Friday, April 17, 2009

Alcopops again

The Federal Government is planning to introduce legislation into Parliament to restore the alcopops excise at the higher rate.

Putting both the politics and the process of the plan to one side, while I have already posted on the absence of any justification for taxing premixed drinks at a different rate to other spirits, a post this month at Angry Bear provides further food for thought.

It is useful to characterise the findings from analytical models on taxes on externality generating activities in terms of three distinct effects on economic welfare: the"primary welfare gain", a "revenue-recycling effect", and a "tax-interaction effect. The first is simply the familiar net (of costs) partial-equilibrium benefits from the reduction in alcohol related harm. In the presence of pre-existing tax distortions, the revenues that are raised by such taxes can be used to reduce the rates on existing distorting taxes (such as taxes on labour). Hence, there is a second source of welfare gain: the revenue recycling effect. The gain comes from the small reduction in the wedge between the gross and net wage with a resulting increase in the level of employment. The third effect, however, discourages work effort by reducing the real wage. This tax interaction effect reduces welfare.

The effect of the alcopos tax on economic welfare thus depends on the net impact of these three effects. Given that many of those who consume alcopops may not be in the workforce, the optimal tax on alcopops may be somewhat more that the marginal external damages from consumption, depending upon the way in which the revenues are recycled and the degree of substitution between alcopops and other externality generating goods.

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