How to RUC

This still doesn't sound like a plan for applying the government's petrol excise discount to Road User Charges:

Minister of Transport Michael Wood said he and officials were aware of the financial risk for transport coffers, if too much “stocking up” occurred.

“I don’t think many people will look to do that, but we do want to make sure there is some integrity built into the system,” Wood said.

Wood would not disclose exactly how RUC purchases would be controlled when the discount kicked in.

“Primarily, it would be about Waka Kotahi having the ability to audit and check after purchases have been made,” he said.

“We’d be looking at what is potentially excessive and unreasonable purchasing.

“If you have someone who purchased 5000 kilometres every three months, and suddenly they were wanting to purchase 25,000, that would obviously be an alarm bell, and we’d be wanting to empower Waka Kotahi to be able to deal with that situation.”

Audit and check what - that kilometres purchased were driven during the allotted time? They'll then need a mechanism for running odometer checks at either end of the discount period. 

Why both sides of the allotted time? Because people will be using expensive previously-purchased RUC during the discount period, and you'll need to weigh that up. If I purchase 50,000 km at the start of the period and wind up with 40,000 km unused at the end of the period, I could claim that I actually put on 50,000 km during the period - I'd just had a lot of km that had been sitting there unused at the start of the period. 

That sounds extreme, but I right now have about 5,000 km of RUC pre-purchased. I've 7,000 km on the odometer and RUC purchased to get me to 12,000 km. If I buy 5,000 km during the period and, at the end of the period, my odometer's at 12,000 km with RUC purchased up to the 17,000 km mark, that isn't me gouging the system, that's me buying a quantity exactly equal to my RUC consumption during the period. But there's no way of telling whether I actually had 5,000 in the bag ex ante without an odometer check at the start of the period.

Or maybe "to be able to deal with" just means "yeah, they can phone the purchaser up and verify that there's a plausible-sounding story around any higher-than-normal purchase, because enforcing anything in this will be a nightmare unless it's just impossible that the purchase was legit." 

It won't be an easy one to get right.

UPDATE: From Newsroom:

Transport Minister Michael Wood told Newsroom those purchasing discounted RUCs would need to “complete an online declaration form stating that they are only purchasing charges that they require for that period’’.

“Waka Kotahi will undertake spot checks of large or suspicious purchases and, where appropriate, take enforcement action.

“Enforcement action could include the charging of unused road user charges at the non-reduced rate,’’ Wood said.

Those diesel users who have charges remaining on their vehicles will also be able to apply for a credit.

“They will be able to purchase what is referred to as an overlap licence. Typically when purchasing a RUC licence, the start distance of that licence will continue from the end of the previous RUC licence.

“However, with an overlap licence, the RUC licence begins from the odometer reading on the date of purchase, with the unused distance automatically credited towards the new licence,’’ Wood said.

Most people who choose this method will have to purchase a top-up for the new licence due to RUCs only being able to be purchased in 1000km units.

“This top-up will be at the discounted rate," Wood told Newsroom.

Legislation will be introduced into the House on Tuesday, and passed under urgency, to allow and enforce these changes ahead of the discount period starting.

So when this comes in, an honest person in my position would apply for the overlap licence, truthfully report the current odometer reading, purchase the amount of RUC they expect to use over the next 3 months, and get a RUC label that combines the amount just purchased with the prior stockpile for a new "paid up until XXXXX km" notice.

A dishonest person would understate their odometer's current position and overstate the amount they were likely to use over the next 3 months, so that their new licence could cover a lot of driving after the three months, or not bother applying for the overlap at all and just hold the new licence.

One fairly simple thing they could do would be to print the discount-period RUC licences on different coloured paper, so there could be some worry that a traffic stop could involve an odometer check if you were still running that permit after the period had lapsed. If your discount-odometer licence had you good through 100,000 km and your odometer only had 20,000 km on it two months after the discount window, it would be pretty obvious that you owed the difference on 80,000 km. 

But if the only penalty is that you wind up paying full price for kilometres that you'd have wound up purchasing and using anyway, sometime, it seems a bit of a one-way bet. Heads you get cheaper RUC for a longer period. Tails you get some cheaper RUC, and you've purchased RUC earlier than you might otherwise have for the rest of it. If you win, 1/3 off the cost of a pile of km. If you lose, you've brought forward a bit of spend - and that could matter a bit if RUC doesn't move up with inflation as quickly as it should. 

RUC rebates - how would you do it?

Drivers of diesel vehicles pay their share of road building and maintenance costs through road user charges, levied per kilometre driven, with higher charges for bigger and heavier vehicles.

When the government announced a petrol excise holiday in response to rising fuel costs (a silly policy), it obviously hadn't thought through how to apply it to Road User Charges.

If you were the poor official tasked with making this work, how would you do it? 

The complexity isn't in that there are lots of different charges for different-sized vehicles - you can sort that out with a calculator.  

The complexity rather is that:

• Drivers buy RUC in advance of using it, generally in increments of 500 or 1000 km;
• You can buy large amounts of RUC. There's *some* limit on it to prevent stockpiling against future levy increases, but as best I can tell, I could go and buy 99,000 km of RUC right now;
• Cars and trucks transfer ownership;
• Amount driven varies considerably across people and vehicles, and potentially over time as well.

All of this was obvious when the government did its too-typical government thing and just announced the policy without having worked through any detail. Normal process followed by better governments will first canvass the Ministries for advice about how to do the thing, put up options, consult with affected stakeholders to see what they've missed, update the options, and pick something that won't be completely terrible. 

It's pretty obvious they didn't do any of that.

So, if you were the official told to sort this mess out, what could you do?

The simplest first cut that would work for most vehicles would just base it on average monthly kilometres driven between Warrants of Fitness. Odometers get checked at WoF. New cars can go a couple years between WoFs though. 

So announce that every diesel vehicle will get free RUC based on average monthly kilometres travelled between the last WoF and the next one, after the next WoF odometer check. Whatever the percentage reduction in petrol excise was, apply that percentage to average monthly kilometres driven, multiply by 3, award the RUC at the end of the period.

But that can be a long way off for some vehicles. So you'll need to make provision for that. Say that diesels can go into a VTNZ or other WoF location for an odometer check and immediately be awarded RUC based on the average kilometres driven per month since the prior odometer check (so long as that was at least a month earlier). And you'll have to pay those centres for doing the odometer checks and filling in the paperwork. 

And then it starts getting complicated.

The petrol excise holiday is free money, not free petrol. So you'll have to give an option for a cash-out in lieu of a RUC award. Some people might prefer having the cash; others will be planning on selling the vehicle before they'd use the RUC. But you're going to need some payment mechanism and that's going to be harder than just figuring out how to put free RUC onto a licence. 

Some vehicles will have changed ownership since the last WoF. Was the odometer checked when it was sold? The owner will claim that the car got a lot less use under the prior owner and so the average will be wrong. What do you do with that? They might not be lying. 

Still others will claim that their vehicle is used very intensively during the period that coincides with the petrol excise holiday, and not much during the rest of the year. Many of them will be lying. But some could be telling the truth - and you just won't hear much complaint from those who don't use their car much during that period and really use it during the rest of the year. 

In both those cases you're then going to need to let them go and get their odometer checked to establish a baseline, then get checked a second time. The queues at the odometer checks might get long. And you're going to have to pay twice for the checking. 

All of that sucks. For the simple case where people are happy just to get free RUC after their next WoF, it's pretty easy. But there will be plenty of people who aren't. And for them, you're likely going to need some odometer checking system, and a way of paying people out. 

But other options aren't great either.

If you let people buy RUC at a discount they can just buy tons of it to use later. Petrol is expensive to store. Unless you've got a giant farm tank kicking around, you're going to spend more on jerry cans than you'd save in excise discounts. And storing it in other containers would not work out well. You can't just stick it into an old milk jug and hope you have reliable petrol that hasn't leached out (or had plastic leach in) months later. But RUC - that's just a piece of paper. 

You could limit the amount that people are allowed to buy during the period, but how do you know how much somebody really needs to drive? You can't base it on prior driving history either because needs may have changed. It would sound simple to just look at the total amount of RUC previously purchased, figure out the average monthly amount used, and give a discount on buying a 3-monthly amount and no more - but you'll hit into all of the problems around people with idiosyncratic usage and then you either have to tell them to lump it, or set up all of the odometer checking stuff. 

