Title: Socially Optimal Taxation of Bads Corresponding author: Karel Janda
Faculty of Finance and Accounting, University of Economics, Prague,
Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, and CERGE-EI.
Address for correspondence: Department of Banking and Insurance, Faculty of Finance and Accounting, University of Economics, Prague W. Churchilla 4 130 67 Prague, Czech Republic Tel.:(+420) 22409 5188 Fax: (+420) 222 112 304 E-mail: Karel-Janda@seznam.cz Co-author: Jakub Mikolášek
Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague.
Acknowledgement: The work on this paper was supported by the Czech Science Foundation, grant number 402/09/0380, Grant Agency of Charles University, grant number 114309, and by the research project MSM0021620841.
Abstract
This study analyzes the possibility of taxation of commodities, which are considered socially undesirable. We provide a general economic optimization model which may be used in such a situation and we apply this model to the analysis of effects of beer consumption on consumers and the society as a whole. We provide a description of possible costs and benefits connected with beer production and consumption. We show that both tangible and intangible costs of beer consumption to the society seem to outweigh production benefits. In order to provide a quantitative recommendation for possible increase of beer taxation we consider the beer consumption by abusers and non-abusers. We find that in order to maximize the welfare of society government should take such measures, which would raise average beer price by from 3.5% to 36%, depending on our assumptions on behavior of beer abusers and non-abusers.
Keywords
Bads, Price Elasticity, Social Costs, Tax. JEL classification: D12, H21, I18, L66
1 Introduction
Since the Czech Republic is one of the leading world’s beer producers and exporters, we will consider beer as an example of socially undesirable commodity in our paper. The analysis of real world “bads” like beer is in reality much more complex than a classical textbook treatment of “bads.” The added complexity of the consumption of these commodities is that besides obvious negative social and individual effects they have some positive effects as well. Actually some of these positive effects are primary reasons leading to their consumption. For Czech consumers, beer has also a very special position among other commodities, which is reflected by the fact, that Czech Republic is the world’s leader in per head beer consumption. Our analytical approach which we apply to beer consumption could be easily used for analysis of other “bads” like other alcoholic beverages or cigarettes.
This study offers a simplified microeconomic model on calculation of optimal (meaning society-welfare maximizing) tax on beer production. While doing so, we have taken similar approach as Pogue and Sgontz (1989)1). Taking some assumptions on beer consumers’ behavior and dividing them into two groups, abusers and non-abusers2), we will try to
propose such level of beer prices, which would maximize welfare of Czech society.
2 Social costs and benefits of beer production and
consumption
Modern national governments must take into account both revenues and costs of alcohol consumption. Strength of voices calling for or against restrictions on alcohol production will be derived from two factors – the importance of beverage industry to the economy and the extent of alcohol consumption (or even abuse) in the society. If there is a large export oriented beverage industry together with low level of alcohol consumption in the country, arguments emphasizing the revenues and positive impact on employment would outweigh those calling for more restrictions. On the other hand, countries with minor importance of local brewing industry but high level of alcohol consumption could prefer to take some measures lowering the social problems and costs connected with alcohol abuse. This reasoning needs not to be applied for alcohol in general, but it can be used for analysis of particular alcoholic drinks separately. However, in most of the countries, the magnitude of Alcohol beverage industry is tightly connected to the level of domestic alcohol consumption. For beer, this statement holds even stronger, if we bear in mind that beer is a highly “national product”. And thus local governments face a difficult task, while assessing the impact of their policies.
As concerning Czech Republic and beer, local government faces just the last situation mentioned above. Brewing industry is an important pert of national economy, employing about 8 600 people directly and another 64 000 indirectly, which means respectively 0.19% and 1.4% of Czech labor-force. On the other hand, beer annual consumption reached 158.5 liters per person in 2007. We could argue that this means approximately one serving of beer3)
per day. However, this logic is false since we include even children, pregnant women and abstinent persons, who are likely not to drink beer at all. However, about 20 liters of the
1) Referenced also by Cnossen (2007). 2) For more detailed description see section 4. 3) In Czech context,
yearly per-head count are in reality consumed by tourists and other foreigners4). Excluding these from the averaging process, we estimated the real average of 200.7 liters. Comparison of data for beer with total alcohol consumption (Hampl 2003) shows that beer counts for about 57.7% of ethanol consumed in Czech Republic5). Beer production is therefore both
important for Czech economy and likely to induce come costs to the society as beer consumption is very high. Let us now analyze those possible costs in detail.
