In defense of the taxman

I'm not sure that NZ excise should take all the blame here.

The popular New Zealand wine Oyster Bay is being sold at home for nearly double the price seen in the United States - but the winemaker says Kiwis should blame the taxman for the difference.

Two pictures of the 2012 sauvignon blanc were taken within 24 hours of each other by the NZ Herald.

One of the bottles was on sale in Mt Eden Countdown in Auckland for $25.99, while the other was on sale for US$11.99 - the equivalent of NZ$14.30 - at Eastport Liquors from Annapolis in the state of Maryland.

Eastport Liquors wine manager Glenn Norris said the wine was popular and he'd sold 40 cases in the past year. "I've got five bottles on the shelf left ... I can tell you for a little store like ours that's pretty darn good."

He was astonished by the New Zealand price. "Wow. I don't know why it would be any cheaper here than there, it doesn't make any sense to me."

He said his purchase price tended to float, although the worst-case retail scenario - including taxes - would be US$16, or $19.08.

Recall that excise in New Zealand for wine is $2.7609 per litre for wine up to 14% alcohol. So excise tax is $2.07 of a 750 mL bottle. GST is 15% of the total retail price including excise.

So a $26 bottle of wine is $22.61 ex-GST, and $20.54 ex-excise. That still has the NZ price more than 40% over the US price.

I'm not sure I'd "blame" the taxman on the GST component: New Zealand, rightly in my view, collects more of its revenues from a very broad-based GST, and consequently less from property and income tax. Stripping out the GST component has alcohol excise responsible for $2.07 of an $8.31 price difference: a quarter of it. I'm definitely not one of the folks that thinks excise on alcohol is too low. But it doesn't explain much of the noted price difference.

Where to lay the blame for the rest?

1. NZ supermarkets tend to run large temporary discounts on popular brands like Oyster Bay, and I'd bet that they shift most of their volumes of those products when they're on special - the everyday price then serves more to make the sale price look better and is only paid by suckers. And I'm pretty sure I've seen Oyster Bay on special around the $18 mark: $15.65 ex-GST, or $13.58 after also taking out excise. 
2. Oyster Bay potentially having contracted with a US wholesaler in $US terms when the Kiwi dollar was much lower than it now is: at a $0.74 exchange rate, that $12 US bottle would have been $16 NZD, not $14. 
3. Potential price discrimination across markets by the producer.
4. Generalised "Everything is more expensive in New Zealand" problems. 

I put the most weight on potential explanations 1 & 2.

Paying for roads

National has announced that petrol excise will increase for the coming three years. Some of my Twitter stream has been suggesting they're doing this to patch up the budget rather than to cover roading expenses. Can't it do both?

The most recent year-end financial statements, those for the year to June 2012, had the government receiving:

• Road user charges of $1,045 million
• Petrol fuels excise of $1,478 million ($847 million on domestic production; $631 million on excise-equivalent duties on imports)
• Motor vehicle fees of $175 million.

So about $2.7 billion in revenues for roads.

Vote.Transport in Budget 2012 had just under $3.4 billion for the National Land Transport Programme, of which a substantial portion was a loan from the Crown for cashflow management. A quick adding-up of the real expenditures on road related stuff looks like $2.6 billion in road spending - about what they collected in revenue. I expect that the loan that's on the books is for expenditures perhaps having been front-loaded during the year with excise dribbling in throughout the year, but perhaps somebody with more familiarity with the Crown Accounts can correct me if I have that one wrong. 

Simple cost inflation would require that petrol excise and road user charges increase if next year's roading expenditures are the same in real terms as they were this year. If the government has any plans on spending more on roads next year than it did this year, then excise has to go up by more than that. I note also that Note e of the Financial Statements, page 129, includes the following:

"Other earthquake costs do not include costs associated with the future repair of local roadways. This exclusion reflects that the first call for funding these future expenses will be from dedicated ring-fenced revenue in the form of road user charges, fuel excise duties, and registration fees paid to the New Zealand Land Transport Fund. Should the Government's share of the costs associated with the future repair of local roadways exceed the amount available from that ring-fenced revenue, the Government has a number of options to allocate future to this expense. The Crown's share of the costs for local roadways remains uncertain, as is the range of funding options available to the Government."

