Radical Reform

New Zealand's Path to 21st Century Prosperity | Mitchell W. Palmer

Drug Policy

Raising taxes on alcohol to prevent problem drinking is akin to raising the price of gasoline to prevent people from speeding —Stringham & Moore (2009, p. 4) [1]

Alcohol and tobacco are the two most taboo legal products on the market today. Heavily regulated, they are still considered scourges on our society. Our responses, however, have been unsound.

The government currently imposes significant taxes on so-called demerit goods, the consumption of which it wishes to reduce, or ‘sin taxes’. Three taxes currently levied can be considered ‘sin taxes’: Tobacco excise, alcohol excise, and gaming duties. Together, they raised over $2.5bn in revenue in FY2018 and accounted for almost 3% of taxes collected. These sin taxes are justified on two grounds: Covering the costs to others of a given activity and protecting consumer health.

The first justification is prima facie reasonable. As I argued in the opening chapter, no one has the right to impose costs on an innocent third-party without his consent and without compensating him. With New Zealand’s publicly-funded healthcare system, any action which seriously harms the health of an individual could be thought to have external repercussions. Smoking and excessive alcohol consumption obviously have this effect. Smoking can also have third-party effects like dirtying the environment and creating second-hand smoke. Drunken behaviour too, is responsible for much public nuisance: A third of crimes committed each year in New Zealand involve alcohol consumption (New Zealand Police, 2009). Problem gambling, too, can have serious impacts on children and necessitate state intervention to ensure the children a decent standard of living.

The problems with such an argument, however, are two-fold. The first: Calculating the social cost of an activity is notoriously difficult to do fairly or accurately. For instance, in 2009, BERL, a left-leaning economic consultancy, calculated the social cost of alcohol to New Zealand as $4.8 billion annually. This figure was, and remains, widely-circulated, even being cited by Sir Geoffrey Palmer when he was President of the Law Commission. Still, Dr Eric Crampton and Matt Burgess (2009), then economists at the University of Canterbury and Victoria University respectively, tore this estimate to shreds, considering it contained “serious deficiencies” and was “wholly insufficient to form the basis for policy”. They found approximately 40% of BERL’s ‘cost’ could be discounted because of methodological errors – for instance, double counting – and much of the rest was the result of inherently faulty assumptions. The real ‘policy relevant’ figure, they calculated, was less than 5% of the headline figure BERL published. Crampton, Burgess, and Taylor (2012) later conducted the same analysis for a similar figure created for Australia. Collins and Lapsley, Australian public health academics, had found alcohol imposed social costs of $15 billion (in 2005 Australian dollars) annually on Australia. They found fewer calculation errors in the Australian work and yet still found only a quarter of the social cost they identified could be considered ‘policy relevant’, even while expressing serious doubts about the excessive accounting of crime-related harm. Even if most calculations of social cost are conducted more rigorously than BERL’s, the disagreement between Crampton et al. and BERL/Collins & Lapsley about what is ‘policy relevant’ is so significant that policymakers must be inherently sceptical of any calculations of social cost. Such calculations are incredibly sensitive to the assumptions made by and value system of the calculating economist/public health academic.

The second problem with ‘external costs’-based arguments for sin taxes is that many of these costs are associated only with excessive use. Using gaming machines can be an enjoyable activity enjoyed by thrill-seeking adults, well within their means, just as moderate consumption of alcohol can be a useful social lubricant adopted by rational adults and conducted responsibly. Just because the excessive use of a substance/technology is associated with high external costs does not mean moderate use is too. Most probably, the first few units of alcohol a given person consumes have a net positive social benefit – they impose minimal external costs [2] and clearly have positive private benefits in excess of their cost (this is why people chose to buy them). Taxing them at the same rate as later units which could impose significant external costs is counterproductive. In essence, the harm of many of the ‘sins’ taxed is non-linear with quantity: Twice as much alcohol or gambling does not mean twice as much harm, it could be quadruple or worse. By contrast, sin taxes are inherently linear with quantity. Even the cleverest boffins at the Treasury or Customs have not yet worked out a practical way to charge you twice the alcohol excise for your fifth drink as your first.

Unfortunately, responsible consumers are much more responsive to price changes, and therefore to any tax, than anti-social or addicted consumers. For alcohol, according to the best-available meta-analysis (Wagenaar, et al., 2009), a 10% increase in the price of alcohol would be expected to lead to a 4.4% fall in quantity consumed for the average drinker. For heavy drinkers, a price increase of the same magnitude would only lead to a reduction of 2.8%. Less than 20% of adult New Zealanders are classified as ‘potentially hazardous drinkers’ (Ministry of Health, 2017). By contrast, over three-quarters of drinkers drink in relative moderation. Given their relative proportions, it is unlikely the reduced societal harm from mildly-reduced hazardous consumption will outweigh the reduction in private benefits accruing to moderate drinkers from more-significantly reduced mild consumption. Any tax, therefore, is much more likely to reduce societally-beneficial consumption than socially-problematic consumption.

The second argument – that government should impose sin taxes to protect the health of consumers – is less economic and more political. To me, it is unclear why ‘sinful’ consumers should have to pay government for the privilege of conducting an activity government feels is bad for them. Granted, they should probably pay for the extra costs they impose on the public health care system – how ever one defines that – but that is covered by the previous argument. Apart from that however, surely, people own themselves and can do what they please to their own property.