2.1 Social Costs of Beer Production
Alcohol consumption might bring many problems both for the individual user and for the society as a whole. Medical research confirmed strong connection between alcohol and various diseases and health complications (see for example Nešpor 2003, Grant and Hartford 1991) and some of them are even treated as caused by alcohol consumption. Alcohol is also proven to increase the rate of injuries in the society.
According to the estimates by Institute of Alcohol studies (Anderson and Baumberg 2006), we could estimate medical expenditures connected to treatment of alcohol related health problems as CZK 5.5 bill. This estimate includes costs of treatment of common alcohol caused diseased and costs of treatment of alcoholism itself.
For estimation of beer abuse costs we used a two-step method. First, we calculated estimate of alcohol abuse costs for Czech Republic. Data on material damages of alcohol-influenced car crashes were the only available from Czech statistics. For the rest of costs, adjusted European average data (Baumberg and Anderson, 2006) have been used. Values for Czech Republic were obtained by multiplying European data with ratio of Czech inhabitants in EU (2.09%), ratio between average Czech and EU alcohol consumption (116%) the 2006 mid year exchange rate EUR/CZK (27.495, Source: Czech National Bank) and a conversion factor – ratio of CZ/EU productivity of labor ratio (49.6%, source: Eurostat) for the productivity parameters and purchasing price parity ratio (79.3%, source: Eurostat). In the second step we used ratio of the ethanol content in total beer consumption on overall ethanol consumption (57.7%, source: CSO, CBMA 2007) to attribute appropriate costs to beer itself.
No normative judgment has been made on degree of “dangerousness” of beer. There are arguments supporting both sides of the dispute. Beer often accompanies main meals which could be hardly treated as abusive drinking. Its low alcohol content also prevents getting drunk by it too quickly. On the other hand, beer is the most popular alcoholic drink in the under-aged population, where it could do serious damages. Furthermore, beer consumption is largely connected to smoking or at least long staying in places full of smoke, which could result in serious health complications. Moreover, just the low alcohol content may result in underestimating of beer influence over ones behavior and thus in serious injuries for example in car crashes. As concerning the intangible costs to families, lower alcohol content of beer and thus possible lower dangerousness of beer could be offset by longer periods, in which the abuser would stay in the pub instead of staying at home.
Moreover, alcohol abuse causes a significant loss of productivity because of either increased absence at work or simple loss of work effectiveness while influenced by alcohol consumption. Given the same reasoning as in previous estimate, we calculate these cost for Czech Republic are approximately CZK 2.2 bill. Loss of production caused by earlier death is estimated to CZK 4.2 bill. Other tangible costs may concern alcohol-originated criminality, as
4) Source: CBMA (2007).
5) This result includes research by Hampl (2003) and Csémy & Sovinová (2003), who agrees on stable Czech consumption of 10 liters per person. Average beer consumption of 138.1 liters per Czech person has been computed using official CSO data and CBMA estimates of consumption by tourists. For the calculation of an average volume of ethanol in beer, average values of 3.8% for mild and 4.75% for lager and special beer have been used.
there is approximately CZK 4.6 bill spent in law, police and jailing costs, CZK 0.4 bill in crime prevention and insurance. This does not include car insurance, which is incorporated in CZK 0.49 bill damages due to car accidents caused or influenced by alcohol.
Besides above mentioned expenditures, there are also less tangible costs of alcohol consumption. Abuse of alcohol may negatively influence the social neighborhood of the abuser. Using results by Anderson and Baumberg, we could estimate the intangible costs caused by Czech alcoholics to their families (divorces, neglect of education etc.) by CZK 21.1 bill. Last but not least it is worth mentioning an interesting issue of relation between beer drinking and smoking. It is broadly accepted in academic literature (Rajeev and Morey 1995) that for not negligible part of population drinking of beer may increase their desire for cigarette. However, it is extremely difficult to evaluate this relation as the causality may be also reversed (the thirst after the cigarette).
