Memorandum from the Institute for Fiscal
Studies
THE REVENUE EFFECT OF CHANGING ALCOHOL DUTIES
This is a summary of Crawford I, Smith Z and
Tanner S (1999) "Alcohol Taxes, Tax Revenues and the Single
European Market", Fiscal Studies, (1999) vol 20, no
3, pp 287-304. The study was funded by the Economic and Social
Research Council and carried out by staff at the Institute for
Fiscal Studies. The paper was published 14 months ago. It investigated
the relationship between the tax rates applied to alcoholic drinks
in the UK and the revenues raised through these taxes. The main
questions addressed were: what is the relationship and how did
the completion of the Single European Market and the introduction
of unrestricted personal importation of alcoholic goods affect
the relationship? Sections 1 to 4 summarise the study. The tables
of excise duties and international comparisons have been brought
more up-to-date. The final section discusses whether the study
has any important implications for the Scottish Drinks Industry.
1. INTRODUCTION
Since the completion of the Single Market in
1992, it has become easier for people in the UK to take advantage
of lower priced goods abroad. Alcohol is one good where there
has been particular concern about the level of cross-border shopping
because of differences in tax rates between the UK and near neighbours.
At the time the study was published the most up-to-date estimate
from HM Customs and Excise was that in 1998, £290 million
of revenue on beer, wine and spirits was lost through cross-border
shopping.[12]
This contrasts with £10.86 billion of total duty and VAT
receipts[13]
collected on alcohol at that time. If the Chancellor cut duty
he could reduce the volume of cross-border shopping and more revenue
would be collected from any increase in domestic sales, but less
revenue would be collected from each unit that is currently sold.
If the Chancellor wants to reduce the amount of cross-border shopping
by cutting duty, the important policy question is whether overall
these two effects would have a positive or negative effect on
revenue.
2. ALCOHOL TAX
RATES AND
REVENUES
Two indirect taxes are charged on alcohol in
the UK. All alcohol is subject to the standard rate of Value Added
Tax (17.5 per cent). In addition, excise duties are levied at
different rates according to the type of alcohol. Duty on beer
and spirits is charged—at different rates—according
to alcoholic content. The rate of duty on wine is applied to the
volume of wine and the same duty rate is applied to wine within
a range of strengths.
Table 1
ALCOHOL TAXES
| |
Duty on typical unit |
Current implied duty/litre
of pure alcohol
| Duty + VAT as % of final price (September 2000)
|
| Beer | 34p per pint
| £11.89 | 29%
|
| Wine | £1.16 per 75 cl bottle
| £14.04 | 50%
|
| Spirits | £5.48 per 70 cl bottle
| £19.56 | 58%
|
Note to Table: A typical unit of beer is defined as
a pint of bitter, bought on licensed premises at 5 per cent abv,
wine is a 75 cl bottle of table wine at 11 per cent abv and spirits
is a 70 cl bottle of whisky at 40 per cent abv. Note that for
beer and wine, the implied duty per litre of pure alcohol does
not depend on the strength used to calculate duty on a typical
unit. Source: HM Customs and Excise, Annual Report (1999),
BLRA, Statistical Handbook (2000).
Table 1 shows the duty on a typical unit of beer, wine and
spirits, updated since the time the study was published. Since
duty is imposed on different drinks in different ways, it is not
immediately clear how the rates on different drinks compare. The
second two columns in the table show two alternative ways of comparing
duty across different drinks in a meaningful way. Whether we compare
duty per litre of pure alcohol or duty plus VAT as a percentage
of final price, spirits are taxed much more heavily than beer
or wine. In terms of duty per litre of pure alcohol, spirits are
taxed more heavily than beer and wine.
These rates of duty were, at the time of the study, and still
are among the highest in the European Union. Using data updated
since the time the paper was published, Table 2 shows the duty
rates in different EU countries of beer, wine and spirits and
shows for example that the duty on beer is more than five times
higher in France than in the UK. VAT is also levied on alcohol
and this is not reflected in the table. The VAT rate in France
for example is 20.6 per cent compared to 17.5 per cent in the
UK and so this would narrow the gap in the total tax rate to some
extent.