Anyway. Jo Moir put the questions to Minister Wood, and got an answer entirely consistent with that the government put zero thought into this stuff before announcing it was going to do it. 

Last week Transport Minister Michael Wood confirmed RUCs would be cut across all 85 vehicle classes by 36 percent between late April and late July, allowing time to implement the changes.

“I want to assure road user charges payers they will get three months of reduced rates, even with the later start date. The complexity of road user charges means that a few more weeks are required to put the reduced rates in place,’’ Wood said.

For two weeks Newsroom has put questions to Wood’s office asking how the Government will stop diesel users from rorting the discount by stocking up, and whether people who had bought RUCs prior to the discount period would be compensated.

The only response Newsroom has received to date is that “agencies are currently working through the implementation of the announced RUC changes and any flow-on implications’’.

Wood’s office told Newsroom last Wednesday, and reiterated on Monday, that the minister is expecting further advice in the coming days.

Whoever in the Ministry has been stuck having to square this circle, because the government went off and announced something that couldn't obviously be made tractable, deserves a beer. 

Ardern told Newsroom the Ministry of Transport and Waka Kotahi knew the Government wanted to find a way to offer relief and weren’t caught on the back foot when the announcement was made.

She insisted the delay was simply a case of working through a complex problem and communicating it to diesel users and the trucking sector as quickly as possible.

For those needing to purchase more RUCs ahead of late April it remains to be seen whether they’ll receive all the 36 percent discount, and when it will back-date to.

No new advice on how to overcome the issues with the diesel discount was presented to ministers at Cabinet on Monday.

What a mess. They should have just announced a carbon dividend. 

FWIW, we bought a diesel back in November. We're a one-car family; waiting 2 weeks for a new alternator to show up for our old Honda Odyssey wasn't great. So we got a Mazda CX-8. Our first diesel and our first encounter with the RUC system. 

It's all pretty straightforward, but I really didn't like the risk of running out of RUC before the next batch of RUC showed up in the mail, so I bought 5000 km worth of it - shortly before the excise holiday was announced. 

I will buy as much RUC at a discount as is permitted by whatever system they set up. But I'd really not want to have to drive somewhere to get an odometer check. Ugh.

Portent

My column from Friday's Insights newsletter:

Carbon prices are the best way of getting us to Net Zero. The Emissions Trading Scheme can get the job done if the government lets it.

This week’s petrol tax holiday is a worrying portent.

Politics has always been the biggest risk facing the ETS.

Carbon prices have quadrupled over recent years, to little fanfare. But what would the government do if carbon prices jumped from $70 to $120 in a hurry? Would it let carbon prices adjust while finding ways to help poorer families? Or would it throw sand into the ETS’s workings and force up the overall cost of reducing net emissions?

The Initiative has advocated a more sustainable approach for reducing that risk.

The government will earn over a billion dollars auctioning new credits into the ETS this year. It could tally its expected ETS earnings, split the money five million ways, and give each family of four a carbon dividend of just over $1000 – right now.

The best way of adapting to permanently higher energy prices is different for each of us. Government cannot know what is best for you and your family. A carbon dividend would help each household adapt in ways suited to its own circumstances. The ACT Party announced its support for a carbon dividend on Sunday.

Increasing carbon prices would then mean a bigger carbon dividend for Kiwi households, helping families adjust while protecting the system.

At the same time, a better ETS price cap would reduce the risk of serious carbon price spikes.

If our carbon prices rose to match prices in reputable international markets, like Europe’s, the government could buy carbon permits there to sell here. Our prices could then never rush ahead of prices elsewhere, reducing the political risk to the ETS while reducing the cost of reaching Net Zero.

The case is now more urgent. We have had a warning that our government responds badly to rising energy costs.

Nothing in the past weeks’ rising petrol prices is due to carbon charges. But being able to adapt to permanently higher energy costs matters.

The government could have announced a carbon dividend or found other ways of supporting poorer households.

Instead, it chose to meddle with prices, in a knee-jerk response to a small hit in the political polls.

It does not bode well for our path to Net Zero.

Afternoon roundup

The tab-closing worthies:

• ACT supports a carbon dividend. Good!
• I had to point a lot of people at this last week on Twitter. The 2018 TWG's advice about GST. Says the same thing as the prior National Government's TWG. Good backgrounder for those needing background.
• Peter Martin worrying that Australia picks up NZ's stupid excise holiday.
• Matt Nolan also doesn't like the excise holiday.
• A helpful reminder that at least some of lockdown's costs were inframarginal.
• The borders are opening. Hope there's more hospital capacity by then, or that visitors are provided with appropriate warnings.
• Rotorua asks to be counted as a Tier 1 City, so it can more easily build houses. It's a fun one to think about. Nothing in the Medium Density Residential Standards rule applied to Tier 1 centres is outside of Councils' ability to do on their own. They could upzone on their own. Perhaps best to think about it as a way of binding to broad upzoning, and avoiding the salami-slices that councillors might otherwise be pushed into?
• Larry Summers worries we're heading for stagflation. I wish I had confidence that RBNZ has the competence to navigate the waters ahead.
• Running urban development through environmental planning processes gives NIMBYs lots of room to veto things. Here's Will Rinehart on how it plays out in California under the California Environmental Quality Act. Sounds a lot like New Zealand's Resource Management Act and its problems. PRI has reform suggestions for California.
• Nobody expects the Royal Society's inquisition. Fortunately, it has now been dropped. 

Gas tax holidays

A temporary petrol tax holiday is a stupid way of responding to cost-of-living pressures.

It's what hundreds of economists argued over a decade ago, when Hillary Clinton and John McCain pitched the idea in 2008.

It was dumb then and there; it's dumb here and now. 

My column in Newsroom this week, now ungated.

All up, adjusting petrol excise when global oil prices change makes little sense. It would have made no sense to hike excise in response to very low oil prices at the beginning of the pandemic, and it makes no economic sense to reduce them in response to high current oil prices.

But that does not mean that the Government should do nothing.

Carbon prices are not to blame for the current oil price shock. But we should expect carbon prices to rise as the Government moves toward Net Zero. Carbon charges will impose a larger burden on household budgets.

And, unlike petrol excise, Government will profit from rising carbon prices. The Government intends to auction 19.3 million tonnes of carbon credits over the coming year – with more credits held in reserve in case the price cap is hit.

If the Government can sell a tonne of carbon credits for $72, it will earn just under $1.4 billion through this year’s auctions.

Currently, government ETS revenues are earmarked for climate activities. But programmes targeting emissions that are already covered by the ETS cannot reduce net emissions unless the Government also reduces the number of credits that it auctions. And a strong majority of Kiwi economists agree it is less costly to just reduce the ETS cap without implementing policies targeting emissions that are covered by the ETS.

The Government could instead take the money it earns at ETS auction and return it to Kiwi households, to help them respond to rising energy costs. The payment to a family of four would be just over $1,000, at current carbon prices.

This kind of carbon dividend would be better than slush-fund expenditures like electric vehicle subsidies for helping mitigate any undesirable distributional effects of rising carbon prices.

It certainly would not solve all of the problems caused by high inflation and by a global oil shock. But it would help households start adjusting to higher longer-term energy costs. And it makes more sense than a temporary excise holiday.

Unfortunately, yesterday’s announcement also suggested that the Government has a few other things planned for the money it earns at ETS auction.

At the same time, low-income households very likely bear a disproportionate burden from current petrol excise. A 1995 Toyota Estima does not impose any greater wear and tear on the road than a 2022 hybrid Toyota Rav-4 but pays an awful lot more to use the roads. Shifting petrol vehicles to road user charges would help undo a substantial inequity in the current road funding system and ease the burden facing households that have not yet been able to afford an upgrade.

Nothing can really cushion New Zealand from global oil price shocks. There were sensible approaches the Government could have taken to ease some of the burdens. A temporary excise holiday is not one of them.

I'd also chatted with Kate Hawkesby at Newstalk early Tuesday morning and with RNZ's The Panel on Monday afternoon about it.  

If this is what the government does when spooked by one bad poll, the path to Net Zero's going to be messy. 

Things that should be common knowledge that seem not to be: Petrol and excise and GST edition

Petrol excise is charged per litre of petrol. It isn't ad valorem. 