In above mentioned estimates, we could not avoid large generalization and it is legitimate to assume that our estimates would be largely inaccurate, as we needed to use average European data as a basis of the calculation in those areas, where appropriate Czech data are not available. However, now we face another analytical problem as we want to identify that part of alcohol abuse costs which is attributed solely to beer. According to Hampl (2003) best guess estimate should be somehow based on content of pure alcohol consumed in form of beer and total pure alcohol consumed, which is estimated to 57.7%
However, we would need to evaluate certain normative issues concerning the difference between impact of beer and other alcohol beverages consumption. For summary see table 1.
Table 1
Estimated Costs of Beer Consumption in Czech Republic
Costs Costs in bill CZK
Medical Expenditures 5.47
Loss of Productivity 3.84
Loss of Productivity (deaths) 4.20
Police and Law Costs 4.55
Prevention and Insurance 0.36
Car Accidents 0.49
Total Tangible Costs 17.29
Intangible Costs (mainly costs to families) 20.64
Total Costs (including intangible) 37.93
2.2 Beer Production Benefits
Beer production brings also some benefits for the society. The most obvious income is tax receipts, which reached CZK 4.0 bill in VAT and CZK 3.55 bill in excise tax in 2006. We should also include CZK 1.8 bill of personal direct taxes paid by employees of breweries and other workers whose jobs are attributed to the production and sale of beer.6) The brewing industry in Czech Republic employs about 8 600 persons and more than 67 000 other jobs is connected to beer production indirectly (in supply or retail sector). It would be really difficult to evaluate the contribution of brewing industry through employment in money terms. We could try to approximate this using the 2006 average nominal wage and total tax burden. Then, the contribution of jobs created (excluding direct taxes paid by breweries’ employees already mentioned) would be CZK 4.63 bill.
6) Source: Ernst&Young 2006.
There are also some intangible benefits from beer production. For example it is legitimate to assume that besides the natural and historical jewels of the country, famous Czech beer is one of the main tourist attractions as well. For example, some breweries launched projects of “beer trails” which should attract tourists’ attention by offering special programs connected with beer degustation, brewing exhibitions and countryside sightseeing.7)
Beer is also one of the key components of Czech Tourism’s fairs while promoting Czech Republic abroad8).
Thus beer does not contribute only through taxes but also in increased incomes from tourism. If we assume that 2% of tourists are dragged to Czech Republic by their interest in local beer (which should be a rather conservative estimate), the tax income from implicit foreigners spending would be CZK 0.85 bill.9) Since the Czech beer was quite well know and appreciated in the former centrally planed economies, the increase standards of living in these countries and the convergence toward EU average GDP in these countries, as shown by Vojinovic and Oplotnik (2008), will allow more of the citizens of these countries to visit Czech Republic and taste the Czech beer in its country of origin.
The most difficult to evaluate would be the cultural benefits from beer consumption. Pubs have always served as places to meet new people, to converse with friends or business partners, to settle past quarrels and to make plans for the future. It would be extremely difficult to evaluate these benefits in money terms. In authors’ opinion, these benefits could reach billions of Czech Crowns. However, finding no theoretical support he will rather stay only naming them without evaluation. For the summary with calculation of net cost of beer consumption to the society see table 2.
7) See: http://www.pratelepiva.cz/svet-piva/pivni-turisticke-stezky.
8) Czech Tourism is an agency promoting the image of Czech Republic as a Touristic destination all around the world. For more information see www.czechtourism.cz .
9) Total foreigners spending attributed to tourism has been CZK 113.1 bill, effective tax rate in the same period is estimated to 37.5%. Source: www.měšec.cz, www.jihomoravskykraj.cz.
