I N T E R O F F I C E M E M O R A N D U M
TO: PROFESSOR YINGER
FROM: KEITH DEVEREAUX, LIZ SIMONHOFF
SUBJECT: ALCOHOL TAX IN THE STATE OF NEW YORK DATE: 5/4/2009
Background
With a projected $15.4 billion budget shortfall, the New York State government is facing serious fiscal challenges. In order to address these challenges, Governor Patterson has introduced several revenue generating ideas including an increase in the tax on beer and wine. We support the Governor’s proposal of increasing the tax rate on beer and wine because we feel it will assist the state in raising necessary revenue, while inducing long term social and health benefits. The following memo briefly discusses the history of alcohol taxes in America as well as the Governor’s proposal before engaging in an in depth analysis of the potential costs and benefits of an increase in New York’s alcohol taxes.
History of Alcohol Taxation
Since the country’s inception, the United States of America has implemented alcohol taxes to address critical funding needs. Although the first tax on alcohol in 1791 led to the Whiskey Rebellion, alcohol taxes soon became an accepted source of revenue. In 1814, an alcohol tax was temporarily imposed to finance the War of 1812. Then in 1862, President Lincoln imposed another tax on liquor to help pay for the Civil War (drug-rehabs.org, 2002). In 1933, following the repeal of Prohibition, New York state imposed its first tax on alcoholic beverages. While the state’s tax rates on alcoholic beverages have changed numerous times in the intervening years, alcohol taxes have not increased in the state of New York since 1991 (New York State Economic, Revenue, and Spending Methodologies, 2008)
In fact, New York has cut its alcohol tax rates several times in the past two decades. For example, in 1994 the tax rate on sparkling wines was cut by $0.20 to $0.19 a gallon to bring it in line with the rate applied to still wines. In 1996, 1999, and in 2001, the tax rate on beer was cut from a high of $0.21 per gallon to the current level $0.11 per gallon (New York State Economic, Revenue, and Spending Methodologies, 2008).
Today, in light of the economic crisis and the budget shortfalls facing many states, increased alcohol taxes are being considered as a source of new revenue. For example, to address the large budget deficit in California, Governor Schwarzenegger and the California state legislature implemented a “nickel a drink” tax on all wine, beer, and distilled spirits at the
beginning of this year (Marin Institute, 2009). Governor Patterson has proposed a similar tax increase on alcohol to address New York’s budget woes.
Governor Patterson’s Proposal
In response to New York’s unprecedented projected budget deficit for the fiscal year beginning April 1, 2009, Governor Patterson is calling for an increase in New York’s tax rate applied to wine and beer. Under the Governor’s proposal, the wine tax would increase from its current level of $0.18 per gallon, the second lowest rate in the nation, to $0.51 per gallon, representing a $0.32 cent increase. The Governor has also proposed increasing the beer tax from its current rate of $0.11 per gallon to $0.24 per gallon, representing a $0.13 per gallon increase (Marin Institute, 2008).
Revenue Generated
According to the Governor’s office, raising the tax rate on beer to $0.24 per gallon and the tax rate on wine to $0.51 per gallon would generate $63 million dollars in additional state revenue over the next year alone (Kesmodel, 2009). All revenue from alcohol taxes is deposited into the state’s general fund. This additional revenue is projected despite forecasts showing that New Yorkers are expected to consume 1.5% less alcohol over the 2009/2010 fiscal year, largely due to the economic downturn and the resulting decrease in consumer spending (New York State Revenue Report, February 2009). In future years, after the economy has recovered from the current recession and New Yorkers resume previous alcohol consumption patterns, these higher tax rates on beer and wine are expected to provide increasing amounts of revenue for the state of New York.
Elasticity and Cross Border Tax Avoidance
Economic theory explains that demand for a good is inversely related to that good’s price. Thus, increased alcohol prices are associated with decreased levels of frequent drinking. This is particularly true among the younger population (Chaloupka, et.al., 2002). Consequently, we expect the demand for alcoholic beverages to decrease if the price of these beverages is raised through increased alcohol taxes.