That means that excise's fraction of petrol prices have been going down as petrol prices go up. MBIE says it's $0.77/litre, plus another $0.10 in Auckland. Check it for yourself on MBIE's website.

Excise is $0.77. Add $0.10 for Auckland gets you to $0.87. Add carbon costs of maybe $0.20 when carbon is $80/tonne gets you to $1.07. GST on excise and carbon gets you to $1.23. 

GST over the base fuel cost would add more. If petrol is $3/litre all up, then total GST is $0.39. GST on excise and charges is $0.16; GST on the rest is $0.23.

There's good reason not to add GST in here at all, unless you're making a generalised case for abolishing GST.

Consider a family that spends every dollar it earns. If the price of petrol goes up and it's paying a lot more GST on petrol, it's by definition spending less on other stuff. Its GST expenditures on other stuff goes down. Government gets 15% of that family's spend through GST before and after the change in petrol prices. 

Yes, GST on petrol goes up as the price of petrol goes up. But the effect works both ways. Would you argue that excise or GST should increase to compensate whenever oil prices drop? I know I heard some calls for that when oil prices were lower, but those were also stupid. 

Or think of it this way. Cutting excise when fuel is particularly expensive is a tax cut particularly benefitting owners of less efficient vehicles. Does that seem like the kind of thing that is likely to make sense?

And remember that the relatively inelastic side of the market bears the burden or enjoys the benefit of tax changes. When global oil markets are a mess and ordering in more fuel is likely to be hitting all kinds of chokepoints, does it seem likely that fuel supply is relatively inelastic in supply? Would a ditching of petrol excise not lead to a bidding up of fuel prices from the demand side, getting us most of the way back to where we were ex-ante?

Petrol excise (and Road User Charges) go into the National Land Transport Fund. That money gets used to build and maintain roads. Unless you think the costs of building and maintaining roads is countercyclical in oil prices, it is dumb to want them abated just because petrol costs are currently high. For a start, aren't roads made using bitumen? Isn't that an oil derivative that should covary in price with oil and petrol? Don't all the big yellow machines use a lot of diesel?

That's also the simplest explanation of why GST has to be charged on top of excise. Excise covers the cost of providing road services. Imagine if all the roads were privately owned and charged a fee for driving on them. There'd be GST on that fee, right? Same for excise. 

It would be coherent to argue that government raids NLTF for a bunch of stuff that shouldn't be funded out of road user charges. Some people like the idea of funding rail lines or public transit out of there, but the case is pretty weak. 

You could then sensibly argue for a permanent end to that, which would result in permanently lower excise and RUC. 

Except for one thing. 

Central government often also uses general revenues to pay for big highway projects that otherwise have a hard time passing a cost-benefit hurdle. It'll have to stop doing that, if you want to be consistent. And that will make RUC and excise go up again, unless you run a tighter CBA on roading projects. And I have no clue which way that cashes out. 

Here is the defensible argument that could be made. 

The Government's ETS revenues have gone through the roof. Carbon is $80/tonne. The government in 2022 will collect enough money in ETS revenues to give a cash transfer of over $1200 to every family of four in the country. It could even weight the thing so that more money went to households with Community Services Cards, and a bit less to households like mine. Call it a carbon dividend, tell families that they should use it however makes most sense for them in adapting to higher energy costs. 

It's almost surprising that the government hasn't gone for this yet. They're under a lot of pressure over rising petrol prices and rising prices of everything else. Some of that is rising carbon prices. Most of it is RBNZ letting inflation get out of control. But government could announce a carbon dividend, right now, give every family a big cheque, and buy a lot of insulation against complaints about rising fuel costs. 

Who pays sin taxes?

Freshly out in the NBER working papers.

Who pays sin taxes? You probably can make a pretty good guess:

We find that sin good purchases are highly concentrated with 10% of households paying more than 80% of taxes on alcohol and cigarettes. Total sin tax burdens are poorly explained by demographics (including income), but are well explained by eight household clusters defined by purchasing patterns. The two most taxed clusters comprise 8% of households, pay 68% of sin taxes, are older, less educated, and lower income. Taxes on sugary beverages broaden the tax base but add to the burdens of heavily taxed households. Efforts to increase sin taxes should consider the heavy burdens borne by few households.

Results will apply a fortiori in New Zealand. 

They note that, in New York, a 1.75L bottle of vodka might be as cheap as $11.99, including $7.97 in tax - all USD. If that bottle is 40% alcohol, that's 700mL of alcohol. 700mL of alcohol, in NZ, draws $39.64 in excise. And of course GST on top of excise. 

They note that House Democrats proposed doubling federal excise to $2.00 per pack, on top of state taxes with a median $1.78 burden per pack. New Zealand's excise is $1.045 - per cigarette. So $20.91 per pack.

The most heavily-taxed clusters in our sample are the Everything cluster, which comprises only 2.5% of the population yet pays 27% of all existing sin taxes (around $288 per adult per year); and Smokers, who comprise 5.5% of the population and pay 41% of all existing sin taxes (around $211 per adult per year). The groups are quite similar to one another, except that the Everything group purchases a large amount of alcoholic beverages (primarily beer and spirits for 9.4L of ethanol per adult per year or 10.2 standard drinks per week), while the Smokers purchase almost none. Both groups purchase more sugary beverages than any other cluster (157-170L per household per year or about 1.5L per person per week). Both groups also purchase about a half pack of cigarettes per day, but with substantial dispersion across households (the top 20% of households in these groups purchase at least one pack per day). Demographically, these two groups look similar to one another: they are older, lower-income, lower-education, less likely to have children or belong to racial or ethnic minority groups. They are most likely to be between the ages of 55-64 and least likely to be below age 35.21 Because many of these households are in the lowest-income bin (< $25,000 per year), their overall sin-tax burden as a share of income can be significant. It averages 2% of income for the Everything group and 1.5% of income for the Smokers group. The hypothetical SSB tax would add another 0.2%-0.3% of income on top of that.

The usual claim is that while excise is regressive, the health benefits are progressive. Of course, the ones paying a ton in taxes aren't the ones enjoying substantial health benefits.  

Thanks to Paul Walker for the pointer. 

Regressive excise

Statistics New Zealand confirms the regressive effect of the continued tobacco tax hikes. 

The latest inflation figures sort inflation by household expenditure quintiles. Poorer households are more likely to include smokers. The government continues its annual excise hikes on tobacco. Meanwhile, the government has made the first year of tertiary study free. Richer kids are more likely to take up tertiary study.

And so living costs for poorer households have gone up more than for richer households.

“Like the March 2017 quarter, prices for cigarettes and tobacco have seen large rises due to the annual tobacco tax increase,” consumer prices manager Geraldine Duoba said. “The tax increase was implemented at the beginning of the year, bringing the average price for a packet of 25 cigarettes up to $35.14.”

Of the different household groups measured, Māori households saw the highest inflation in the March 2018 quarter (up 1.3 percent), compared with 0.8 percent for all households. This increase for Māori households was driven by higher prices for cigarettes and tobacco, and interest payments.

The lowest-spending households experienced more inflation than the highest-spending households in the March quarter, partly because cigarettes and tobacco are a greater proportion of their living costs. Cigarettes and tobacco make up approximately 3 percent of total household living costs for the lowest-spending households, compared to 1 percent for the highest-spending households. Price increases for rent (up 0.7 percent) and petrol (up 2.5 percent) made the next-biggest contributions to price rises for the lowest-spending households.

The introduction of the Government’s new ‘first year free’ policy for tertiary education had a dampening effect on inflation for all households. The highest-spending households received the greatest benefit because they spend proportionally more on tertiary education. These households also experienced the greatest effect from the seasonal price drop in international air transport.

We warned about these distributional effects around education in our report on zero-percent loans a couple of years ago.

I'd run the numbers on the effects of National's tobacco excise hikes back in 2016. They'd then locked in 10% excise hikes every year through 2020. I'd focused on effects on Maori households, using the Otago public health peoples' numbers on quit rates.

So for every 1000 Maori, we have:

• 773 who would not have smoked regardless,

• 13 who quit because of the tax and enjoy health benefits, save some money, and may or may not be happier from having quit – we’ll assume happier,

• 214 who keep smoking about 90% as much as they had been smoking. Each and every one pays about $1020 more in excise per year than they otherwise would have paid.