If the Crown's share of roading rebuild costs has increased, then petrol excise rising to cover it isn't crazy either.

A reasonable argument against the excise increases would be an alternative of issuing roading bonds to be paid off over a longer period of excise revenues, so the burden of current road construction is spread across future road users. And that would be reasonable for one-off shocks like the Christchurch earthquakes. But if every year we have to spend some amount to maintain the stock of existing roads, and some amount to build new roads to match population growth, and if the annual increases in the roading stock are roughly the same from year to year, then the annual burden should work out to being roughly the same under either regime.

I don't think there's sufficient evidence to conclude that National's ramping up petrol taxes as a deficit-fighting measure, except inasmuch as it allows the government to continue building roads without drawing on revenues coming from outside the National Land Transport Fund. But I suppose that next year's budget will reveal whether that's right. It would be rather disappointing if the government were using petrol charges to raise funds for other purposes, but I expect that will not turn out to be the case.

As for whether the Government will produce a surplus ... iPredict says there's a 15% chance for 2014/15.

Update: Liberty Scott posts something useful in the comments; I'm hoisting it up here. If the new roading expenditures are a one-off rather than part of an ongoing set of construction projects, then it really makes far more sense to use debt to finance them.  Here's Liberty Scott:

The fundamental problem is that the current capital expenditure on major roads is a one-off, as it really is a bunch of projects that have at best marginal economic benefit. There wont be equivalent major projects ever built again, so there is a major problem with the PAYGO funding system paying for capital the year it is built, even though that capital has a depreciated life (particularly if you consider earthworks and tunnels which largely never deteriorate) of 90 years +.

What should have been done is that the state should have borrowed for those projects and paid for them over many years, but MoT has been almost wilfully blind to this issue. What ought to happen in future is that there should be less long term spending on roads, because the network will largely be built out by the time all of the RoNS are finished.

Tobacco plain packaging, if we cared about evidence

The Science Media Centre provides an expert round-up of commentary on a new paper finding, unsurprisingly, that people like branded tobacco packs more than they like plain packs. What's more relevant for policy, and what we really have no clue about, is whether changing the branding on packages has effects on aggregate sales or whether it works instead to break brand loyalty and move consumers to lower-cost no-name packs. As Professor Richard Edwards noted in his plenary address to the Oceania Tobacco Control Conference in Brisbane last October:

Plain packs have not been implemented, so evidence of the probable population impact must come from experimental studies, focus groups, surveys and so on; rather than rigorous controlled studies of the impact of the actual intervention in the real setting, as would be the ideal.

If we cared about knowing whether tobacco plain packaging has any effect, we could find out pretty easily. Set the whole thing up as a randomized policy trial. Some parts of the country get plain packs, some parts don't, and watch what happens over the subsequent few years. I'd sketched out a framework for that kind of trial back in April. Even better: if Australia is implementing the same policy, run the trial across both countries.

Instead, we're designing policy to avoid ever being able to find out whether it's had any effect. In Oz, they're bundling plain packaging with a simultaneous national increase in tobacco excise taxes. The effects of price increases will be hopelessly confounded with the effects of plain packaging unless there's reasonable ex ante state level variation in tobacco prices.

The price of cigarettes would rise to $20 a pack under a Gillard Government proposal that would reap an extra $1.25 billion a year in taxes.

The West Australian understands the Government is considering a 25 per cent rise in tobacco excise that would raise $5 billion over four years.

The plan emerged from a Treas- ury reconsideration of so-called "sin" taxes. It would repeat the financial windfall from an identical move in 2010.

The proposal is in line with long-standing advice from the National Preventative Health Taskforce and would lift the price of a pack of 30 cigarettes by $2.62.

Peter Jackson 30s, now about $18.30, would cost almost $21 under the measure and the price of Dunhill 25s would increase $2.18, taking the retail price to more than $19.50.

The excise increase may be timed to coincide with the introduction of mandatory plain-packaging for tobacco products on December 1. [emphasis added]

International research has found there is a 4 per cent fall in smoking rates for every 10 per cent increase in price. Anti-smoking crusader and Curtin University Professor Mike Daube said higher cigarette prices would discourage children and people on low incomes from smoking. "An excise increase sooner rather than later could also prevent tobacco industry efforts to subvert the impact of plain packaging by lowering prices," he said.

