THE WELFARE EFFECTS OF ALCOHOL TAXATION

Abstract

This paper analyses the question of how to appropriately tax alcoholic beverages at a disaggregated level. Using the theory of tax reform, the social cost of raising revenue from different alcoholic beverages is calculated. The externality associated with alcohol consumption is explicitly modeled. In conjunction with unusually high wedges between producer and consumer prices, this leads to results rarely encountered in the literature of the welfare effects of taxation. The problem is approached by building a multistage budgeting model of expenditure. This is necessitated by the availability of elasticity information only for aggregates of the goods in question while pricing policy must be developed at a more disaggregated level. The model is applied to a data set for 1989 for the province of Ontario, Canada. We find that there is a major scope for welfare-improving tax changes, but that such changes depend crucially upon the magnitude of the externality associated with alcohol consumption.