Table 2
EU DUTY RATES ON ALCOHOL AS AT 1 APRIL 2000
| Country | Beer/pint @
5% abv (pence)
| Wine/75 cl @
11% abv (pence)
| Spirits/70 cl @
40% abv (£)
|
| Austria | 6.1
| Nil | 1.25
|
| Belgium | 7.2
| 21.7 | 2.85
|
| Denmark | 16.2
| 46.2 | 6.34
|
| Finland | 49.8
| 108.2 | 8.67
|
| France | 4.5
| 1.5 | 2.49
|
| Germany | 3.3
| Nil | 2.24
|
| Greece | 5.1
| Nil | 1.52
|
| Ireland | 34.6
| 125.6 | 4.76
|
| Italy | 5.9
| Nil | 1.11
|
| Luxembourg | 3.3
| Nil | 1.79
|
| Netherlands | 7.4
| 22.4 | 2.58
|
| Portugal | 4.9
| Nil | 3.50
|
| Spain | 2.9
| Nil | 1.18
|
| Sweden | 30.5
| 149.2 | 10.27
|
| UK | 33.8 |
115.8 | 5.48
|
Source: Confederation des Brasseurs du Marche Commun
(2000), BLRA Statistical Handbook (2000).
These large differences in duty provide a financial incentive
for UK consumers to shop across the border. One way to reduce
this incentive would be to cut duty in the UK, but would this
enable the Chancellor to recoup some of the revenue that he is
losing to cross-border shopping or would it result in further
revenue losses? Increasing the tax rate would increase domestic
sales but less revenue would be collected on each unit sold. Whether
the overall result would be an increase or decrease in revenue
depends on the balance of these two effects.
For any particular good, the relationship between the tax
rate and tax revenue depends on total expenditure on the good,
the current tax rates and how responsive consumers are to a change
in the price of the good (the price elasticity of demand). Other
things being equal, the more responsive people are to a change
in the price of a good, the more likely it is that a cut in duty
will lead to an increase in revenue. This is because for a given
fall in price after a tax cut, the larger the increase in sales
so the more likely it is that the extra revenue from the increase
in sales will outweigh the loss per unit sold. It is also important
to consider the effect that cutting duty on one type of alcohol
would have on the demand and therefore the revenue from other
types of alcohol and all other goods. A change in the price of,
say, beer will lead to a re-allocation of spending between beer
and all other goods. The effect is likely to be greatest on the
demand for other types of alcohol because of characteristic similarities
between different types of alcohol. If beer and wine are complements,
then when the price of beer falls (following a tax cut) people
buy more beer and also more wine. This means there will be an
increase in revenue from wine so we are more likely to see an
increase in total tax revenue following a tax cut on beer than
would be the case if wine demand were unrelated. If beer and wine
are substitutes then a cut in the tax of beer will lead to an
increase in sales of beer but a fall in sales of wine. The result
would be a fall in revenue from wine so we are less likely to
see an increase in total revenue following a tax cut on beer.
The responsiveness of demand for one good with respect to a change
in the price of another good is called the cross-price elasticity
of demand.
Also important for the total revenue effect is the rate at
which the complement or substitute is taxed. The more heavily
the complement or substitute is taxed relative to the good itself
the more likely the change in revenue on the complement or substitute
will outweigh any opposite effect on revenue on the good itself.
This is because for a given change in demand, the higher the tax
rate the grater the change in revenue.
3. RESULTS
In order to determine whether cutting duty would lead to
an increase or decrease in revenue we need to know expenditure,
current tax rates and own- and cross-price elasticities. We know
current tax rates and expenditure and we use data from the Family
Expenditure Survey from 1979-1996 (about 120,000 households) to
estimate elasticities.
