Pigovian taxes and minimum pricing

Excessive alcohol consumption is associated with many deleterious effects on individual health.  Its negative impact on wider society includes crime (including domestic violence), drunk driving, sexual assault, unnecessary hospital admissions, excessive demands on policing, and workplace absenteeism. The coalition’s policy on tackling alcohol abuse includes banning below-cost alcohol, removing problem-causing licensees, raising the cost of late-night licences, and doubling fines for selling to under-age consumers.

In a new article in Economic Affairs, we examine the argument that setting minimum prices for alcohol improves public health and decreases public health care costs. Our analysis focuses on binge drinking observed on weekends, when large numbers of young people drink heavily in cities and towns. Binge drinking is defined as men consuming more than eight units of alcohol and women more than six units in a day. Excessive alcohol consumption in the home, some of which may qualify as binge drinking as defined, is addressed as our second concern.

Economic theory indicates that the most appropriate way to allow citizens to acquire goods is by the market. However, alcohol may deviate from an efficient market when externalities exist whereby irresponsible drinkers impose costs on others. Setting a minimum price per unit of alcohol is intended to increase price and thereby reduce consumption and harmful health effects and other behaviours injurious to others. Standard economic theory calls for external costs to be ‘internalised’ through Pigovian-style taxes that raise prices and lower consumption towards efficient levels.

Our paper argues that minimum pricing advocates fail to answer two critical questions regarding their scheme. Firstly, they fail to discuss whether current tax rates are above, below or equal to ‘correct’ Pigovian taxes on alcohol consumption. Secondly, advocates do not explain why they don’t support tax increases – an especially curious omission given research demonstrating that alcohol taxes are mostly passed fully to consumers in higher prices, especially for young adults. Ignoring these two issues leads us to wonder whether advocates do not understand the standard theory of externalities or simply have other motives in mind.

The paper also delves into issues surrounding several obvious unintended consequences of minimum alcohol pricing. One is why it is appropriate to tax responsible drinkers. Another is why lower-income drinkers should bear much of the burden of taxation. Other adverse consequences that deserve discussion are substitution into cheaper alcohol, illicit alcohol, or illegal drugs – and the fostering of criminal activity that survives on the many incentives created for circumventing taxes.

We develop a dynamic model whereby a minimum price placed in a ‘lowbrow’ market fosters demand increases in the ‘midbrow’ and the ‘highbrow’ markets. The implication is that, while consumption in the targeted lowbrow market falls, consumption rises in the other markets, thus indicating an ambiguous effect on overall consumption as well on the degree to which negative externalities are internalised.

In sum, our article identifies a wide range of issues that proponents of minimum pricing of alcohol must resolve before they can safely claim that their proposal promotes public health. Problems range from our inability to know the ‘correct‘ price and why it makes sense to tack minimum pricing regulations on to markets that are already taxed, to various unintended adverse consequences on citizens such as generating higher demand in substitute markets in illegal drugs and alcohol. Media distortions and misinformation by health pressure lobbies promote these unintended consequences. Indeed, the growing problem of illegally produced alcohol in the UK has been highlighted by editors of the British Medical Journal.

The Economics of Minimum Pricing for Alcohol’ appears in the June 2013 issue of Economic Affairs.