"Economic Issues in Alcohol Taxation"

Full Reference:  Stephen Smith (2005) "Economic Issues in Alcohol Taxation", in Sijbren Cnossen (ed) (2005) Theory and Practice of Excise Taxation. Smoking, Drinking, Gambling, Polluting and Driving. Oxford: Oxford University Press. ISBN 0 199278598, pp 61-87.


There is considerable diversity across European Union (EU) member states in the taxation of alcoholic drinks. All apply excise taxes, in addition to value added tax (VAT), to at least some categories of alcoholic drink, but the scale of these taxes varies widely. In the Scandinavian member states, Ireland, and the UK, alcoholic drinks are particularly heavily taxed, and alcohol taxes are a significant source of public revenues, contributing over 100 in tax revenue per head of population. Elsewhere in the Community, alcohol taxes are lower, and in the Mediterranean EU countries, alcohol taxes are, in the main, of trivial economic and revenue significance.

This chapter reviews the range of arguments that could justify taxing alcohol at higher rates than other commodities. Alcohol demand is insufficiently price-inelastic to warrant higher-than-average taxation on the basis of the Ramsey inverse-elasticity rule. While short-run price elasticities for alcohol may be quite low, demand is more price-elastic in the long run (this pattern reflecting the addictive nature of alcohol over-consumption). Likewise, there do not seem to be strong grounds for taxing alcohol heavily as a leisure complement (the Corlett-and-Hague argument). The relationship between demands for alcohol and leisure is likely to be complex, and it is unclear that alcohol is a good that is uniformly complementary with leisure.

The main justification for levying additional excise taxes on alcohol, over and above standard VAT, lies in the role that alcohol tax can play in reducing the externalities associated with alcohol consumption (and, especially, abusive over-consumption). Using alcohol taxes for this purpose involves targeting the incentive somewhat imprecisely to the underlying externality, since alcohol externalities are not proportional to alcohol consumption but are largely confined to abusive over-consumption by a subset of all consumers. Externality taxation of alcohol thus involves a compromise between the potential gains from reducing external costs of abusive consumption and the welfare costs of discouraging non-abusive consumption.

The external costs of alcohol consumption are likely to be heavily affected both by the institutional arrangements for financing healthcare, pensions, and so on, and by the cultural context in which alcohol is consumed. It is therefore unlikely that US estimates can be carried over without modification to the European context, or that externalities will be uniform throughout Europe. Because healthcare in many European countries is financed through taxation, or through contributions that have much of the character of taxes, and because European countries have more-significant tax-funded pensions and higher levels of income taxation, some of the major items in US calculations of alcohol externalities would be different in Europe. A study for the UK by Maynard, Godfrey and Hardman (1994) estimates the annual external costs of alcohol consumption to be around 2.7 billion, or some 17 per cent of the value of pre-tax consumer expenditure on alcohol. It is unlikely that this result can be straightforwardly extrapolated to other European countries because of significant social differences in how alcohol is used in different parts of the EU. There is clearly a need for further systematic and comparative research on alcohol externalities in European countries.

Some of the US literature has observed that alcohol taxes are regressively distributed with respect to current household income and significantly less regressive from a lifetime perspective. Further evidence is also needed on this for European countries. At least, however, alcohol taxation does not appear to be so regressively distributed as tobacco taxes, and therefore distributional concerns may not be a major constraint on European alcohol tax policies.

Because of the differences across European countries in alcohol consumption patterns and probably external costs of alcohol consumption, it is unlikely that the optimal tax treatment of alcoholic drinks will be identical in all members of the EU. Imposing greater uniformity on the very diverse pattern of EU alcohol taxation may thus involve some economic inefficiency (as well as some limitations on national fiscal sovereignty). Nevertheless, narrowing differences in alcohol taxes between EU member states would reduce the economic and fiscal costs associated with legal cross-border shopping and with the various forms of illegal smuggling and tax evasion that are encouraged by significant tax differences. The most appropriate form for such EU fiscal coordination to take would be through significant increases in the agreed EU-wide floors to alcohol taxes. There is no obvious Community-wide reason to prevent member states setting higher duty levels than those elsewhere.

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