Table 2
Estimated Contribution of Beer Consumption in Czech Republic
Contribution Contribution in bill CZK CZK Costs in bill CZK Net Contribution in bill CZK
Value Added Tax 4.00
Excise Tax 3.55
Personal Direct Tax 1.76
Total Tangible Contribution 8.38 17.29 -8.91
Tourism Enhancement 0.85
Jobs Created (76 000 jobs) 4.63
Cultural Cohesion Benefits ?
Total Costs (including intangible) 13.86+ ? 37.93 -24.1+?
3 Optimal Taxation of a Commodity with Socially
Undesirable Effects
3.1 The theoretical model of taxation of “bads”
In our analysis we use a simple microeconomic model based on Pogue and Sgontz (1989). We treat beer, which serves as our example of a good with socially undesirable effects of consumption, as a homogenous product produced under the situation of perfect competition and sold for a constant price P equal to the long run marginal cost and (minimal) average total cost. Let us divide the whole beer-drinking population of N people into two groups of beer consumers who differ in their demand for alcohol Da and Dn, which describe the relation between individual beer consumption and price. Let us assume also that the individual demand function is in linear form. Let us call the two groups of drinkers “abusers” and “ non-abusers” and let us denote their count by Na and Nn. Moreover let us assume that demand of abusers is higher and perhaps less elastic (this assumption is not necessary for the model, although it is widely accepted) than demand of non-abusers. Now we will make some critical and very simplifying assumptions. Let all the beer drinkers correctly account for all internal costs of their own beer consumption (such as possible injuries, medical costs etc.), that means that their demand reflects all the costs connected to beer consumption, born by individual drinker. Moreover let us assume that possible damage caused by non-abusive drinkers to other members of society is negligible, but with increased consumption, the chance of harming other people (by excess noise, damages to other’s property like car crashes, violence, crime etc.) increases. Therefore we define a function of marginal external abuse cost E, which is a positive function of individual beer consumption x withE′>0, lim 0
0 =
→ E
x and limx→0E′=0. For graphical representation, see figure 1.
8
In this situation, non-abusers demand quantity xn, which is socially acceptable,
because it reflects all the costs (recall the assumptions from previous paragraph). On the other hand, quantity xa, consumed by abusers is excessive from the perspective of the whole society
as it creates positive external costs. This is in fact almost a classical Pigouvian situation calling for a tax mechanism, which would correct the distortion made by negative externality (in this case external costs of beer drinking). However, in reality it is difficult to find the first best solution which imposes the tax only on the originators of the externality. By imposing the tax we also damage the welfare of those who drink beer responsively (non-abusers). Now we impose a unit tax T on beer consumption, supposing the price will move up just by T. Quantity consumed of both groups of drinkers will fall according to the slope of their demand function (see figure 2).
The welfare gain of the whole society will comprise of three parts. The first will be the gain from lowering the external abuse costs (area a+b) and the other will be welfare losses of both abusers and non-abusers (area b and c respectively). Mathematically we could calculate the welfare gain as:
(1) Dn E Da Beer Price P Individual Beer Consumption P+E xn xa
Figure 1
Dn P Da Beer Price P Individual Beer Consumption P+E xn xaFigure 2
xn1 xa1 P+T a b c(
)
(
)
1
1
( )
,
2
2
a x a a a n nW
=
N
∫
E x dx
−
T
−∆
x
N
−
T
−∆
x
N
where ∆xi =xi1−xi
(
i=a,n)
is the reduction in individual demand caused by the tax. For simplicity let E* be a marginal external abuse cost averaged over the reduction in consumption∆xa, let us denote:a a a x N X = , Xn = xnNn (2) Let P T x x a a a ∆ = ε and P T x x n n n ∆ = ε (3)
be demand elasticities for abusers and non-abusers.10)
Then, using expressions (1), (2) and (3) we could simplify the model to following:
(
)
(
)
(
)
P X T P X T P X T E W a a a a n n 2 2 2 2 * ε ε ε − − − − − = (4)Maximizing W as a function of T brings us to following first order condition:
(5)
Solving the equation for the ad valorem tax
P T
t= and assuming εa≠ 0, we get
(6)
Analogically, if we would be able identify k groups of alcohol abusers and assuming their price elasticities and marginal external costs of their consumption to be known, we would come to following expression:
+ =
∑
∑
= = n n k i i i k i i i i X X X E P t ε ε ε 1 1 * 1 (7)However, there could be also another issue, which needs to be discussed. Heavy drinkers (who most often fall into the abuser category) may react to increased price of beer by
substituting to other alcohol beverages. This would influence our model in two ways. First the elasticity of demand for beer in the abusers group could be now even higher than for the
non-abusers, if we assume they are more interested in beer as in a source of ethanol than in its taste. Second, as the abusers are likely to substitute most of the beer by another alcohol
10) Note that given the construction of
x
∆ (see above) we calculate the negative value of
elasticities. Thus assuming beer is not a Giffen good, values of εa andεn arepositive.