We evaluate the elasticities for the period after the completion
of the Single Market. We might expect a different elasticity in
the South East from the UK as a whole since the fixed cost of
crossing the border is lower so we compare elasticities for the
UK with those for the South East. However, we find no significant
difference between the two. We also might expect the elasticities
for the period after the Single Market to differ from those before
since consumers now have an additional way in which to respond
to an increase in price. We test whether the elasticities for
the two periods are different, but again we find no significant
difference. Since the elasticities are not significantly different
in the South East or in the different time periods, the elasticities
that we use to determine the revenue effect of cutting duty are
those for the whole of the UK after the Single Market. The elasticities
are reported in table 3[14]
(with standard errors in brackets).
Table 3
ESTIMATED ELASTICITIES FOR THE UK
The numbers in the table show the change in the quantity
demanded of the drinks in each column with respect to changes
in the price of the drinks in each row. The diagonal elements
are the own-price elasticities. For example, the own-price elasticity
of beer is-0.76. This means that if the price of beer falls by
1 per cent there will be a 0.76 per cent rise in the quantity
demanded of beer. Of these three types of alcohol, beer is the
least price responsive and wine is the most although they are
not significantly different from each other.
Equally important are the cross-price elasticities. The number
in the first row of the wine column shows the change in the quantity
demanded of wine with respect to a change in the price of beer.
Since this number is negative it tells us that an increase in
the price of beer would lead to a fall in the demand for wine
so beer and wine are complements. The amount by which demand would
fall for a 1 per cent increase in the price of beer is 0.6 per
cent. The fact that beer and wine are complements means that if
duty on beer was cut, demand for wine would rise so there would
be an increase in revenue from wine. Since the cross-price elasticity
of spirits and beer is negative, these drinks are also complements
whereas the cross-price elasticity of spirits and wine is positive
which means they are substitutes.
Table 4 summarises the effect that cutting duty would have
on its own sales and revenue and on sales and revenue of the other
types of alcohol.[15]
Table 4
THE EFFECTS OF TAX CUTS ON REVENUES
| | Cut in beer duty
| Cut in wine duty
| Cut in spirits duty
|
| Effect on | Sales
| Revenue | Sales
| Revenue | Sales
| Revenue |
| Beer | Increase
| Decrease | Increase
| Increase | Increase
| Increase |
| Wine | Increase
| Increase | Increase
| Increase | Decrease
| Decrease |
| Spirits | Increase
| Increase | Decrease
| Decrease | Increase
| increase |
| Overall |
| Decrease |
| Decrease |
| at max |
A cut in beer duty will lead to an increase in sales of beer
but the important question is whether sales increase by enough
to outweigh the fall in duty on each unit sold. Beer is not very
price responsive and so the increase in sales is not enough meaning
that a cut in beer duty would lead to a fall in revenue on beer.
But we also have to take into account the effect that a cut in
beer duty would have on wine and spirits revenue. Beer is a complement
to wine so a cut in beer duty would lead to an increase in sales
of wine and so an increase in revenue from wine. Beer is also
a complement to spirits so again a cut in beer duty will lead
to an increase in sales on spirits and this means an increase
in revenue on spirits. The increase in revenue from wine and spirits
would offset the loss of beer revenue but not by enough. Overall
we find that a cut in beer duty would lead to a fall in indirect
tax revenue.
A cut in wine duty will lead to an increase in sales of wine.
Wine is the most price responsive of the three types of alcohol
and unlike beer, we find that the increase in sales following
a tax cut is sufficient to outweigh the loss of revenue per unit
sold meaning that a cut in wine duty would lead to an increase
in revenue on wine. Beer and wine are complements so there would
also be an increase in sales of beer and revenue from beer. However,
the effect on spirits works in the other direction. A cut in wine
duty would decrease sales of spirits (since wine and spirits are
substitutes) and so reduce revenue from spirits. Since spirits
are taxed the most heavily this effect is relatively large and
overall it offsets the increase in revenue from wine and beer.
Overall we find that as for beer, a cut in wine duty would lead
to a fall in indirect tax revenue. This shows the importance of
taking the cross-price effects into account.