Many economists have attempted to measure the change in demand for alcohol that results from an increase in its price. For example, the state of New York uses elasticity estimates calculated by Grossman et al. (1993) in making its alcohol tax revenue projections (New York State Economic, Revenue, and Spending Methodologies, 2008). However, because measuring consumer responsiveness to changes in prices is often vague, we have identified alternate estimates of elasticity calculated by Leung et al. (1993) for comparison purposes.
It must be noted though that both the elasticity estimates used by New York’s Division of the Budget to make revenue forecasts as well as the alternate estimates of elasticity we have
identified are based on national consumption patterns. These estimates may adequately capture the consumer preferences of New Yorkers, as New York’s alcohol consumption patterns mirror the national averages (New York State Revenue Report, 2009). However, these estimates do not account for variations in state level taxing that may cause consumers to cross jurisdictions to avoid taxes. If consumers can easily buy alcohol at a lower price in a neighboring state, then the elasticity estimates previously discussed may overstate the revenue raising potential of an increase in New York’s alcohol tax.
Over half of New York’s population lives within a few miles of Connecticut and/or New Jersey (U.S. Census Bureau: 2000 Census). Consequently, we are most concerned with how New York’s tax rates on alcohol compares to the rates in these states.
Spirits Tax (per gallon) Wine Tax (per gallon) Beer Tax (per gallon)
New York $6.44 $0.19 $0.11
New Jersey $4.40 $0.70 $0.12
Connecticut $4.50 $0.60 $0.20
New York
(proposed) NA $0.51 $0.24
Source: The Tax Foundation, 2009
Taxes and Demand for Beer
The New York Division of the Budget expects the demand for beer to decrease by 0.3 percent for each 1 percent increase in the tax on beer (New York State Economic, Revenue, and Spending Methodologies, 2008). This elasticity estimate is identical to the alternate estimate of elasticity we identified (Leung et al., 1993). Thus, absent any cross border effects, the additional revenue generated by an increase in the tax rate applied to beer is expected to more than compensate for the lost revenue associated with the reduction in demand for beer.
The likelihood of significant cross border effects resulting from the proposed increase in the beer tax are minimal. New York currently taxes beer at a lower rate than its neighbors. But, New York’s current tax rate does not appear significantly low enough to attract out of state residents to New York to purchase beer, especially given the additional transportation and time costs involved.
The proposed tax increase on beer would make the state’s tax rate slightly higher than the rates in New Jersey and Connecticut. Although such a situation could incentivize New Yorkers to cross state lines to purchase beer, we believe this type of tax avoidance will be minimal given the relatively small tax savings that could be achieved and the higher transportation costs a consumer would expect to incur.
Thus, we are comfortable accepting the state’s revenue projections resulting from an increase in the beer tax. We believe cross border tax avoidance, both in terms of out of state residents shopping in New York and New Yorkers shopping out of state, to be minimal enough so as not to impact the elasticity estimates of -0.3.
Taxes and Demand for Wine
Unlike beer, there does not seem to be a consensus estimate of the price elasticity of demand for wine. Leung and Phelps (1993) calculate the price elasticity demand of wine to be -1.0. That is, a one percent increase in the price of wine is associated with a one percent decrease in demand for wine. Consequently, raising taxes on wine is predicted to be revenue neutral as the impact of the higher tax rate is exactly offset by a reduction in demand. However, Grossman et.al. estimate the price elasticity of wine to be -0.7. This estimate, which is utilized by New York in making revenue projections, predicts that an increase in the tax rate on wine will result in an increase in tax revenue for the state.