(
)
(
)
(
)
0 * = − − − − − = ∂ ∂ P X T P X T P X E T W εa a εa a εn n + = a a n n X X P E tε
ε
1 1 *beverage (elasticity of demand for alcohol is low), the decrease of external costs caused by tax imposed would diminish. The situation is illustrated in Figure 3.
Let us denote elasticity of demand for alcohol by εalc. Then using the same maximization procedure as in steps (1) – (6), we arrive to an optimal tax formula:
+ = n n a a a alc X X X P E t
ε
ε
ε
* (8)It is straight forward that desired effect of the taxation would be largely reduced. Assuming that beer is one of the cheapes “sources” of alcohol for consumers, this approach could describe the response for the lowest income ranks among the heavy drinkers. However, if we compare average prices for whole (bottled) beer and wine market, the maximum increase in beer prices before equivalent ethanol price is achieved is only 15%.11) Since we do not know exactly, which case does occur in reality, it would be appropriate to calculate the effects of optimal taxation for more alternatives.
11) According to CSU, the average price of bottled beer in 2006 was CZK 8.60 and average price of wine was CZK 55.83. For the calculation, we used 4.17% as weighted average of mild and lager beer alcohol content and 12.0% as average alcohol content of wine.
Dn P Da Beer Price P Individual Beer Consumption P+E xn xa
Figure 3
xn1 xa1 P+T Dalc a b c3.2 The model for econometric estimation of
elasticities
While the first theoretically consistent estimations of demand systems were done using the linear expenditure systems, the majority of estimations in recent years have been done by systems belonging to the class of flexible functional forms. The most prominent of these are Almost Ideal Demand System (AIDS) models.
The AIDS demand system of Deaton and Muellbauer (1980) including the time trend leads to the following econometrically estimable system of demand functions in expenditure shares: 1 log log n i i ij j i i i j m w p t P α γ β τ ε = = +
∑
+ + + , (9) where 0 1 1 1 1log log log log
2 n n n k k jk j k k j k P α α p γ p p = = = = +
∑
+∑ ∑
. (10)Dependent variable wi is the expenditure share of good i to the sum of expenditures on all
goods considered in a given model. Variables q … q1, , n and p … p1, , n are, respectively, quantities and unit values. Variable m is the total value of of consumed goods. Variable t is the time trend having the value 1 in the first period and increasing by 1 in every subsequent period. The term
ε
i is the disturbance term.The Stone price index, which may be used instead of logP, given by (10), to obtain the
starting values for the full nonlinear AIDS systems is defined as:
1 log n klog k k P w p = =
∑
. (11)The expenditure elasticities of demand ei and compensated (Hicksian) price elasticities eij
are computed from the estimated parameters of the AIDS system as: 1 1 i i i e w β = + , (12) 1 ( log ) ij ij i j j ij i m e w w γ β β P δ = + + − , (13)
whereδij is the Kronecker delta (δij =1 for i= j and δij =0 for i≠ j).
The main reason for the choice of the AIDS system to model demand is the firm theoretical support for this system as opposed to some other approaches. In order to be fully consistent with underlying economic theory, the demand system has to satisfy the restrictions of a) adding up: 1 1 1 1 1 0 0 0 n n n n i i ij i i i i i j α β γ τ = = = = = ; = ; = ∀ ; = ,
∑
∑
∑
∑
(14)b) homogeneity of degree zero in prices:
1 0 n ij j i γ = = ∀ ,
∑
(15) c) symmetry:ij ji i j
γ =γ ∀ , , (16)
and d) negativite semi-definiteness.