There are non-crazy reasons for wanting to bundle excise increases with plain packaging. If, absent brands, smokers see there being less difference between low cost off-brand cigarettes and higher cost branded cigarettes, they may substitute down to the lower cost cigarettes and then smoke more - I expect this is the main worry of the tobacco industry as they make their returns on the branded product. Consumption goes up but margins go down more than proportionately. Countering this with excise increases isn't entirely nuts if you want to curb smoking rates, but it makes it awfully hard to tell whether plain packaging does anything other than destroy the value of the tobacco companies' brands.

I still think a randomized policy trial is what's needed if we care about finding out truth rather than just beating up on Big Tobacco.

Tobacco excise incidence

The latest paper by Callison and Kaestner* makes me a bit more worried about the incidence of Tariana Turia's proposed excise increases. Recall that the MoH is modelling things using a fairly high estimate of price elasticity of demand. At paragraph 55 here, MoH says:

the price elasticity of demand (ie. the extent to which each percentage increase in the tobacco price causes consumption to fall) - current estimates are that each 10% rise in tobacco prices will engender about a 4-5% drop in tobacco consumption, but based on recent Treasury revenue returns and behavioural research by Auckland University, there is emerging evidence that price responsiveness may be increasing.

Presumably the -0.4 to -0.5 elasticity estimate is what they had NZIER use in their analysis; MoH seems to be suggesting this is a lower bound.

Callison and Kaestner start by surveying the existing literature.  My clipping from their survey:**

• Lewit and Coate (1982): adult smoking participation elasticity (age 35+) of -0.15; younger smokers more elastic.
• Evans and Farrelly (1998); Farrelly et al (2001): same dataset as above; younger smokers respond to price changes; adults aged 40+ not responsive.
• Wasserman (1991): Adult participation elasticity -0.17 in 1985.
• Ohsfeldt (1998): Participation tax elasticity for teen and young adult males of -0.15 to -0.22, but only -0.07 for males over age 45.
• Tauras (2006): Same dataset as Ohsfeldt but more recent years' coverage: participation elasticity among adults 18+ of -0.12.
• DeCicca and McLeod (2008): Post-2001 data. Participation elasticity of -0.3 for 45-59 year olds and -0.2 for 45-64 year olds. 
• Gallet and List (2003): A survey of existing elasticity estimates giving a price elasticity of demand (I read this as combination of participation and intensity elasticity) of -0.32 for adults aged over 24.

When O'Dea ran his analysis, he used a price elasticity of demand of -0.5 and a participation elasticity of -0.2. 

Callison and Kaestner use a difference-in-difference method comparing smoking prevalence in states with large excise increases with those in states that didn't increase taxes. Among adults, they found participation and price elasticities of demand on the order of -0.02 to -0.05: a 10% tax increase reduces consumption by -0.5% or less, not 2% and not 5%. They write:

Considering all the evidence, we conclude that there is insufficient justification for the widespread belief that raising cigarette taxes will significantly reduce cigarette consumption among adults, even young adults. Our evidence suggests that, at best, increases in cigarette taxes will be associated with a small decrease in cigarette consumption and that it will take very sizeable tax increases, on the order of 100%, to decrease smoking by as much as 5%.

Maybe that's why the Australian Treasury modelled tobacco excise revenues on the assumption that excise revenues will be increasing.

Recall that, on an assumption of a -0.2 participation elasticity, O'Dea reckoned that, for a 20% price increase, 129,200 households in the bottom four deciles that continued to smoke would suffer losses of $396 per household; these were balanced by gains to 5,400 quitting households of $2,988 per household in cash savings (no accounting for reduced consumption benefits for those who enjoyed smoking) plus 2 Quality Adjusted Life-Years in each household. They value a QALY at $50k. So losses to non-quitting households for the 20% tax increase total $51.2 million while gains to quitting households total $16.1 million plus $540 million in QALY benefits. 