Of course, neither of these elasticity estimates take into account the potential for cross border tax avoidance. New York’s tax rate on wine is currently the second lowest rate in the nation, $0.41 lower than Connecticut’s rate, and $0.51 lower than New Jersey’s rate (Tax Foundation, 2009). Thus it is likely that at least some New Jersey and Connecticut residents are currently crossing into New York to make wine purchases. As the proposed tax increase still keeps wine prices in New York nearly a dime cheaper than either of the comparison states, New York may continue to capture some revenue from New Jersey and Connecticut residents after the tax increase.
Given New York’s cross border price advantage relative to New Jersey and Connecticut, we feel comfortable accepting the assumption of New York’s Division of the Budget that demand for wine is somewhat inelastic. However, because the proposed tax increase is likely to cause fewer out of state residents to shop for wine in New York, we believe New York’s revenue projections to be slightly optimistic.
Taxes and Demand for Spirits
Like in the case of wine, there are conflicting estimates of the price elasticity of demand for spirits. Leung and Phelps (1993) calculate the price elasticity of distilled spirits to be -1.5. In this case, the lost revenue associated with the reduced demand for spirits more than offsets the increased revenue associated with a higher tax rate. However, Baltagi et.al. (1990) estimate the elasticity of spirits to be -0.7. Thus, an increase in the tax rate on spirits is predicted to result in increased tax revenue for the state. New York uses this elasticity estimate in making its revenue forecasts.
Again, however, these elasticity estimates do not take into account the ability of consumers to cross state lines to make purchases of spirits. New York’s current tax on spirits is
the highest in the nation and significantly higher than the tax on spirits in both New Jersey and Connecticut (The Tax Foundation, 2009). Consequently, New Yorkers who live near Connecticut or New Jersey are probably already crossing state lines to make liquor purchases. A further increase in the tax rate on spirits would only increase New Yorkers’ incentive to buy spirits elsewhere. Thus, we are confident that in terms of elasticity of demand, New Yorkers will be highly responsive to an increase in the price of spirits. For this reason, we do not believe increasing the spirits tax will result in increased revenue for the state. We support the Governor’s decision to not increase the liquor tax.
Societal and Health Benefits
Generating revenue is not the only potential benefit of taxing alcohol. Increased alcohol prices also reduce alcohol consumption and thereby reduce several associated societal problems. Research by the American Association of State Highway and Transportation Officials (1996-97) indicates that higher beer prices are associated with less drinking and less motor vehicle crashes. This is particularly true for underage drinkers. The Center for Science in the Public Interest (2009) finds that higher alcohol taxes increase the probability of attending and graduating from a four year college or university. One can infer this is because the increase in tax reduces the amount of drinking for college students, thus increasing their ability to perform academically. Additionally, the University of Vermont’s Legislative Research Shop (2009) concluded that a 10 percent increase in excise tax on beer will reduce rapes by 1.32 percent, robbery by .90 percent, murder by .3 percent, and assault by .3 percent. On the other hand, lower beer prices are associated with a higher incidence of troublemaking with authoritative figures, property damage, and fighting (Center for Science in the Public Interest, 2009).
In addition to these societal benefits, there are also significant health benefits associated with increasing the alcohol tax. The Center for Disease Control and Prevention (2000) estimated that a $0.20 state tax increase for every six pack of beer would reduce U.S. gonorrhea rates by almost 8.9 percent and syphilis rates by 32.7 percent. Other research found that for every 10 percent increase in the liquor tax, cirrhosis deaths decrease by 9 percent (Cook, et.al., 1982). The same research also shows that cirrhosis rates were drastically reduced during Prohibition when consumption of alcohol was lower. Other research found that a 37 percent increase in the beer tax in Alaska led to a 29 percent sustained reduction in alcohol related deaths (Wagenaar, et.al, 2008).
