Effects of Changes in Alcohol Prices and Taxes Effects of Changes in Alcohol Prices and Taxes Alcohol research is carried out from a variety of this section does not contain a comprehensive disciplinary backgrounds and perspectives. From review of earlier research on these topics (such an economic perspective, alcoholic beverages are reviews can be found in Chaloupka 1993; consumer goods, and therefore what is known Chaloupka et al. 1998; Cook and Moore 1993a; about consumer behavior in general is likely to Kenkel and Manning 1996; Leung and Phelps provide insights into alcohol consumption in 1993). In addition, although this section is particular. Perhaps the most basic prediction limited to studies of alcohol prices and taxes, from the economic model of consumer behavior economic research has made other important is that, other things being equal, consumer contributions to the field of alcohol research. demand for a given good falls when the price These include studies of the effect of advertising of that good rises. A large body of research shows on alcohol demand (Saffer 1996); the geographic that this “law of demand” holds for alcoholic relationships between outlet density, alcohol beverages. This means that excise taxes and other availability, and alcohol-related problem rates public policies that affect the price of alcohol can (Gruenewald et al. 1996); the effect of raising influence the demand for alcohol. legal drinking ages on traffic fatalities (Wagenaar 1993); the effects of macroeconomic conditions Because excessive consumption of alcohol has on alcohol consumption and drinking and adverse consequences for health and safety, the driving (Ruhm 1995, 1996); and the relationship consumer response to changes in alcoholic bever- between alcohol consumption and earnings age prices is an especially important topic for (French and Zarkin 1995; Kenkel and Ribar investigation. One research approach, pioneered 1994; Mullahy and Sindelar 1993). in the early 1980’s (Cook 1981; Cook and Tauchen 1982), is to examine the direct relation- Public Policies and Alcohol Prices ships between alcohol tax rates and such public health outcomes as traffic fatalities and cirrhosis Public policies can affect alcoholic beverage of the liver. An alternative approach is to prices in several ways. One is that national, examine the linkages through which an alcohol State, and local governments impose excise taxes tax increase might reduce alcohol-related prob- on alcoholic beverages. An excise tax is based on lems. Taking this approach leads to questions the quantity of alcoholic beverage purchased, in such as: How much does the consumption of contrast to a sales tax, which is based on the price alcoholic beverages fall when prices increase? of a purchased good. Current Federal excise tax Do persons who drink heavily respond as much rates are $0.58 per gallon for beer, between $1.07 to price changes as lighter drinkers do? Do and $3.40 per gallon for wine (depending on the college students and young adults respond as type), and $13.50 per proof gallon of distilled much to price changes as other adults do? The spirits (a “proof gallon” is the amount of liquid two approaches complement each other and that contains one-half gallon of pure alcohol). provide a richer and more complete under- These rates translate into taxes of about 10 cents standing of the nature of price and tax effects. for each ounce of pure alcohol in beer, 7 cents in wine, and 21 cents in spirits. This section reviews recent economic research on the relationship between alcohol prices or taxes The excise tax rate is an important factor, but and alcohol consumption and related problems. not the only factor, in determining the price of Because the focus is on recent research findings, alcoholic beverages. An important variable is the 341 Chapter 6: Economic and Health Services Perspectives extent to which increases in excise taxes are passed resulting significant change in beer consumption. along to consumers as opposed to being absorbed It may be that the existence of exclusive territories by firms. For competitive industries with con- encourages dealer-level promotional activities stant average costs of production, economists (which tend to increase consumption) but also expect taxes to be fully passed through to limits competition, which raises prices (and consumers—a 1-cent tax increase would result tends to decrease consumption). This example in a 1-cent price increase. This may not apply to illustrates a more general point that a given policy business sectors in which competition is limited, can have multiple effects on alcoholic beverage which some authors have suggested is the case markets. for alcoholic beverages (Cook and Moore 1993b). In such industries, a 1-cent increase in taxes may When evaluating alcohol price and tax policies, increase prices, but by less than or more than it is important to consider the context provided 1 