3  Application to the Case of Alcohol

This section considers which of the mechanisms discussed in section 2 is best to address the externalities of alcohol consumption.

In the case of alcohol there is evidence that low levels of alcohol consumption by some consumers confers an external benefit, mainly because there is a reduction in expected public health expenditure due a reduction in the risk of ischaemia. Alcohol consumption also confers external costs relative to the situation of no alcohol consumption. These costs include increased use of the public health and justice systems, uncompensated damage to third parties’ property due to accidents, injury to third parties and reduced productivity that affects third parties.[15]

3.1  Institutional Solutions

Many of the externalities of alcohol consumption are the result of institutional structure. However, the opportunities to change institutional structures to reduce the externalities of alcohol consumption are limited.

For example, one of the externalities is the additional use of the public health care system arising from alcohol related health damage. These externalities would be avoided if individuals were required to pay for health costs associated with alcohol consumption. However, wholly private funding of health care for alcohol related illnesses is unlikely to be a tenable solution.

First, if only the costs of alcohol related illnesses were required to be paid by individuals there would be information problems. For any given case it is difficult to be precise about the extent to which alcohol contributed to the illness. Second, requiring all health care costs or even alcohol related health care costs to be paid by individuals is likely to be inconsistent with the objectives of government involvement is the health system. Third, if the government were not to fund public health services a comprehensive insurance market would be needed. There are likely to be inefficiencies in this market if consumers cannot be distinguished. In such a market particular individuals may not receive cover.

Health cost recovery for particular types of damage is another option. Apart from the above concerns, this policy would draw arbitrary boundaries. For example, feasibility may allow recovery of the costs of acute alcohol consumption but not the costs of chronic alcohol consumption. However all consumers would pay any tax imposed on alcohol.

Charging for alcohol related police and justice services would have many of the same problems as discussed above. In addition, for these services it is difficult to determine the cost of use of these services in a particular case. For example alcohol breath tests only catch a proportion of drunk drivers. Thus only a proportion of the cost of breath tests could be charged to those who give rise to the need for this system.

There is an element of cost recovery associated with health and justice services presently. The above arguments imply that those who use these systems because of alcohol consumption should be required to contribute the same proportion of costs as those who use the system due to other reasons, such as undertaking dangerous activities or committing crimes.

As the ability to address alcohol externalities through institutional change is limited, alternative mechanisms need to be considered.

3.2  Trade

Even if liability rules with regard to generating alcohol externalities were defined, bargaining in rights to generate alcohol externalities would not occur because transaction costs are prohibitively high. This also means that if an optimal tax were imposed bargaining would not result in a non-optimal resource allocation.

Transaction costs of bargaining would be high largely because of information and monitoring costs and the number of people involved. In particular, a lot of information is required to identify individuals who are likely to generate externalities and to estimate the likely damage; the bargain would need to define what type of consumption the individual can/cannot undertake and it would be costly to monitor whether the consumer complies with the bargain. Further, as the cost of externalities is spread over many people, a society bargaining group would need to be established. This group would involve costs and would not be able accurately to assess the costs of externalities, as many of these costs are subjective. Further, paying individuals to reduce drinking would create an incentive for individuals to claim that they would drink large quantities in the absence of payment.

As neither an institutional nor a trade solution is likely to be successful in fully addressing alcohol externalities, consideration should be given to other mechanisms.

3.3  Targeted Measures 

Targeted policies, such as education, age restrictions and alcohol dependency services are important tools to use in reducing alcohol externalities. They are also likely to be the best tools to ensure that consumers correctly assess the internal costs of consumption and will have a significant role in influencing the consumption of those who do not take all internal costs into account. These tools work best when implemented as part of an overall strategy for addressing the harms of alcohol.

Generally, education campaigns have limited impact in reducing alcohol-related externalities. Education campaigns may have some success in causing long-term changes in attitudes, making other alcohol regulatory measures more acceptable and ensuring consumers correctly take account of internal costs. Education has been successful in particular areas, such as drink driving.[16]

The effective enforcement of the law can also be an important tool in reducing the costs associated with alcohol, particularly costs associated with acute consumption. For example, higher penalties and better law enforcement have lowered the amount of drink driving in New Zealand.[17] Third party costs, such as the costs of property damage and injury, are sometimes recovered through the court system.

Regulations such as age limits and bans on serving intoxicated people are useful in that they are able to target those most likely to generate externalities or most likely not to consider fully the internal costs of alcohol.

Judgements must be made about the costs and benefits of these policies. Costs include the direct fiscal cost, but also economic costs such as lost consumption benefits from limits on who can consume alcohol. On occasion these policies can also have perverse effects, such as making underage drinking “cool”. These policies are limited in their effectiveness and are most appropriate when they can address particular individuals or activities that are likely to generate externalities. Significant non-internalised externalities will still remain despite these policies. For this reason one should consider whether it is appropriate to apply a specific tax to alcohol to address externalities that are not adequately addressed by regulatory mechanisms.