Negativite semi-definiteness cannot be ensured by any restrictions on the parameters alone. But it can be easily verified at any sample point by checking the eigenvalues of the matrix
[ ]ij K = k defined as: i j ij ij ij i p p s k e w m = = , (17)
where sij is an element of the Slutsky matrix. The eigenvalues of matrix K have the same
signs as those of the Slutsky matrix. If all of the eigenvalues are non-positive, then Slutsky matrix is negative semi-definite and the underlying expenditure function satisfies the concavity property.
3.3 Optimal taxation in the case of Czech Republic
In order to solve the problem of optimal taxation mentioned above, assumptions about price elasticities of two examined groups of beer drinkers are crucial. Ratio of abusers’ to non-abusers’ price elasticity in recent studies varies, so that we calculate two variants of equation (6) with elasticity ratio 1:1 and 1:2 as in Pogue and Sgotz (1989). Moreover we investigate also a scenario based on equation (8) where we assume large substitution effect between various alcohol beverages. Calculating all these three alternatives for both intangible-including and intangible-excluding costs we end up with six different estimates. We should also mention a simplifying assumption of zero substitution between bottled and draught beer as well as between “premium” (more expensive) and cheaper brands. While working with fixed average beer price, we tacitly take these assumptions. If the consumer was allowed to switch from draught beer to cheaper bottled one, our analysis would be much more difficult. Similar assumption has been taken concerning non-existence of substitution from “premium” (and more expensive) to “popular” beer brands.In literature, the values of price elasticities of demand for beer vary significantly. In United Kingdom, Smith (1999) estimates for example -0.76 whereas Nelson (1997) presents only -0.16 for US data. Mikolášek (2008) estimated on Czech data price elasticity of approximately -0.22. Choosing an average of these three values (-0.38) should give us a reasonable and still quite conservative estimate. For the last two cases based on equation (8) we choose a higher estimate of -0.8 for the abusers’ beer demand and -0.1 for their demand for alcohol in general (which only will influence the shift in external abuse costs).
For dividing Czech non-abstinent adult population between abusers and non-abusers
group, we approximate the distribution of beer drinkers by results of a study by Matoušková (2001) who examines consumption of all alcoholic beverages. We let those consumers, who drink more than 50g of ethanol (approximately 2.5 beers) per day on average, fall in the former and the rest in the latter category. Applying this definition on 2006 Czech population data, we end up with about 8 170 thousand persons who drink alcohol without abuse and about 615 thousand abusers. These results very precisely correspond with the ones recently published by Nešpor (2008).Using again the distribution by Matoušková, we calculate those two groups to be responsible for 70.3% and 29.7% of domestic alcohol demand respectively. For simplicity we assume that this distribution should be valid also for consumption of beer. According to CBMA, about 12.6% of Czech beer consumption is being consumed by non-resident consumers (tourists etc.). Given this, we estimate that total Czech non-residents’ beer
consumption reaches 14 247 th. hl12). From this and the distribution mentioned above, we calculate average volume a non-abuser consumes as 122.3 liters of beer per year, whereas for abusers it is 687.7 liters.
