1 Introduction
This paper considers the role of government in the case of consumption externalities and, in particular, in the case of alcohol externalities. The purpose of the paper is to assess whether the current level of the alcohol excise can be justified on externality grounds. This issue has been controversial lately, particularly given the recommendation of the New Zealand Tax Review 2001 to remove the alcohol excise.
It is important to draw a distinction between internal and external costs and benefits (externalities). Internal costs and benefits are borne by the consumer. Externalities are borne by third parties. Externalities occur when the actions of one individual directly affect the well being of another individual.
Policy relevant costs and benefits are costs and benefits that the consumer does not take into account. These are usually external costs and benefits but may be internal costs or benefits, for example when consumers are not fully rational or not fully informed. The focus of this paper is on the external costs and benefits.
Where a consumer does not take all costs or benefits into account, the price paid by the consumer for the good does not reflect all the costs/benefits of that consumer’s consumption (social costs/benefits).[1] The usual justification for government intervention in such a case is that the failure of the consumer to consider all costs or benefits will result in market failure or non-optimal resource allocation.
The first section of this paper develops a framework that can be used to determine the role for government in the case of externalities. This section discusses when externalities cause market failure and considers institutional change, tradable property rights and regulatory and tax mechanisms as tools to address externalities. The second section of the paper applies this framework to the case of alcohol and concludes that a specific tax can be justified in the case of alcohol. The final section of the paper considers the incidence and magnitude of the externalities of alcohol consumption and uses this information to assess whether the current alcohol excise can be justified on externality grounds.
Notes
- [1]The social cost (benefit) is the internal cost (benefit) + the external cost (benefit).