For every Maori smoker who quits, 16.46 Maori smokers will pay a bit over a thousand dollars more in excise per year – assuming they start with a half-pack-a-day habit. Some will pay more, some less. The 2014/2015 NZ Health Survey says that Maori daily smokers smoke on average 10.3 cigarettes per day, so that’s about right. On the other side, the same survey says that current prevalence of daily smoking is 35.5% among Maori. If Wilson’s figures underestimate baseline smoking in 2020, then the tax hike would have a few more current smokers quitting than here estimated, and a lot more current smokers paying that extra thousand bucks per year.

The NZ Health Survey notes that daily smoking rates are 25.4% overall in the most deprived neighbourhood quintile (as compared to 8.3% in the least deprived quintile). MoH estimates there are 178,000 daily smokers in the most deprived quintile. If each of them is pays an extra $1000 in tax, the government is pulling $178 million more dollars out of our poorest communities.

When the Otago Public Health people talk about the package of policies that they support, and that I'm evil for not supporting, they mean the continued excise hikes. That's what "implementation of cutting-edge methods to reduce the affordability" means. It's more tax hikes on the poorest people in New Zealand.

My package of reforms? Freeze the excise hikes. Reduced harm products are now legal in New Zealand. Allow them to be advertised - they should not have the same advertising restrictions as smoked tobacco. Make sure that nobody tries applying plain packaging to them. Weigh seriously the trade-offs with an R18 status - if you keep it R18, then monitor to see whether that's winding up making youth smoking rates higher than they need be. Heck, distribute leaflets about reduced-harm products in the dairies and shops that sell cigarettes and let the dairy owners know about distributors who can supply them with reduced-harm products.

Over the next few years, there'll be a lot of switching to reduced-harm products. Eventually, you'll be left with a small number of continuing smokers for whom reduced-harm products simply don't work. Punishing that group with high levels of excise - I don't know what the point of it is. Schedule a reversal of the excise hikes, recognising that excise is less needed where there are better substitutes for smoking available. You just don't need as high an excise rate to discourage use when acceptable substitutes are more readily available. That's just maths and how elasticity works. Goods with more substitutes are more elastic in demand. Any excise hike does more to curb consumption for relatively elastic goods than for relatively inelastic goods. So you don't need as high of excise to induce any given demand reduction if you've been able to make more substitutes available. It's bizarre that parts of the public health community have worked so hard to make sure that acceptable substitutes don't become available.

It really annoys me when people say stuff like "The taxes are regressive but the health benefits are progressive!" Why? The person paying the tax isn't getting much health benefit from the tax. Quitters get the biggest health benefit, but there aren't that many of them.* Current smokers cut smoking rates a bit, but they'll also draw harder on each cigarette to compensate. And it's a bit funny to laud excise for the health benefits of a 10% reduction in the number of cigarettes smoked while damning vaping because some vapers will have the occasional cigarette as well.

Bottom line: the continued hikes in excise should not be part of any reasonable harm reduction package. The harms that excise imposes on those who continue to smoke are substantial. The now-legal status of reduced-harm devices means that you don't need to beat people up with excise.

And if you like excise because it beats up on tobacco companies, think again. Cigarette supply is basically infinitely elastic at the world price. Demand is highly inelastic, in no small part because there have not been good available legal substitutes. Basic tax incidence means the burden of tobacco excise falls predominantly on the relatively inelastic side of the market. That's the demand side.


* And there's still the more difficult question of whether they then see themselves as better off. Many will, some won't.

Tobacco prices

Tobacco control folks have been calling for a rather substantial hike in tobacco excise in New Zealand. I thought it might be worth having a bit of context for that.

Here's prices for cigarettes and tobacco against the CPI. 1971 Q1 is the baseline, as that's when the tobacco series starts.

If you want to check my numbers, go to Infoshare. I'm using CPI009AA for the CPI data, and CPI012AA for the Level 2 Subgroup Cigarettes and Tobacco.

Tobacco targets

In a New Zealand that cared more about harms from tobacco use than about bashing tobacco companies, we'd expect to see things like:

• Legal and simple access to nicotine cartridges for e-cigarettes. They could be accompanied by a very low excise tax and sold through licensed outlets, like tobacco, under an R18 regime, if the public health folks worried about sales of an addictive but relatively benign substance (coffee?). 
• A regime providing excise scaled to harms for different tobacco products. If heated rather than smoked products were less harmful, they should be available on a lower excise rate. And similarly for snus or for chewing tobacco. 

Instead, what do we get? New Zealand gloating over that tobacco was exempted from investor-state dispute settlement provisions in the TPP, hints that more tobacco excise hikes are coming, and the Prime Minister noting that he'd like to implement tobacco plain packaging.

Surely we're well into massively diminishing returns on the bash-tobacco side. Why not put the effort instead into getting legal markets in less harmful alternatives with an excise regime that's sensitive to the relative harms of the different products?

Sure, tobacco excise hikes will continue to cut down on the number of smokers; demand curves do slope downward, and especially in the longer term. But at current excise levels, the ones left are surely the least price sensitive. We know that the price elasticity of demand for products with close substitutes is much greater than the price elasticity of demand for products with no close substitute. And we know that the current regime is highly regressive for those households that continue to smoke. 

Why not open up the market to less harmful substitutes? Isn't it just a bit nuts that e-cigarette users have to import their nicotine capsules from abroad, where they have much harder recourse if they're provided adulterated product?

Update: here's the anti-smoking campaigners' wishlist from last week. 

Sane treatment of e-cigarettes wasn't mentioned anywhere.

Tax incidence isn't a subsidy

Suppose alcohol excise doubled. As you walked down the supermarket aisle, you saw that excise tax pass-through rates varied from product to product: low-cost product prices didn't go up quite as much as you'd expected they would.

Does this mean that supermarkets are subsidising lower-priced products? The University of Sheffield / East Anglia alcohol folks think it does.

The findings, published today in the journal Addiction, showed that supermarkets responded to tax increases by subsidising prices of cheaper products. Price rises for cheaper products were up to 15 per cent below the level expected if the tax increase had been passed on fully. 

Although under-shifting affected around one in six of all product lines, these drinks account for a large proportion of total sales: approximately 68 per cent of beer, 38 per cent spirits and 31 per cent of cider sales. 

There is a likely implication on health with previous research showing the heaviest 5 per cent of drinkers in the UK population, classified as higher-risk drinkers according to NHS guidelines, buy 33 per cent of all shop-bought alcohol and favour cheaper supermarket products. Subsidising cheaper alcohol when taxes are increased is likely to lead to smaller reductions in excessive alcohol consumption, and consequently smaller reductions in the harms caused by excessive alcohol than if tax rises were passed on in full.

Paul Dobson, professor of Business Strategy and Public Policy at UEA, said: “Subsidising cheap alcohol might be attractive to supermarkets in their efforts to increase the number and frequency of store visits that shoppers make, but it is socially irresponsible when it encourages excessive consumption. 

Ok, let's go back to the basics on tax incidence again.

First, we rarely expect perfect price pass-through. The burden of any tax increase will be shared between buyers and sellers depending on the relative price elasticity of the two groups. We get perfect pass through where demand is perfectly inelastic (consumption doesn't vary at all with price), or where supply is perfectly elastic. Otherwise, they share the burden. So undershifting just tells us that we don't have perfectly inelastic demand or perfectly elastic supply. If demand is perfectly inelastic, then prices are a dumb policy for trying to curb consumption in the first place. Supply's likely to be pretty elastic, but perfectly?

Now let's make things a bit more complicated.

Suppose that we have two alcoholic product categories in perfectly separated markets. In both cases, supply is pretty elastic. In the first market, customers are moderately price sensitive on the whole, but don't put a lot of effort into price comparison shopping. In the second market, customers are much less price sensitive when it comes to total consumption, but are incredibly price sensitive when it comes to product or outlet selection. So in market A, customers don't flip brands or stores much when prices go up, but they will scale back total purchases. In market B, customers will flip brands or stores immediately for a penny's price difference while not changing their total consumption very much.

We typically say in tax incidence theory that the relatively inelastic side of the market bears the greater part of the tax burden. If customers would flip to other brands or other retailers really quickly in market B, we'd expect that the retailers and producers would bear a greater part of the burden in market B than in market A. It's going to be a bit complicated by that I'd expect total demand at the bottom to be more price inelastic than in the middle ranges, but the main action here should be in sensitivity across brands and retailers if there are some rents going to producers through imperfect competition.