Of note, not all reductions in consumption of alcoholic beverages produce the same health and societal benefits. Research shows that reduced consumption of beer and spirits has greater health and societal benefits than reduced wine consumption (Klastsky, et.al, 2003). Some research even claims that low levels of wine consumption may result in a reduced risk of heart disease (Gronbaek et.al., 1995). However, research generally shows that any potential benefits of light drinking are more than offset by the large costs of heavy drinking. And so we
are confident that the reduced consumption of wine that will accompany a tax increase will result in health and societal savings for the state of New York.
Estimating the exact health and societal benefits that would result for New York from an increase in alcohol taxes is difficult. But as nearly 400 people in New York died as a result of drinking and driving related crashes in 2006 alone, any reduction in alcohol consumption could save a significant number of lives (NY State 2007 Highway Safety Annual Report). And given the numerous positive impacts of decreased alcohol consumption, we believe an increase in the alcohol tax will provide long term benefits to the New York state budget in terms of reduced need for health, policing, and counseling services.
Equity Issues
It is also important to consider who the alcohol tax is most likely to affect. For this purpose, we consider two notions of fairness in tax issues; the benefit principle and the ability to pay principle.
Benefit Principle
The benefit principle is based on the idea that those who receive the greatest benefit should pay the most taxes. We feel alcohol taxes rate very strongly in terms of this equity principle. Only those individuals who enjoy the benefits of consuming alcohol pay alcohol taxes. However, in the case of alcohol it may make sense to think of the benefits principle in reverse. Specifically, those individuals who create the costs should pay for it. Given the large health and societal costs associated with alcohol consumption, it is only fair that alcohol consumers pay for these costs through higher alcohol taxes. And as we believe it unlikely that current alcohol taxes are sufficient to cover the numerous health and societal costs associated with drinking, an increase in alcohol tax rates may actually make alcohol taxes more equitable in terms of the benefits principle. Thus, we believe an increase in the alcohol tax is strongly justified in terms of the benefit principle.
Ability to Pay Principle
The ability to pay principle is based on two ideas; vertical equity and horizontal equity. Vertical equity is the idea that those who have the ability to pay more in taxes should pay more. Horizontal equity refers to the idea that those with the same ability to pay should pay the same amount in taxes.
The alcohol tax is mixed in terms of vertical equity. Alcohol consumption represents a greater share of income for low income individuals. Thus, these individuals pay a greater share of their income on alcohol taxes than high income individuals. However, the average effective
alcohol tax rate for low income individuals is only slightly higher than the average effective tax rate for higher income individuals, making the alcohol tax more flat than regressive. Additionally, high income individuals consume alcohol at a higher rate than low income individuals. Consequently, they pay more alcohol taxes in absolute terms than low income individuals. These trends are shown in the following table, which displays the national average effective alcohol tax rate and average alcohol tax burden per income quintile.
Household Income Quintile Avg. Effective Tax Rate Avg. Tax Burden per
Calendar Year Bottom 20 Percent 0.06% $19 Second 20 Percent 0.05% $28 Middle 20 Percent 0.05% $41 Fourth 20 Percent 0.05% $56 Top 20 Percent 0.03% $77
Data from Chamberlain et al (2007)
As you can see from the table, the bottom income quintile of households spends the largest share of their income on alcohol. In comparison, the top income quintile of households consumes alcohol at a higher rate and thus incurs a higher tax burden. Similar findings on alcohol consumption patterns have been made by Wanat and Whitney (2009), the New York State Assembly (March 2009), and the Bureau of Labor and Statistics (2007). Of note, by no means are we arguing this tax is progressive. On the other hand, we are arguing that the tax is less regressive than it appears because individuals consume alcohol at various rates.
The alcohol tax does not rate well in terms of horizontal equity. Because alcohol consumption is based on personal preferences, individuals with the same ability to pay may actually spend much different percentages of their income on alcohol taxes. In fact, the New York State Assembly estimates that 15-20% of alcohol consumers’ drink 80% of alcoholic beverages. These heavy drinking individuals are paying a much greater share of their income on alcohol taxes than their peers.
