The DFL caucus in the Minnesota House has issued tax proposals intended to close a pending budget deficit and repay $854 million “borrowed” from the state’s school districts, among other things.
The proposal includes substantial increases in taxes on alcoholic beverages and a more-than-doubling of cigarette taxes. It also includes other measures. However, the tobacco and alcohol taxes have the most interesting economics because they account for $789 million of the projected $2.6 billion in additional revenue.
News reports refer to these as “sin taxes,” although that is a term economists would not use. Such taxes date back centuries and largely were introduced for pragmatic reasons, such as ease of collection, rather than for moral reasons.
Arguments about these taxes had to wait until British economist Arthur Pigou’s work 90 years ago on reducing the economic inefficiency that inevitably occurs when external costs are not controlled.
External costs are those borne by society, but not directly by either the producer-seller or the buyer-consumer. Pollution is a common example. External costs like pollution often are thought of as unfair, since they hurt third parties, but, at least as importantly, they cause resources to be wasted and society ends up with fewer goods and services to meet people’s needs from the same use of resources.
Pigou argued that the optimal way to halt waste caused by such “market failure” was to impose a tax on the product activity producing the external cost, or harm to others, equal to the amount of that external cost. That way, the purchaser of the good or service would face its full cost to society when deciding whether to buy it or not. This would not reduce production of such harmful goods to zero, but it would restore efficient use of resources.
Both smoking and drinking produce pleasure for some people and both have external costs.
The greatest harm caused by inhaled tobacco is to users themselves in terms of lung cancer and other smoking-induced diseases. There is harm to third parties who inhale secondhand smoke, including family members, but these damages are small compared to those incurred by smokers themselves. So the scope for restoration of economic efficiency via Pigou’s tax theory is limited.
More importantly, because of the way we socialize medical spending via insurance or tax-supported programs like Medicare and Medicaid, the costs of treating both drinking- and smoking-induced diseases effectively becomes an external cost to those paying premiums or taxes.
The health-care costs of smokers themselves would be “internalized” in a free market that did not have government-paid health care and that allowed insurance companies to charge sharply higher premiums to drinkers and smokers.
All this aside, the external costs to society as a whole of alcohol consumption are now many times higher than that of tobacco.
There is a plethora of studies of costs going back 30 years showing annual social costs of about $5 billion in 2011 dollars.
That was the amount found in a 2012 Minnesota Department of Health study. Adjusted for inflation, it is about the same as other studies done in 1995 and 1983.
This is about 17 times the amount collected in alcohol taxes, so current levels are far from meeting Pigou’s recommendation. Doubling the taxes, as proposed by the DFL, still would leave a large gap.
However, alcohol-related externalities differ from externalities like pollution, in that the harm is not linear. Someone drinking a beer or two a week may cause zero external costs for society. Someone getting plastered every other night may create enormous costs. Why, some would argue, should a majority of moderate drinkers pay a tax when the majority of damage is caused by a minority of the population who drink a lot?
One answer is that moderate drinkers pay very little in tax. I drink about a beer a week, on average. My wife doesn’t drink at all, but we occasionally buy a bottle of wine when having guests. The proposed increase will cost us somewhere between $6 and $10 per year. We may lean toward the abstemious end of the scale, but, given the skewed pattern of little alcohol use by many and heavy use by a few, a large majority of households would probably pay less than $50 additional a year.
Alcohol taxes are not indexed for inflation and were last raised in 1985. The general consumer price index has increased by a factor of 2.17 since then, so the proposed overall increase still would leave the overall inflation-adjusted tax levels a bit below what it was when last raised.
However, the increase on beer is much sharper, from $4.60 to $27.72 per 31-gallon barrel.
On a per-12-ounce bottle basis, it goes from 1.4 cents to 8.4 cents per bottle.) Adjusted for inflation, this brings it back up toward where it was in 1934, when first instituted. Then it was $2 per 31-gallon barrel. In 2013 dollars, that would be $34.75 or over 25 percent above the proposed the new level over seven times the existing one.
Brewers and distributors argue, somewhat confusedly, both that the higher tax would be a burden on them and that customers would see much higher increases than the nominal 7 cents per beer, because everyone in the distribution chain would not only pass the tax along but also add their usual markup. To the extent that the tax gets passed to consumers, as it does almost entirely, for alcohol taxes, it does not hurt the producers or distributors. And studies show that, over time, competitive forces keep consumer price increases pretty much to the level of the tax change.
Furthermore, with major population centers near the Wisconsin border, Minnesota always has to consider its competitive position relative to that state. Beer is the lifeblood of Wisconsin, and its liquor taxes already are below Minnesota’s before the proposed increase.
Most people would not drive to Wisconsin because of higher Minnesota taxes, but hard drinkers, especially those who do most of their drinking at home, might. The degree to which this would happen is hard to estimate.
Of course, the general level of taxation always is an issue.
However, the “Minnesota price of government,” that shows the combined revenue of state and local government relative to personal income is at 15.5 percent, about 2 percentage points lower than 20 year ago.