Again, we get differential responsiveness to the excise change without any "subsidy" to lower-cost products.

The most puzzling thing the paper finds is supranormal pass-through on the higher cost products. I expect this is what draws the "subsidy" explanation. For me, it instead upweights something I've heard a lot from smaller brewers but hadn't expected would have huge absolute effects. They've argued that, because excise gets paid at the brewery/distillery at point of production, and because everybody along the way then takes margin on the total price on the product coming out of the plant, you should expect more-than-proportional pass-through. I've not worried about it a lot, because the excise component of an $8 half-litre bottle of something by Three Boys, Yeastie Boys, Emersons, Panhead or otherwise really isn't that huge, so the absolute effects there wouldn't be huge either. But it would show up in these kinds of measures of retail-end pass-through rates.

Crystal balls: tobacco plain packaging edition

When Australia was moving toward plain packaging, I expected that it would shift consumers toward discount brands and that you could simultaneously reduce tobacco company profits while increasing consumption, absent substantial-enough excise increases. Where brand appeal becomes less effective, we'd expect moves toward price competition instead. I'd written:

The tobacco industry's been pretty angry about plain packaging. If brand labelling mostly works to reduce competition across brands and to help maintain customer loyalty, we'd expect that plain packaging mandates will lead to a shift towards discount brands and lower prices absent further excise hikes. And that's also what Clarke and Prentice expect.** You can simultaneously have a policy anger the tobacco industry while increasing smoking if it pushes current smokers to discount brands, reducing the average price they pay and consequently increasing consumption while decreasing industry profits. The policy that's the enemy of your enemy isn't necessarily your friend.

And see here as well.

The "Scream Test" is a poor measure of whether a policy reduces harm: a policy that hurts some industry you don't like doesn't automatically make the world a better place.

Sinc Davidson reports that prices are dropping in Oz, despite excise increases, and that consumption's rising. Always-reliable Senator Nick Xenophon is consequently pushing for tobacco minimum pricing. A graph showing reduced tobacco expenditures has been making the rounds on Twitter; that can be entirely consistent with increased consumption where consumers are shifting to discount brands or if tobacco companies are dropping prices to maintain market share.

I suppose in full equilibrium, where the government raises excise sufficiently to get prices back up to ex ante levels, you'll have transformed some producer and consumer surplus into tax revenue, with excess burden in the form of reduced brand affiliative benefits for consumers who enjoy brand affiliation.

While I understand excise hikes for the next few years were scheduled a while back, I wouldn't be surprised if discounting and increased consumption led to excise increases greater than those previously scheduled.

Increasing alcohol excise is great, if you assume the right things

Imagine that hazardous drinkers really really cared about the price of alcohol. If you increased the price of alcohol just a little bit, they'd stop drinking harmfully. Imagine further that moderate drinkers didn't respond very much to prices: what does it matter to the rich Chardonnay-sipping set if a bottle is $8 or $40? If that were the true state of the world, we would have a very simple solution to alcohol problems: hike excise taxes. Harmful drinkers would stop drinking and would stop doing alcohol-related harmful things; moderate drinkers would pay more but that would just be tax revenue for the government. Since they wouldn't change their consumption by very much, deadweight costs would be pretty small relative to the harms avoided. Yay taxes!

Unfortunately, the world don't quite look like that. Our best evidence on it remains Wagenaar's metastudy showing that heavy drinkers respond to a 10% price hike by reducing consumption by 2.8%; average consumption drops by 4.4% with the same price increase. Moderate drinkers respond more to price increases than do heavy drinkers.

Even worse, Byrnes et al show that heavy drinkers' price responsiveness mostly comes from their reductions in drinking on low-drinking days: they basically save up to be able to continue binging on the weekend. So their reduction in consumption is in the part of their consumption that does the least harm. Boo taxes!

Enter the NZ Government report on excise and minimum pricing. Fortunately, the Minister has more sense than her Ministry and hasn't gone ahead with minimum pricing; hopefully, she's not looking at excise. What's the problem with the report? They started by assuming that heavy drinkers are more responsive to prices than are moderate drinkers.

And they know it's wrong. Here, at Table 5, they show the general consensus of the international literature: heavy drinkers don't respond to prices nearly as strongly as do moderate drinkers.

The Wagenaar numbers vary a bit from the -0.44 that I tend to cite as average; I usually go for the weighted measure. Bottom line: heavy drinkers are roughly half as responsive to prices as are moderate drinkers. That's page 20. And they cite Byrnes accurately at page 21.

But then what do they go and do? They started by trying to get SHORE to estimate NZ elasticities, but something went wrong there: the elasticities were completely out of whack with reality. Reading between the lines at page 25, it looks like SHORE was using the increase in purchases of products on special at supermarkets as part of its price elasticity estimation, and that just ain't right. If you switch brands because something's on special and buy more of it than you otherwise would have, that isn't the same effect as you'd expect for across-the-board price changes you get with excise or minimum pricing.

As the report rather bluntly puts it:

"It was decided that the significant reductions in consumption estimated using NZ elasticity estimates are not a realistic representation of what is likely to happen in reality and are contrary to all international evidence of the responsiveness of alcohol consumers to changes in price."

Rather than discard the completely nuts NZ numbers, they let those figures stand and added alternative numbers as robustness checks. Those big headline estimates you've been seeing in the papers about just how awesome excise is? They're based on the numbers that, according to the report, "are not a realistic representation in reality and are contrary to all international evidence of the responsiveness of alcohol consumers to changes in price."

Example? A 133% excise hike means about a 40% increase in the cost of low-priced beer, a 44% increase in the cost of low-priced wine, a 45% increase in the cost of low-priced RTDs, and a 103% increase in the price of low-cost spirits. The heavy drinkers SHORE estimated a 61% reduction in harmful consumers' consumption with that tax hike. So they're saying that harmful consumers are more than unit elastic. That's just not right.

The other problem with the SHORE numbers is that they couldn't distinguish between heavy and moderate drinkers. Everybody's elasticity was equally overestimated.

Because those numbers were so out of whack, they also ported in some Sheffield elasticity estimates from the UK. Problem with those estimates is that, while they're about right on average, they've messed up the relative elasticities: they have harmful drinkers being more price responsive than moderate drinkers. I'm not sure why they didn't pull in the 2008 Sheffield estimates noted at Table 5. At Table 25 they say, using Sheffield, that a 133% excise increase would reduce low risk consumption by 18.6% while reducing harmful consumption by 21%. If that 133% excise increase corresponds to about a 45% price increase, then Wagenaar's estimates would say we'd get only a 12.6% decrease in heavy consumption and a 28% decrease in moderate drinkers' consumption (using the figures from Table 5). Heavy drinkers' real-world price responsiveness is 60% of that advertised, while moderate drinkers' responsiveness is 150% of their figures.

Now, why does this matter? The more responsive are moderate drinkers to price measures as compared to heavy drinkers, the more expensive is any bit of harm reduction in terms of harms imposed on moderate drinkers. And the folks who wrote the report know this matters too! Here's what they wrote at page 85:

Overall it appears that excise increases have a greater impact on harmful drinkers than low risk drinkers, based on University of Sheffield elasticity estimates. This is driven by the greater own-price elasticities, particularly for spirits. However, this result is inconsistent with findings in studies such as Wagenaar et al (2009), which found that heavy drinkers are much less responsive to price changes (with an elasticity of -0.28 compared to -0.62 for all drinkers). The University of Sheffield also found that harmful drinkers are much more price inelastic compared to low risk drinkers when total alcohol consumption was considered, rather than consumption by beverage type.

We also do not have separate elasticities for per occasion drinking, and recent evidence indicates that people are much less price responsive during drinking occasions (Byrnes et al, 2012). Therefore there is a risk that the effects on purchases could have been over-estimated for per occasion purchases. 

Therefore we cannot conclude with confidence that excise increases will have a greater impact on harmful drinkers. More research is needed to confirm this, which could be done once revised University of Sheffield elasticity estimates are available.