Callison and Kaestner say that the participation elasticity isn't -0.2, it's -0.05 to -0.02. What happens if you simply halve O'Dea's participation elasticity estimate to -0.1? Then half as many households quit: we have 2700 quitting households (in the bottom 4 deciles) enjoying aggregate cost savings of $8 million  plus $270m in QALY against 131,900 non-quitting households paying an extra $52.2 million in tax. If we go all the way to the -0.02 estimate, then a tenth as many households quit: 540 quitting households gain a total of $55.6 million (including QALY) and 134,060 non-quitting households suffer aggregate losses of $53.1 million.

The O'Dea numbers are calibrated around a 20% price increase from 2005 prices and prevalence levels that then obtained; MoH has been talking about excise increases well in excess of that. I'd be nervous about applying the Callison and Kaestner estimates to New Zealand as total prices here are well in excess of anything they'd have in the US data. On the other hand, non difference-in-difference estimates from the US aren't crazily out of the ballpark on participation elasticities: O'Dea was using -0.2, which is well in line with the US studies that used somewhat less sophisticated techniques. 

Note as well that if reduced effective income hurts QALY measures, then we perhaps need to add QALY costs on the non-quitting side as the poorest households effectively get poorer. 

Another cool bit of the Callison and Kaestner paper: they use only MSA data and correct for distance to nearest lower-tax jurisdiction to try to correct for leakage from smuggled product - the find little effect on their estimates from cross-border purchases. But if it is the case that smuggling rings are a bit more organized and folks with semi-loads of smokes from lower-tax jurisdictions don't much care whether they're driving 50 miles or 250 miles, then smuggling might still confound their measure: it probably well captures individuals' decreased likelihood to drive out of state to get smokes, but it might not catch organized groups handling the transport. As each state has its own particular tax stamp for cigarette packets, such opportunities may be limited. 

If New Zealand goes ahead with very large tobacco excise increases, the government might consider some offsetting income tax cuts for lower decile groups. Callison and Kaestner didn't split their sample by income decile rather than just by age group to see whether price responsiveness varied by income; price elasticities split by income could be important in assessing overall incidence of the NZ changes. But as smoking is fairly concentrated among lower decile groups, overall estimates likely aren't far from estimates restricted to lower decile groups. 

It could also be fun to have iPredict run markets on aggregate tobacco excise revenues over the next few years. 

* Previously noted here.

** Note that the participation elasticity is the percent change in the proportion of the sample who report smoking given a percent change in the price. So if a 10% price increase is associated with 5% of the sample quitting, the participation elasticity would be -0.5. MoH above is using a total consumption elasticity that combines those quitting with reductions in smoking among those who don't quit entirely. Callison and Kaestner also list some of the smoking intensity elasticities: the percentage change in the amount that you smoke (conditional on your smoking) given a percentage change in price. These values are usually about half of reported participation elasticities.

Minimum pricing

What would the world have to look like for minimum alcohol pricing to be a reasonable policy solution?

Suppose it is the case that harmful heavy drinkers, the sort that impose the greatest harms on others when they consume alcohol, really don't care about the quality of the alcohol they're drinking; they're buying whatever product provides alcohol at the lowest price per standard drink. Suppose further that this cohort's consumption is reasonably responsive to price measures: if you raise the price of the cheapest form of alcohol, you'll do a lot to curb that cohort's consumption while not doing much to reduce the normal consumption of moderate drinkers. Finally, assume that there's little overlap between the kinds of alcohol consumed by harmful drinkers and that consumed by moderate low-income drinkers.

In that kind of a world, minimum pricing on alcohol makes more sense than broader-based alcohol excise tax increases: you can get more reduction in harmful drinking at lower spillover cost to moderate drinkers than by simply increasing excise. A quick Google search suggests lab grade 95% pure ethanol sells for less than $7 per litre if you buy in bulk, or less than $0.10 per standard drink. In this hypothetical world, only harmful drinkers ever go for that product. Typical moderate drinkers instead choose something like, say, Glenmorangie 10 year old single malt. That scotch currently sells for $77 and includes 280 mL of pure alcohol, so just under $14 is excise. With no excise, Glenmorangie would sell for $2.86 per standard drink. If you wanted a $2 minimum price per standard drink, you'd have to charge $1.90 per standard drink to do it via excise to make sure you're charging enough on the lab grade alcohol. But that would load a lot of costs onto the moderate drinkers who then forgo enjoying a harmless bit of scotch before bed.

