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Design of optimal corrective taxes in the alcohol market

IFS Working Paper W17/02

Alcohol consumption is associated with costs to society due to its impact on crime and health. Tax can lead consumers to internalise these externalities. We study optimal corrective taxation in the alcohol market. We allow for the fact that the externality generating commodity (ethanol) is available in many di fferentiated products, over which consumers might have heterogeneous preferences, and that there may also be heterogeneity in marginal externalities across consumers. We show that, if there is correlation in preferences and marginal externalities, setting different tax rates across products can improve welfare relative to a single tax rate on ethanol. We estimate a model of demand in the UK alcohol market and numerically solve for the optimal tax rates. Moving to an optimal system that taxes alcohol types at different rates would close half of the welfare gap between the current UK system and the fi rst best.

Watch IFS researcher, Kate Smith, talking about the design of alcohol taxes.

A more recent version of this working paper is available here.

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Presentation
Presentation given at CREST, Paris.
Video clip
Presentation
This presentation was given by Kate Smith at the Public Economics Lecture Day on 6 January 2017.
Presentation
Alcohol consumption is associated with costs to society due to its impact on crime and health. Tax can lead consumers to internalise these externalities.
External publication
Governments have long used taxation to correct for the socially costly overconsumption of alcohol, but as the external cost of overconsumption varies across drinkers, a single tax rate is not optimal. This column argues that variation in preferences for different products and in price ...
IFS Working Paper W17/28
We study optimal corrective taxation in the alcohol market. Consumption generates negative externalities that are non-linear in the total amount of alcohol consumed. If tastes for products are heterogeneous and correlated with marginal externalities, then varying tax rates on different products ...
Video clip
Newspaper article
Heavy drinkers have a higher social cost than other drinkers and are more responsive to changes in alcohol prices, say the Institute for Fiscal Studies. So why not raise taxes on the high-strength drinks they most often consume?