Here are but a few of the the ways this will affect their analysis:

• Crime reduction benefits are overestimated both because heavy drinkers are modelled as being far more price responsive than they really are and because crime seems more responsive to binge drinking than to longer term heavy drinking, and it's the latter that seems more affected than the former among heavy drinkers. 
• The health effects will be overestimated where harmful drinkers are modelled as sharply curtailing consumption and where we underestimate by how much moderate drinkers shift into non-drinking and miss out on the health benefits of moderate drinking.
• The deadweight costs facing moderate consumers are underestimated in the Sheffield figures that understate moderate drinkers' consumption elasticity.
• All the other benefits that require consumption reductions among heavy drinkers will also be overstated.

Tables 40 and 41 have a whole whack of sensitivity checks. What if population growth is lower or higher? What if we use a higher or lower discount rate? Nowhere in the 21 sensitivity analyses is the one that really matters: "What if we use a sane, international-consensus measure of relative price elasticities?"

Whether this is enough to overturn their net benefits finding - I can't tell without a pretty extensive bit of work. Just linear extrapolations from the changes in harmful and moderate consumption won't do it: deadweight costs will increase extraproportionately, and harms are likely exponential in heavy consumption.* But I'm pretty sure that Collins was dead right in not relying on this stuff to justify imposing minimum pricing: the case hasn't been made. 

A few other potential problems on a cursory reading:

• They estimate the productivity costs of those showing up to work with hangovers under the assumption that those prone to showing up to work with hangovers have average productivity characteristics but for their propensity to show up for work with hangovers. I rather suspect that less conscientious workers are more prone to showing up unfit for duty, and that this affects more than just hangovers.
• They estimate the productivity costs of taking a day off for a hangover under the assumption that the kinds of people who take a sickie for a hangover wouldn't have used up that free sick day for some other recreational purpose later in the year. This also seems implausible. 
• Their analysis of alcohol-related unemployment is bereft of consideration of comorbidity between alcoholism and depression and the independent effect of underlying characteristics on employment.
• Frictional costs to employers of replacing fired or deceased workers seem predicated on an assumption that the employer would never otherwise have to have replaced that worker.
• Their crime estimates count as an alcohol-caused crime any crime committed by someone arrested within 12 hours of offending and presenting as at least moderately intoxicated. While this may underestimate things by excluding those who aren't caught until much later, it also says that every one of those moderately intoxicated arrestees would never have committed the offence but for the alcohol. Not sure which way things will cut on that one, but I'm awfully sure that they'd do better by just porting in some decent estimates of the elasticity of crime with respect to alcohol out of something like Carpenter. 

I'll be interested to see what they come up with when they have a second go at this, with some sane elasticity figures. 

On the plus side, Footnote 31 points to my blog post on likely effects of minimum prices on producers. I'd have recommended this one instead.

* At Table 37, they give a $268,185,000 cost of a 133% excise hike. If moderate consumers are 150% as responsive as they're reckoning, then a linearisation would put that cost up to $402 million. At Table 30, they give a value of harm reduction in Year 1 of $740,344,000. If heavy consumers are only 60% as price responsive as they're reckoning and if harms were linear, that knocks the benefits down to $444m. So we're down to a net benefit of about $40 million, without considering that deadweight costs will be higher than implied by linearisation, and without considering the other problems noted above. Whether the linearisation on harms here overstates or understates things gets complicated: for any individual drinker, harms are strongly non-linear, so if we had a pile of really really heavy drinkers estimated to become moderate drinkers, but instead only become heavy drinkers, then my linearisation overestimates how much the report overstates harm reduction: the reduction in harm in moving from really really heavy drinking to heavy drinking is bigger than the reduction in harm from moving from heavy to moderate drinking. But if instead we get the harm reduction from greater proportions of heavy drinkers shifting into moderate drinkers than really would, then the linearisation would be about right. And if prices are really bad at hitting acute drinking that contributes most greatly to harms, then even my linearisation understates the extent to which the report overstates harm reduction. It's complicated, and I haven't access to the guts of this machine. 

Duty Free

Otago's Richard Edwards wants to close the "loophole" allowing duty-free import of tobacco and costing the country millions in lost excise revenue. Let's look at this from first principles.

First, recall that excise is imposed not for the purpose of revenue generation, but rather (ideally) as a quasi-Pigovean charge to internalise external costs of consumption, noting however that current tobacco excise is roughly three times any cost smokers impose on the government through the public health system. "Lost revenue" matters a lot less than whether we've messed up relative prices.

Visitors to New Zealand bringing tobacco or alcohol products with them for their own consumption while here should not be subject to excise taxation on those imports where excise is intended to defray the costs to the public health system involved with the consumption of those products. Tourists will go home and eventually potentially impose costs on their own public health systems for tobacco consumed while here, but are not likely to impose costs in New Zealand. Alcohol could potentially lead to the imposition of social cost if someone flies here, gets drunk, and does silly things. We then need a balancing between the expected social cost per unit import and the cost of collecting duties and tariffs at point of import. Excise on spirits is $50 per litre of pure alcohol; the duty-free concession is three bottles of spirits that would likely contain about 1.35 litres of pure alcohol, or $67.50 in tariff. A very small portion of that would represent potential expected costs that could be imposed on the New Zealand government through the consumption of the imported product by foreign tourists. But note too that we make many other concessions to foreign visitors because the cost of charging them would be a hassle. Tourists are given free coverage for minimal accident treatment by ACC without paying premiums despite that a small ACC levy imposed at the border would be pretty straightforward. Any of these measures that slow down processing at the border and annoy tourists risk imposing cost rather in excess of the potential benefit.

Returning residents are a bit different. Whether a Kiwi consumes alcohol or tobacco brought with them from abroad or bought at the local shoppes, the external costs are the same. A duty free limit then should be set simply in recognition of that it can be more expensive to collect taxes at the border from returning residents than to run those taxes within the country. There are perfectly legitimate, non tax avoidance reasons for bringing in product from abroad. When I go home to Canada, I like to bring back ice wine that's otherwise here hard to get. Smokers may wish to find products that are different from those commonly available here. We also have a personal goods concession allowing the import of goods valued up to $700. This gives us a bit of a benchmark on Customs' expected hassle-cost of collecting taxes at the border. If it isn't worth hassling an incoming returning resident for $100 in GST because of collection costs, it would be surprising if it were worth hassling an incoming returning resident for $67 in excise. Presumably the import allowances are set with a recognition of that returning residents will often have a combination of personal goods, tobacco and alcohol. The threshold for imposing hassles at the border is then pretty high, because hassle costs at the border are pretty high.

Where Edwards has a reasonable point is that as excise increases, the duty-free allowance should presumably change. The higher is excise, the lower should be the duty-free allowance because it will be easier to hit the break-even point where excise matches the transaction cost of collecting it. I've not seen the time path on the personal concession for tobacco product. If it isn't lower now than it was a decade ago, there could be grounds for checking whether it should go down a bit. But were the personal limit to be lowered substantially, we'd need a separate and higher limit for incoming tourists. And that too imposes hassle costs.

Finally, it isn't hard to imagine second-best arguments where, if consumption among higher income cohorts is less likely to impose substantial external harm - they tend to have private health insurance, for starters - then duty-free imports for jet-setters is one way of having excise rates that scale appropriately.

In other news, the NBR reports that changes are afoot for low-value GST exemptions on imports. I really hope that whatever regime they come up with recognizes the potentially large fixed cost imposed on any import when you make online shoppers go through an extra hassle step to collect the goods they're buying. It would be very very easy for regulations here to turn into protectionism for local inefficient retailers.

Legal marijuana markets

Business Insider has a great write-up on Colorado's legalised marijuana markets. Currently restricted to medical marijuana sold through dispensaries, recreational use without prescription will be legal and anyone will be able to purchase from the dispensaries. They're expecting to raise $130m in taxes, although the tax mechanism is rather opaque. IRS won't let you take business deductions on things it deems illegal, even if the State is cool with it.

I read the story through an Austrian entrepreneurial-discovery lens. We always have a path to some new equilibrium rather than simple blackboard comparative statics. Business Insider details the mistakes made along the way. Because the regulations effectively required vertical integration of dispensaries with growers, businesses needed a combination of a business-type to provide financing and run retail, and a former basement grower who knew how to grow.

Often, the grower and the retail entrepreneur viewed their entities as entirely different organisations. This would prove to be an issue when it came to pricing the product.

The basement growers entered the formal industry assuming that the price of marijuana would hold steady with the black market price. The initial offer they made to the retail entrepreneurs — $US4,000 worth of marijuana for a $US3,500 wholesale price — was based on that assumption.

