensus a warped ideologue in the pocket of the vice-merchants.

    There is more hope when it comes to beer than tobacco, though: many more people enjoy a beer than a smoke, and there's bound to be fairly significant electoral costs of raising taxes.

  4. "Matt Nolan, who's sat on his hands about the BERL report"

    I would note that I haven't had time to read the BERL report - hence why I've said nothing.

    I don't need time to read in order to see that some of the policy recommendations out at the moment are stupid - but I would have to read a report before I criticised it methinks.

    If you can get the macroeconomy to stop gyrating I will read the report and say what I think ;)

  5. Division of labour -- I've sat on my hands about the latest unemployment numbers. :>

  6. Fair enough - there is just too much economics out there :)

  7. What about the higher alcohol content of boutique beers? Doesn't that make them subject to a higher rate of excise tax?

  8. A higher level, not a higher rate. It's still the same tax per litre of alcohol until you hit in to alcohol percentages you get in spirits. The difference won't be huge for the different strengths of beer.

  9. $24.765 per litre is the tax rate on alcohol at the low alchol levels. So 500 mL bottle of 5% beer has 25 mL of alcohol: $0.69 in tax. Of 4% beer: 20 mL alcohol and $0.50 in tax. Suppose that all craft beers are 5% and sell for $5 without tax and all mass market beers are 4% and sell for $1 without tax. Tax adds 50% to the cost of the mass market beer and 14% to the craft beer....

  10. Even though I am not an economist I have been intrigued by your blog and criticism of the BERL report. Nothing quite like beer to act as a gateway drug to economics ;-)
    I know your criticism to date has been focussing on the academic integrity of the report (or apparent lack thereof) but is there not a argument for changes to the excise rate to address one of the points of the Terms of Reference: the application of competition law to the sale of liquor (in the Law Commission's TOR).
    Here's kind of my thinking: You have an alcohol production level where the excise charged in zero or nominal for any and all alcohol producers after which a higher excise rate is applied but which still maintains the same amount of revenue $573 million. Of course the ones who loose the most are the bigger producers so I can see it going down like a bucket of cold sick with them but it should lead to more competition in the production of alcohol (and hopefully i'm not drawing too long a bow here) more competition to the sale of liquor. I echo your sentiments on another posting that the Bigger Alcohol producer in NZ actually make fine beverages but if increased competition and a balance between harm and consumer benefit is to be applied then isn't a tiered excise scheme based on production a means to this end? Call it excise burden redistribution in the name of competition and consumer benefit.
    In all honesty I favour the status quo on excise (other points such as advertising, etc could well do with revision).
    I reckon I'm way out of my depth here (trying to grapple with the economics of it all) but I'm finding the commentary from yourself and Matt interesting stuff! Learning much as I go....

  11. In theory, I can see an argument for a reduced excise tax rate where the actual product selling price is very high. If the point of the excise tax is to reduce externalities, and most of the externalities come from crime, it's not terribly likely that bottles of Grange are involved in many alcohol-fueled crime sprees. On the other hand, the excise tax component of higher-valued products is such a small part of the overall selling price, it's really unclear that it's worth the added complexity to the tax regime. I'd tend to suggest keeping the tax as is.

    Glad that I'm helping to serve as a pusher for Economics :>