With tobacco, a particular political incentive to tax to reduce consumption has acted since National committed to a Smokefreee Aotearoa by 2025. It is from there that the current policy of increasing the tobacco excise at rates significantly exceeding inflation stems. Here too, the parallel arguments of external costs and public health are typically deployed.

The external costs argument is obviously flawed. In 2012, before significant recent increases, Treasury found excise revenue “may already exceed the direct health system costs of smoking” (Isaac, 2012). There is, therefore, no need to further increase excise to cover health expenditure. While there may be certain other negative externalities (e.g. second-hand smoke) of smoking that the excise also wishes to minimize, a regulatory approach (like bans on smoking in front of children) seems more appropriate, given the possibility of harm.

As regards the health protection rationale for higher tobacco excise, it is, frankly, ludicrous. More than those of any other product in the country, thanks to compulsory packaging laws and education campaigns, tobacco consumers are well-informed regarding the risks. These are informed adults, who are paying their way and who, thanks to innovations like e-cigarettes and nicotine patches, have many alternatives. Paternalism is not appropriate.

However, even aside from being principally unjustified, tobacco taxes are deeply flawed in their practical application.

First, tobacco taxes are regressive – they hit the poor hardest. As a proportion of income, such taxes take a much greater percentage of income for poorer families. This is because, even (naively) assuming consistent smoking rates across socioeconomic strata, they impose a flat dollar-amount tax on all incomes. Really, however, they are doubly regressive. Smoking is three times as common for those living in the most deprived 20% of New Zealand households as in the least deprived (Ministry of Health, 2010) [3]. When government policy in every other area seeks to improve the lot of the worst off, it seems perverse to implement a tax on an addictive good which will fall hardest on those least able to pay.

Increasing the price of legal cigarettes has also increased the demand for (and therefore price and profitability of) their only true substitutes: illegal cigarettes. There exist two options for sourcing illegal cigarettes: Theft or smuggling. Recent reports have revealed a burgeoning smuggling market. Typically, however, our status as an island and alert customs officials make smuggling difficult. Instead, violent theft, often targeting small and ill-defended dairies, has experienced a resurgence. A tax-induced shift to illegal cigarettes and increase in criminality has been experienced around the world. For instance, Fleenor (2003) found, “New York’s high cigarette taxes have spawned a massive black market that has diverted billions of dollars from legitimate businesses and governments to criminals”. Shop owners have a right to feel secure in their property. Tax policy should not – wherever possible - hurt them while creating a new black market for exploitation by organised crime.

We should also note that the excise hits Māori especially hard. Over 40% of Māori adults smoke, whereas only 17.1% of European/other adults do (Ministry of Social Development, 2016). A core goal of all recent governments has been to improve the lot of Māori. A programme of increasing taxes on already overtaxed activities more prevalent in their communities seems counterproductive.

We should significantly cut tobacco excise. Helpfully, the concerns about punishing moderate users to ward off excess does not apply here. There is little disagreement: Tobacco is dangerous and addictive in any quantity. In lieu of proper risk-based premia for healthcare (see p. 56), it is sensible that smokers, who have knowingly taken on a particularly dangerous habit, compensate other taxpayers for the increased burden they create. It is not, however, sensible that tobacco excise be set far in excess of net healthcare costs imposed. Paternalism is not appropriate, particularly in the context of other interventions in the market which ensure an information failure is effectively impossible. The excise should therefore be cut to the necessary level to meet net external costs from smoking – determined by rigorous economic analysis, rather than hare-brained political imperatives to reach ‘Smokefeee 2025’. Lost revenue from tobacco taxes should be made up from either expenditure reduction or much less distortionary and fairer revenue sources – like income tax or GST.

For alcohol, it is not clear that there are significant problems with the status quo of taxation. This is probably due to alcohol consumption being much more widespread than that of tobacco. Politicians are aware that most of their voters (79.3% of adults over 15 in 2016/17) drink and will therefore feel the brunt of any increase in alcohol excise. Being broadly sensible people who want to keep their jobs, they don’t increase this excise excessively. Crampton et al.’s more rigorous recalculation of BERL’s shoddy work found that excise taxes remain roughly equal to external costs. Sure, acute problems remain, but these are probably better solved by direct action than by probabilistic attacks on wide swathes of drinkers. Using excise to solve public drunkenness, for instance, would be terrible public policy: Higher excise might reduce consumption overall, but – as mentioned above – the decrease in truly problematic consumption is unlikely to be significant. We should, therefore, guard against any attempt to increase alcohol excise unjustifiably, to avoid seeing the same problems we have seen with tobacco.

Policy Recommendations

  1. Significantly cut cigarette taxes to cover the net taxpayer cost of smoking
  2. Abandon Smokefree Aotearoa 2020
  3. Hold alcohol excise at its current level
  4. Prefer ex post punishment of drunken behaviour

[1] My thanks to Crampton & Burgess (2009). They quoted this excellent analogy from Stringham and drew my attention to his paper.

[2] Indeed, they could provide a net external benefit, as significant evidence suggests a positive health impact of mild alcohol consumption – the so-called J-curve (Xi, et al., 2017).

[3] The proportion of ‘current smokers’ among those living in the least deprived quintile of households (according to the 2006 Deprivation Index) in 2009 was 11.5%, compared to 35.0% for the most deprived.