In order to distinguish between external and internal costs of beer consumption we use the following methodology. We assume that an individual bears approximately 50% of medical costs connected with abuse of alcohol. The rate of individual contribution to costs of drugs and medicaments is about 62% (Source: CSO), however, there are also transport, waiting and other transaction costs, which are born solely by the abuser. External costs ratio for productivity loss and production potential loss (because of early death) has been set to 19%, which is the level of taxation. We estimate that approximately half of the costs of crimes committed under influence of alcohol are being covered by the culprit, as most of the costs consist of police and justice salaries, which are generally born by state. Costs attributed to public insurance and alcohol prevention are treated as external in full as they are born entirely by the state. On the other hand, costs of car accidents are treated as internal because they are being paid from private sector – both by the abuser and through car insurance. We treat only 33% of intangible costs to abusers’ families to be external, as costs of family disruption are felt mainly by the abuser himself. Data for alcohol in general then need to be converted into beer data. This is done by using a ratio of pure ethanol content consumed in the form of beer to total ethanol consumption. For Czech Republic, this ratio is quite large; 57.7%13)
Using reasoning described above we classify CZK 6.59 bill of beer abuse costs as external and the rest CZK 10.69 bill as internal costs. Analogically we treat CZK 6.81 bill of estimated intangible costs being external and CZK 13.83 bill being internal to the abuser. Assuming marginal abuse costs equal to average costs we therefore come to per liter abuse costs of CZK 15.85 and CZK 16.11 for tangible and intangible costs respectively. The list of input data is now a complete one (for data summary see table 3) and we could calculate the numerical results of our model.
Table 3
Assumptions
External abuse costs of alcohol consumption–Tangible only (CZK bill) 6.59 External abuse costs – both Tangible and Intangible (CZK bill) 13.40 Average price of bottled beer (CZK per/liter) 16.80
Average price of draught beer (CZK/liter) 35.60
Ratio of bottled beer on total production 48.7%
Original average price of beer (CZK/liter) 26.05
Total population (2006 in thousands) 10 287
Non-abstinent population (in thousands) 8 785
Average beer cons. Over whole population (liters/year) 158.5 From which tourists (non-Czech residents) count for (liters/year)14) 20
Number of abusers (in thousands) 615
Number of non-abusers (in thousands) 8 170
Yearly beer consumption of an abuser (liters) 688.5 Yearly beer consumption of a non-abuser (liters) 122.6 Total Czech residents Beer consumption (th. hl) 14 247
12) In our analysis we neglect volume of beer consumed by Czech residents abroad. However, beer prices in rest of Europe (say with exception of eastern Europe) are relatively higher compared to Czech prices. Moreover many Czech tourists prefer travelling with supplies of their preferred Czech beer brand to buying local brands, while on vacation. Given these arguments we hope that neglecting consumption of foreign beer abroad would not cause much harm to our model.
13) Source: CBMA, CSO, author’s calculation. 14) Estimate by CBMA.
Note: Original (meaning “before optimal taxation”) average beer price is calculated as weighted average of average bottled and draught beer price, where the weights is ratio of bottled and draught beer on total production (tanks and micro-keg packaging is included in “draught” group, PET package is included in “bottled” beer).
In our model, we avoid possible biases arising from complicated structure of taxes to which beer is currently subjected15) Instead we reduce the problem to calculation of optimal
retail price increase, meaning such increase which would minimize the external cost function (described in chapter 4.1). Note that this approach abstracts form treating tax receipts as net gain for the society because it treats taxes as just a transfer of money within the society. The only issue we are interested in is in fact balancing the aggregate dead weigh losses arising from unregulated beer consumption (areas “a” in Figure 2 and 3) and those arising from its restriction (areas “b” and “c”).
Analyzing three sets of assumptions on consumer behavior together with two levels of external abuse costs (with and without intangible costs) we calculate our model for six cases (listed in Table 4):
Table 4
Optimal Tax on Beer Production
Case 1 Case 2 Case 3 Case 4 Case 5 Case 6 Non-abuser's elasticity of demand for beer -0.38 -0.38 -0.38 -0.38 -0.38 -0.38 Abuser's elasticity of demand for beer -0.38 -0.38 -0.19 -0.19 -0.80 -0.80 Abuser's elasticity of demand for alcohol -- -- -- -- -0.10 -0.10 Optimal tax (avg. price increase) 36.1% 17.8% 21.2% 10.4% 7.2% 3.5% Decrease in Abuser's consumption (liters per year) 94.48 46.46 27.74 13.64 39.40 19.37 Decrease in Non-abuser's consumption (liters per year) 16.82 8.27 9.88 4.86 3.33 1.64 Tax receipts (CZK bill) 8.13 4.32 5.09 2.61 1.82 0.91 Decrease of external costs (CZK bill) 1.84 0.44 0.54 0.13 0.77 0.19 Optimal average beer price (CZK) 35.46 30.68 31.58 28.77 27.92 26.97 Optimal average price of bottled beer (CZK per 1/2 litre) 22.53 19.49 20.06 18.28 17.73 17.13 Optimal average price of draught beer (CZK per 1/2litre) 47.74 41.30 42.51 38.73 37.58 36.31 Overall decrease in Beer consumption (th. hl) 1 955 961 978 481 514 253
Case 1: We assume the elasticity for both Abusers and Non-abusers being equal and we take into account both tangible and intangible external abuse costs. This set of assumptions results in highest recommended tax. Such a situation calls for more than one third increase in beer retail price in order to optimize social welfare from its consumption.