cent. In addition, an excise tax may be passed by private market forces, other public policies, to customers at different rates depending upon and general economic conditions. For example, where the purchase is made, as the price of the alcohol excise tax rates are not routinely increased same beverage can differ widely within a given to compensate for the effects of inflation. As a geographic area even though the tax rates are result, the “real” (that is, inflation-adjusted) tax the same (Treno et al. 1993). It is difficult to rates have declined over most of the postwar quantify the relationship between taxes and period, except for the significant tax increase that prices for alcoholic beverages because, to date, took effect in 1991. This erosion of real tax rates little research has been conducted on the topic. has contributed to overall declines in real beverage prices over time (figure 1). Some States exercise more direct influence over alcoholic beverage prices by maintaining mo- Alcohol Prices, Taxes, and Consumption nopoly control over the retail and wholesale sale of alcoholic beverages, usually covering distilled Although there is a consensus among researchers beverages and sometimes wine as well. Retail that higher alcoholic beverage prices and taxes monopolies generally control sales for off-premise result in less drinking and fewer drinking-related consumption, while wholesale monopoly opera- problems, the precise magnitude of consumer tions often serve as the exclusive source of supply response to price or tax changes has been for outlets with on-premise consumption. Where somewhat harder to determine. Economists State retailing monopolies exist, the prices of measure consumer response to price changes by alcoholic beverages are under direct government computing the “price elasticity,” defined as the control. Limited evidence suggests that alcoholic percentage change in the quantity demanded beverage prices have, on average, been about the that results from a 1-percent change in price same or only slightly higher in States with (see the box on page 344). monopoly control (Nelson 1990) and that privatization has sometimes, but not always, Price changes seem to affect the demand for resulted in lower prices (MacDonald 1986). beer less than they do the demands for wine and spirits. A 1993 review of 15 studies that Public policies can also indirectly affect alcohol used State and national consumption data found prices by making alcoholic beverage markets more that every 1-percent increase in price translated or less competitive in other ways. For example, to a 0.3-percent decrease in demand for beer, in the beer industry, 24 States have exclusive- a 1.0-percent decrease in demand for wine, and territory mandates that require brewers to have a 1.5-percent decrease in demand for spirits only one distributor marketing their products (Leung and Phelps 1993). Thus, this study within a given area (Sass and Saurman 1993). supported benchmark price elasticities of –0.3 Researchers have estimated that these mandates for beer, –1.0 for wine, and –1.5 for spirits. raise retail beer prices, but they have found no 342 Effects of Changes in Alcohol Prices and Taxes Figure 1: Inflation-adjusted alcoholic beverage prices, 1978–1998 130 120 Federal excise tax increase M 110 100 Index of real beverage prices (1991 = 100.0) Index 90 80 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 Year Beer Wine Spirits Source: Calculated from Consumer Price Index data, not seasonally adjusted, for all items: beer, ale, and other malt beverages at home; distilled wine at home; and spirits at home. Data obtained from the Bureau of Labor Statistics web site (http://stats.bls.gov/sahome.html) December 1999. A more recent study provided evidence that alco- also has been declining over most of the same hol demand may not respond as much to price period (figure 2). These trends seem to contradict changes as previously thought (Nelson 1997). the law of demand, which predicts that falling The researcher analyzed data from a number of prices will lead to higher consumption, other sources, including quarterly data from 1974 things being equal. through 1990 on per capita consumption, real income, real alcohol prices, and the age composi- As Nelson’s analysis revealed, however, other tion of the U.S. population. The study found things were not equal; important determinants relatively unresponsive price elasticities of –0.16 of alcohol consumption changed over the time for beer, –0.58 for wine, and –0.39 for spirits, period studied. Specifically, the study showed with an overall price elasticity of –0.52. that the demographic shift to an older population—which consumes less alcohol— The analysis also provided an explanation of what outweighed the impact of falling real prices. might appear to be a puzzling feature of general Other factors, such as a shift to healthier lifestyles, trends in U.S. alcohol consumption and prices.