The risk of growing marijuana in a basement when it wasn’t legal was priced into that high wholesale cost: The idea was that when the industry transitioned to the legal medical market, the portion of the price that went to cover the risk would instead cover new expenditures like rents on warehouses and retail facilities.

But those initial price estimates did not hold, and that’s when people began to panic.

Then follows a story of price discovery, time-to-build problems, price and quality competition, and problems where you can't sell surplus product on to other markets. And more changes are to come when customers no longer need a prescription, effectively allowing a tourist market to emerge.

I also love that the story provides us with some benchmark market prices for lower and higher grade product: retail price of $25 to $50 per quarter ounce. Now this is still in a not-quite-free market: the growers have to be vertically integrated with the dispensaries, so this limits the economies of scale that could obtain in a fully legal market. But it suggests that USD $100-$200/oz would be a ballpark price to consumers.

I'd guessed NZD$100/ounce as baseline costs in a legal NZ market. If Colorado's cost structure approximates that which would here obtain and we reckoned NZ prices of NZD$100-200,* and if excise were set to keep selling price to consumers constant at $300/oz, then we'd be setting excise and GST revenues at about $150/oz rather than the $200/oz I had expected. So excise would be closer to $125 million than to the $167 million I'd expected. That back of the envelope reckoning wasn't far from this one though.

* Power's more expensive (by lots) but the weather's also much better than Colorado. I'm guessing that further economies of scale in growing approximate the exchange rate difference, but I still have low confidence in the point estimate. I've updated my range to (very rough ballpark) of $75m - $200m. No numerical magic went into that estimate; it just gives the range of figures I wouldn't bet against at reasonable odds.

In defense of the taxman

I'm not sure that NZ excise should take all the blame here.

The popular New Zealand wine Oyster Bay is being sold at home for nearly double the price seen in the United States - but the winemaker says Kiwis should blame the taxman for the difference.

Two pictures of the 2012 sauvignon blanc were taken within 24 hours of each other by the NZ Herald.

One of the bottles was on sale in Mt Eden Countdown in Auckland for $25.99, while the other was on sale for US$11.99 - the equivalent of NZ$14.30 - at Eastport Liquors from Annapolis in the state of Maryland.

Eastport Liquors wine manager Glenn Norris said the wine was popular and he'd sold 40 cases in the past year. "I've got five bottles on the shelf left ... I can tell you for a little store like ours that's pretty darn good."

He was astonished by the New Zealand price. "Wow. I don't know why it would be any cheaper here than there, it doesn't make any sense to me."

He said his purchase price tended to float, although the worst-case retail scenario - including taxes - would be US$16, or $19.08.

Recall that excise in New Zealand for wine is $2.7609 per litre for wine up to 14% alcohol. So excise tax is $2.07 of a 750 mL bottle. GST is 15% of the total retail price including excise.

So a $26 bottle of wine is $22.61 ex-GST, and $20.54 ex-excise. That still has the NZ price more than 40% over the US price.

I'm not sure I'd "blame" the taxman on the GST component: New Zealand, rightly in my view, collects more of its revenues from a very broad-based GST, and consequently less from property and income tax. Stripping out the GST component has alcohol excise responsible for $2.07 of an $8.31 price difference: a quarter of it. I'm definitely not one of the folks that thinks excise on alcohol is too low. But it doesn't explain much of the noted price difference.

Where to lay the blame for the rest?

1. NZ supermarkets tend to run large temporary discounts on popular brands like Oyster Bay, and I'd bet that they shift most of their volumes of those products when they're on special - the everyday price then serves more to make the sale price look better and is only paid by suckers. And I'm pretty sure I've seen Oyster Bay on special around the $18 mark: $15.65 ex-GST, or $13.58 after also taking out excise. 
2. Oyster Bay potentially having contracted with a US wholesaler in $US terms when the Kiwi dollar was much lower than it now is: at a $0.74 exchange rate, that $12 US bottle would have been $16 NZD, not $14. 
3. Potential price discrimination across markets by the producer.
4. Generalised "Everything is more expensive in New Zealand" problems. 

I put the most weight on potential explanations 1 & 2.

Paying for roads

National has announced that petrol excise will increase for the coming three years. Some of my Twitter stream has been suggesting they're doing this to patch up the budget rather than to cover roading expenses. Can't it do both?

The most recent year-end financial statements, those for the year to June 2012, had the government receiving:

• Road user charges of $1,045 million
• Petrol fuels excise of $1,478 million ($847 million on domestic production; $631 million on excise-equivalent duties on imports)
• Motor vehicle fees of $175 million.

So about $2.7 billion in revenues for roads.

Vote.Transport in Budget 2012 had just under $3.4 billion for the National Land Transport Programme, of which a substantial portion was a loan from the Crown for cashflow management. A quick adding-up of the real expenditures on road related stuff looks like $2.6 billion in road spending - about what they collected in revenue. I expect that the loan that's on the books is for expenditures perhaps having been front-loaded during the year with excise dribbling in throughout the year, but perhaps somebody with more familiarity with the Crown Accounts can correct me if I have that one wrong. 

Simple cost inflation would require that petrol excise and road user charges increase if next year's roading expenditures are the same in real terms as they were this year. If the government has any plans on spending more on roads next year than it did this year, then excise has to go up by more than that. I note also that Note e of the Financial Statements, page 129, includes the following:

"Other earthquake costs do not include costs associated with the future repair of local roadways. This exclusion reflects that the first call for funding these future expenses will be from dedicated ring-fenced revenue in the form of road user charges, fuel excise duties, and registration fees paid to the New Zealand Land Transport Fund. Should the Government's share of the costs associated with the future repair of local roadways exceed the amount available from that ring-fenced revenue, the Government has a number of options to allocate future to this expense. The Crown's share of the costs for local roadways remains uncertain, as is the range of funding options available to the Government."

If the Crown's share of roading rebuild costs has increased, then petrol excise rising to cover it isn't crazy either.

A reasonable argument against the excise increases would be an alternative of issuing roading bonds to be paid off over a longer period of excise revenues, so the burden of current road construction is spread across future road users. And that would be reasonable for one-off shocks like the Christchurch earthquakes. But if every year we have to spend some amount to maintain the stock of existing roads, and some amount to build new roads to match population growth, and if the annual increases in the roading stock are roughly the same from year to year, then the annual burden should work out to being roughly the same under either regime.

I don't think there's sufficient evidence to conclude that National's ramping up petrol taxes as a deficit-fighting measure, except inasmuch as it allows the government to continue building roads without drawing on revenues coming from outside the National Land Transport Fund. But I suppose that next year's budget will reveal whether that's right. It would be rather disappointing if the government were using petrol charges to raise funds for other purposes, but I expect that will not turn out to be the case.

As for whether the Government will produce a surplus ... iPredict says there's a 15% chance for 2014/15.

Update: Liberty Scott posts something useful in the comments; I'm hoisting it up here. If the new roading expenditures are a one-off rather than part of an ongoing set of construction projects, then it really makes far more sense to use debt to finance them.  Here's Liberty Scott:

The fundamental problem is that the current capital expenditure on major roads is a one-off, as it really is a bunch of projects that have at best marginal economic benefit. There wont be equivalent major projects ever built again, so there is a major problem with the PAYGO funding system paying for capital the year it is built, even though that capital has a depreciated life (particularly if you consider earthworks and tunnels which largely never deteriorate) of 90 years +.

What should have been done is that the state should have borrowed for those projects and paid for them over many years, but MoT has been almost wilfully blind to this issue. What ought to happen in future is that there should be less long term spending on roads, because the network will largely be built out by the time all of the RoNS are finished.

Tobacco plain packaging, if we cared about evidence

The Science Media Centre provides an expert round-up of commentary on a new paper finding, unsurprisingly, that people like branded tobacco packs more than they like plain packs. What's more relevant for policy, and what we really have no clue about, is whether changing the branding on packages has effects on aggregate sales or whether it works instead to break brand loyalty and move consumers to lower-cost no-name packs. As Professor Richard Edwards noted in his plenary address to the Oceania Tobacco Control Conference in Brisbane last October:

Plain packs have not been implemented, so evidence of the probable population impact must come from experimental studies, focus groups, surveys and so on; rather than rigorous controlled studies of the impact of the actual intervention in the real setting, as would be the ideal.