But overall, we believe the strong arguments in favor of alcohol taxes in terms of the benefit principle as well as the fact that alcohol taxes are not as regressive as perhaps assumed outweigh any concerns about horizontal equity. While those with similar ability to pay may pay different amounts in terms of alcohol taxes, this is a reflection of consumer preferences, not poor tax targeting.
Political Feasibility:
The political feasibility of increasing alcohol taxes in New York is complicated by the large wine industry in the state. New York is the third largest wine grape producing state in America and, as of 2006, home to 219 wineries (International Trade Administration, 2008). These vineyards employ a fair number of New Yorkers and attract tourism from outside the state. As a result, New York politicians may be hesitant to increase tax rates on such an important local industry. Additionally, restaurants, convenience stores, and liquor stores have all expressed concern that the Governor’s alcohol tax proposal could reduce alcohol purchases and consequently hurt their businesses.
However, there are strong political arguments in favor of an increase in alcohol tax rates. The most important of which is public support. A December 2008 randomly selected poll conducted by Beck Research found that after being told the potential benefits of an increase in the alcohol tax, including the potential to increase funding for underage drinking prevention programs and reduce the need to cut public services, 74 percent of New York voters indicated that they support an increase in alcohol tax rates (CCC NY, 2008). Furthermore, the same survey showed that by margins of more than 3 to 1, voters prefer taxes on alcohol and sugar-sweetened beverages over cuts in government services. We do realize that using the newly generated tax revenue to fund programs to combat underage drinking will not help the deficit. Given the fiscal crisis, we believe the Governor can justify to the public the need to at least temporarily divert alcohol tax revenue towards closing the budget gap rather than expanding underage drinking prevention programs. Overall, in a time of economic crisis, one of two things usually occurs: elimination of services or raising taxes. Given the choice between the two, it seems clear that the public supports increasing the alcohol tax.
Another compelling political argument that New York politicians can use is that alcohol taxes have not been increased in New York in nearly two decades (Marin Institute, 2009). Due to inflation and tax cuts, real taxes on alcohol are lower today than at any time in the past twenty years. Given the dismal fiscal situation the state is in, continuing to let alcohol tax rates fall behind inflation is hard to justify, especially in light of the relatively higher tax rates borne by wine and beer consumers in most other states.
Recommendation:
As shown by the discussion of elasticity and cross border tax avoidance, we are confident that an increase in the beer tax will generate significant new tax revenue for the state of New York. We also believe that an increased beer tax will positively impact the state budget in terms of health and societal benefits, as overconsumption of beer will decrease. The beer tax is also strongly justified in terms of the benefit principle. Given these reasons and the political feasibility of increasing the beer tax, we strongly support the Governor’s proposal to increase the tax rate applied to beer from $.11 per gallon to $0.24 per gallon.
We also support the Governor’s proposal to increase the tax rate applied to wine from $.18 per gallon to $.51 per gallon. Although the estimates of elasticity of demand for wine vary, we feel confident that an increase in the wine tax will result in new revenue generation for the state, although perhaps not as much as projected. Additionally, while some evidence suggests there are health benefits associated with low levels of wine consumption, we believe these benefits are outweighed by the health and societal costs of heavy wine consumption. Thus, we believe an increase in the wine tax and the subsequent reduction in wine consumption will result in health savings for the state. As is the case with beer, increasing the wine tax is strongly justified in terms of the benefit principle and seems to be politically feasible.
Finally, we do not recommend an increase in the tax rate on spirits. Although there are strong health and societal benefits associated with reduced consumption of spirits, increasing New York’s tax rate on these beverages is hard to justify given that the state’s rate is already the highest in the nation. Further increases would likely cause more consumers to cross state lines to make liquor purchases and would fail to generate additional revenue for the state. Given the fiscal crisis, the state should not risk losing tax revenue by increasing the tax on spirits.
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