A cut in duty on spirits would lead to an increase in revenue
on spirits. Beer is a complement to spirits so a cut in spirits
duty would lead to an increase in beer sales and an increase in
beer revenue. But, since wine is a substitute for spirits, a cut
in spirits duty would lead to a fall in sales of wine and this
means a fall in revenue from wine. Overall we find that we can't
reject the hypothesis that the duty rate on spirits is at the
revenue maximising rate. This means there is little scope for
the Chancellor to increase indirect tax revenue by increasing
or cutting duty on spirits since at the current tax rate he is
already getting the maximum amount of revenue.
4. CONCLUSION
The Chancellor faces a dilemma. If he cuts duty on beer,
wine or spirits he would probably reduce the amount of cross-border
shopping but the result would be further revenue losses. Our results
suggest in fact, that the Chancellor could get more revenue by
increasing the tax rate on beer and wine. Spirits are different
however, because there is little scope to increase indirect tax
revenue by increasing the tax rate.
Our research addressed the very specific issue of whether
the Chancellor would lose or gain revenue by cutting duty on alcohol.
The results don't mean that there are no reasons for cutting duties
to reduce the volume of cross-border shopping but they do mean
is that it is likely to cost the Chancellor revenue. It is also
important to remember that there are other reasons for taxing
alcoholic drinks apart from raising revenues. Perhaps the main
reason, and part of the reason why taxes on spirits have been
high historically, is to do with the health effects of over consumption.
IMPLICATIONS FOR
THE SCOTTISH
DRINKS INDUSTRY?
The study did not differentiate alcoholic drinks by region
of manufacture. For example, it does not distinguish Scotch whisky
from other domestically and non-domestically produced spirits.
If the price-sensitivity of alcoholic drinks produced in Scotland
were the same as for alcohol produced elsewhere, then these demand
elasticities could be used in calculating the direct effects which
indirect taxes on alcohol might have of Scottish output and employment.
If the demand elasticities for Scottish produced goods were very
different then these results would be much less relevant. We do
not have any way of checking this with our data.
However, we would guess that main respect in which these
results are relevant to the Scottish Drinks Industry relates to
the conclusion draw for spirits. This is because Scotch whisky
is one of the largest single components of UK domestic spending
on spirits accounting for about one third. Given this large market
share we would not expect the results for Scotch to be markedly
different from those for spirits in general. Furthermore, the
majority of UK gin and vodka comes off bottling lines in Scotland.
As a result it would seem that a large proportion, and perhaps
even the bulk of the spirits spending observed in our data is
on goods which are, at least in part, produced in Scotland. The
own price elasticity is low (less than minus one in absolute terms)
so the direct output and employment effects in Scotland might
be expected to be lower for spirits than they would be for other,
more price elastic goods. However, the output of the industry
is currently close to being taxed to the maximum extent. Because
of the pattern of complementarities between spirit and other goods,
and the high tax rate imposed on spirits, if simply raising further
tax revenues were the aim of government then further increases
in the tax on spirits may be counterproductive. Of course, raising
revenue is not the only reason for taxing goods. Taxes are also
used to try to discourage activities that are bad for the environment
(petrol taxes for example) or bad for the individual (over consumption
of alcohol for example). These types of concern would provide
a rationale for taxing such a good past the point of revenue maximisation.
The Institute for Fiscal Studies
January 2001
12
Pre-Budget report, November 1999. Note that in our analysis we
do not need to measure the level of cross-border shopping directly
to estimate the effect on tax revenues of excise duty changes. Back
13
Total receipts are calculated from figures of duty receipts taken
from HM Customs and Excise (1998) plus an amount for VAT based
on data from Consumer Trends (1999). Back
14
There are no statistically significant differences between these
elasticities and the ones published in M. Chambers, (1999) "Consumers'
demand and excise duty receipts equations for alcohol, tobacco,
petrol and DERV", Government Economic Service, Working
Paper No 138. Back
15
Note that we assume that producers and retailers pass the tax
on change on in full to consumers. Back
| 