If we cared about knowing whether tobacco plain packaging has any effect, we could find out pretty easily. Set the whole thing up as a randomized policy trial. Some parts of the country get plain packs, some parts don't, and watch what happens over the subsequent few years. I'd sketched out a framework for that kind of trial back in April. Even better: if Australia is implementing the same policy, run the trial across both countries.

Instead, we're designing policy to avoid ever being able to find out whether it's had any effect. In Oz, they're bundling plain packaging with a simultaneous national increase in tobacco excise taxes. The effects of price increases will be hopelessly confounded with the effects of plain packaging unless there's reasonable ex ante state level variation in tobacco prices.

The price of cigarettes would rise to $20 a pack under a Gillard Government proposal that would reap an extra $1.25 billion a year in taxes.

The West Australian understands the Government is considering a 25 per cent rise in tobacco excise that would raise $5 billion over four years.

The plan emerged from a Treas- ury reconsideration of so-called "sin" taxes. It would repeat the financial windfall from an identical move in 2010.

The proposal is in line with long-standing advice from the National Preventative Health Taskforce and would lift the price of a pack of 30 cigarettes by $2.62.

Peter Jackson 30s, now about $18.30, would cost almost $21 under the measure and the price of Dunhill 25s would increase $2.18, taking the retail price to more than $19.50.

The excise increase may be timed to coincide with the introduction of mandatory plain-packaging for tobacco products on December 1. [emphasis added]

International research has found there is a 4 per cent fall in smoking rates for every 10 per cent increase in price. Anti-smoking crusader and Curtin University Professor Mike Daube said higher cigarette prices would discourage children and people on low incomes from smoking. "An excise increase sooner rather than later could also prevent tobacco industry efforts to subvert the impact of plain packaging by lowering prices," he said.

There are non-crazy reasons for wanting to bundle excise increases with plain packaging. If, absent brands, smokers see there being less difference between low cost off-brand cigarettes and higher cost branded cigarettes, they may substitute down to the lower cost cigarettes and then smoke more - I expect this is the main worry of the tobacco industry as they make their returns on the branded product. Consumption goes up but margins go down more than proportionately. Countering this with excise increases isn't entirely nuts if you want to curb smoking rates, but it makes it awfully hard to tell whether plain packaging does anything other than destroy the value of the tobacco companies' brands.

I still think a randomized policy trial is what's needed if we care about finding out truth rather than just beating up on Big Tobacco.

Tobacco excise incidence

The latest paper by Callison and Kaestner* makes me a bit more worried about the incidence of Tariana Turia's proposed excise increases. Recall that the MoH is modelling things using a fairly high estimate of price elasticity of demand. At paragraph 55 here, MoH says:

the price elasticity of demand (ie. the extent to which each percentage increase in the tobacco price causes consumption to fall) - current estimates are that each 10% rise in tobacco prices will engender about a 4-5% drop in tobacco consumption, but based on recent Treasury revenue returns and behavioural research by Auckland University, there is emerging evidence that price responsiveness may be increasing.

Presumably the -0.4 to -0.5 elasticity estimate is what they had NZIER use in their analysis; MoH seems to be suggesting this is a lower bound.

Callison and Kaestner start by surveying the existing literature.  My clipping from their survey:**

• Lewit and Coate (1982): adult smoking participation elasticity (age 35+) of -0.15; younger smokers more elastic.
• Evans and Farrelly (1998); Farrelly et al (2001): same dataset as above; younger smokers respond to price changes; adults aged 40+ not responsive.
• Wasserman (1991): Adult participation elasticity -0.17 in 1985.
• Ohsfeldt (1998): Participation tax elasticity for teen and young adult males of -0.15 to -0.22, but only -0.07 for males over age 45.
• Tauras (2006): Same dataset as Ohsfeldt but more recent years' coverage: participation elasticity among adults 18+ of -0.12.
• DeCicca and McLeod (2008): Post-2001 data. Participation elasticity of -0.3 for 45-59 year olds and -0.2 for 45-64 year olds. 
• Gallet and List (2003): A survey of existing elasticity estimates giving a price elasticity of demand (I read this as combination of participation and intensity elasticity) of -0.32 for adults aged over 24.

When O'Dea ran his analysis, he used a price elasticity of demand of -0.5 and a participation elasticity of -0.2. 

Callison and Kaestner use a difference-in-difference method comparing smoking prevalence in states with large excise increases with those in states that didn't increase taxes. Among adults, they found participation and price elasticities of demand on the order of -0.02 to -0.05: a 10% tax increase reduces consumption by -0.5% or less, not 2% and not 5%. They write:

Considering all the evidence, we conclude that there is insufficient justification for the widespread belief that raising cigarette taxes will significantly reduce cigarette consumption among adults, even young adults. Our evidence suggests that, at best, increases in cigarette taxes will be associated with a small decrease in cigarette consumption and that it will take very sizeable tax increases, on the order of 100%, to decrease smoking by as much as 5%.

Maybe that's why the Australian Treasury modelled tobacco excise revenues on the assumption that excise revenues will be increasing.

Recall that, on an assumption of a -0.2 participation elasticity, O'Dea reckoned that, for a 20% price increase, 129,200 households in the bottom four deciles that continued to smoke would suffer losses of $396 per household; these were balanced by gains to 5,400 quitting households of $2,988 per household in cash savings (no accounting for reduced consumption benefits for those who enjoyed smoking) plus 2 Quality Adjusted Life-Years in each household. They value a QALY at $50k. So losses to non-quitting households for the 20% tax increase total $51.2 million while gains to quitting households total $16.1 million plus $540 million in QALY benefits. 

Callison and Kaestner say that the participation elasticity isn't -0.2, it's -0.05 to -0.02. What happens if you simply halve O'Dea's participation elasticity estimate to -0.1? Then half as many households quit: we have 2700 quitting households (in the bottom 4 deciles) enjoying aggregate cost savings of $8 million  plus $270m in QALY against 131,900 non-quitting households paying an extra $52.2 million in tax. If we go all the way to the -0.02 estimate, then a tenth as many households quit: 540 quitting households gain a total of $55.6 million (including QALY) and 134,060 non-quitting households suffer aggregate losses of $53.1 million.

The O'Dea numbers are calibrated around a 20% price increase from 2005 prices and prevalence levels that then obtained; MoH has been talking about excise increases well in excess of that. I'd be nervous about applying the Callison and Kaestner estimates to New Zealand as total prices here are well in excess of anything they'd have in the US data. On the other hand, non difference-in-difference estimates from the US aren't crazily out of the ballpark on participation elasticities: O'Dea was using -0.2, which is well in line with the US studies that used somewhat less sophisticated techniques. 

Note as well that if reduced effective income hurts QALY measures, then we perhaps need to add QALY costs on the non-quitting side as the poorest households effectively get poorer. 

Another cool bit of the Callison and Kaestner paper: they use only MSA data and correct for distance to nearest lower-tax jurisdiction to try to correct for leakage from smuggled product - the find little effect on their estimates from cross-border purchases. But if it is the case that smuggling rings are a bit more organized and folks with semi-loads of smokes from lower-tax jurisdictions don't much care whether they're driving 50 miles or 250 miles, then smuggling might still confound their measure: it probably well captures individuals' decreased likelihood to drive out of state to get smokes, but it might not catch organized groups handling the transport. As each state has its own particular tax stamp for cigarette packets, such opportunities may be limited. 

If New Zealand goes ahead with very large tobacco excise increases, the government might consider some offsetting income tax cuts for lower decile groups. Callison and Kaestner didn't split their sample by income decile rather than just by age group to see whether price responsiveness varied by income; price elasticities split by income could be important in assessing overall incidence of the NZ changes. But as smoking is fairly concentrated among lower decile groups, overall estimates likely aren't far from estimates restricted to lower decile groups. 

It could also be fun to have iPredict run markets on aggregate tobacco excise revenues over the next few years. 

* Previously noted here.

** Note that the participation elasticity is the percent change in the proportion of the sample who report smoking given a percent change in the price. So if a 10% price increase is associated with 5% of the sample quitting, the participation elasticity would be -0.5. MoH above is using a total consumption elasticity that combines those quitting with reductions in smoking among those who don't quit entirely. Callison and Kaestner also list some of the smoking intensity elasticities: the percentage change in the amount that you smoke (conditional on your smoking) given a percentage change in price. These values are usually about half of reported participation elasticities.