Case 2: This case is similar to the first one but includes only tangible external abuse costs of beer consumption. This results in appropriate decrease in recommended tax policy.
Case 3: This set of assumption is similar to the first case, but abusers are assumed to be twice less responsive to the beer-price changes. Such a situation would significantly decrease the effectiveness of any tax (or other price-increasing) policy. Note that (as noticeable from Equation 7)16), the optimal level of price increase does not depend on nominal values of elasticities but just on their ratio.
Case 4: This case is similar to the second one but takes the same set of elasticities as a case 3.
15) This means Excise taxes, which are partly paid in advance, VAT and other payments including various licences and ecologic fees.
16) We could arrange the expression in Equation 7 so that we obtain
+ =
∑
∑
= = n i n k i i k i i i X X X E P t ε ε 1 1 * 1 .Case 5 and 6: Unlike for the previous cases, in the last two cases, we assume abusers are likely to substitute beer by other alcoholic beverage because they wish to maintain their level of ethanol consumed (in other words we assume they behave more or less as alcoholics). It is legitimate to assume that excess consumption of other alcoholic beverages would not lead to lower external abuse costs than consumption of beer. Therefore, following optimization of social welfare, we are only interested in such effect of beer taxation, which lowers the total abusive consumption of alcohol (see Figure 3). Such a situation would dramatically decrease the effectiveness of any tax policy. Note that this assumption would be only valid in a situation when other alcohol beverages have similar price/ethanol content characteristics as beer has (this is discussed in section 4.1).
We should also remark that in reality, the optimal tax in Cases 1, 3 and 5 should be lower, according to marginal social cohesion benefits from beer consumption, which are not observed and thus not included into our calculation.
The results of our model show that the optimal increase in taxation of beer significantly depends on the assumed costs and benefits and on the price elasticities. Nevertheless, according to our results, the marginal increase in the sales tax on beer would increase the social welfare.
4 Conclusions
Since the Czech Republic is one of the leading world’s beer producers and exporters, we considered beer as an example of socially undesirable commodity in our paper. The analysis of real world “bads” like beer is in reality much more complex than a classical textbook treatment of “bads.” The added complexity of the consumption of these commodities is that besides obvious negative social and individual effects they have some positive effects as well. Actually some of these positive effects are primary reasons leading to their consumption. Our analytical approach which we applied to beer consumption could be easily used for analysis of other “bads” like other alcoholic beverages or cigarettes.
Analyzing the estimated impact of beer production to the society, we found that tangible costs exceed the benefits. Despite the fact, that not all the intangible gains form beer consumption could be really calculated, it seems that even in intangible sphere the benefits seem to be outnumbered by the costs. Using a simplified microeconomic modeling of negative externalities connected to beer drinking, we found that in order to maximize the welfare of society government should take such measures, which would raise average beer price by a percentage in the range from 3.5% to 36%, depending on our assumptions on behavior of beer abusers and non-abusers, and estimated level of external abuse costs. Generally, the less the beer abusers are responsive to price changes relative to non-abusers, the less efficient the tax policy will be. Moreover if we treat abusers as people who are likely to be more interested in receiving sufficient volume of ethanol, regardless of particular drink in which it is contain, sharp increase in taxes on beer could even damage the society as a whole. Such a situation would then most probably call for higher tax on all alcohol beverages.
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