But are we in that kind of world?

First, in the real world, lower tier product is consumed not just by harmful drinkers looking for the lowest per-unit cost product. A lot of it also is consumed by moderate drinkers of lower income. The more overlap there is between low income harmless drinkers and harmful drinkers in product choice, the less attractive is minimum price in avoiding harming moderate consumers. As David Farrar likes to point out, under Labour's preferred $2 minimum price per standard drink, you could not buy a bottle of wine for less than $16. Most of the wine I purchase runs between $12-$18 per bottle; there are pretty decent wines available in the $8-10 range too, if we watch for specials. If we were in a lower income bracket, we'd be sticking with the $8 bottles. A $2 minimum price would double the cost of our consumption were we sticking with the bottom end of the drinkable price range. And, harmful drinkers also might be choosing the Glenmorangie too.

Second, where both heavy drinkers and moderate drinkers are choosing the same kinds of products, albeit in different quantities, we have to worry a lot about how each kind of consumer responds to changes in prices. The best meta-study on the topic remains Wagenaar, who found that heavy drinkers are roughly 60% as price responsive as moderate drinkers: the price elasticity of demand among heavy drinkers is -0.28 while it's -0.44 for average drinkers. If we doubled the price of lower cost products, which we'd have to do to get to Labour's preferred $2 minimum price per standard drink, moderate drinkers who currently choose that class of product would cut back their consumption by about 44% while heavy drinkers would reduce their consumption by only about 28%. A new paper in Drug and Alcohol Review confirms this kind of finding using data from the Australian National Drug Strategy Household Surveys. From their abstract:

A 1% increase in the price of alcohol was associated with a statistically significant increase of 6.41 days per year on which no alcohol is consumed (P ≤ 0.049), and a statistically significant decrease of 7.30 days on which 1–4 standard drinks are consumed (P ≤ 0.021). There was no statistically significant change for high or moderate-intensity drinking.

People respond to prices changes, but changes in average consumption levels are less informative than changes in consumption patterns. The study above finds that, when drinkers cut back on their consumption with price increases, they tend to do it by reducing the number of days in which they have small amounts of alcohol rather than the number of instances of heavier drinking. Wagenaar found that heavy drinkers respond less to price changes on average than do moderate drinkers; if that responsiveness comes from the least harmful parts of heavy drinkers' consumption, then the benefits of price increases in terms of harm forgone are overstated. If the J-curve is right, we're then imposing harms on light drinkers while not doing a whole lot to reduce the harms imposed by heavier drinkers.

If moderate and harmful drinkers consume similar products, albeit in different quantities, and if harmful drinkers are less responsive to price increases than are moderate drinkers, then it's harder to build a case for minimum pricing over excise as mechanism for internalising external harms from consumption; it's an even blunter instrument than is excise.

But, I don't think we can say that minimum pricing just transfers money to the brewers and distillers. Unless there are other bottlenecks in the system, we should expect that competition among producers and retailers would lead to products at the bottom end of the market disappearing unless they can be usefully bundled with things that consumers care more about than marginal increases in drink quality: packaging improvements, promotions, or free complementary goods like t-shirts or shot glasses. There will be deadweight costs where moderate drinkers preferring lower-cost product are forced to purchase products more expensive than they'd prefer, but these are attenuated to the extent that retailers or producers are able to get around the regulations by including, say, lotto tickets with lower quality products. If instead restrictions on liquor permits give some retailers local monopoly powers, minimum pricing will yield rents for those retailers that will be capitalised into the value of the firm. I'd walked through this two years ago.

If we are comfortable in imposing disproportionate consumption harms on moderate drinkers of low income and if harmful drinkers disproportionately consume lower priced product, then a minimum price plus excise can get around one of the stickier problems with excise. A linear excise tax that matches the average external harm from consumption necessarily undercharges harmful drinkers and overcharges moderate drinkers relative to the external harm each imposes: harms from heavy drinking rise nonlinearly in consumption while excise rises only linearly. A minimum price combined with a lower alcohol excise rate lets you impose lower costs on moderate consumers of products of higher inherent cost while still doing something to curb harmful drinkers' consumption; the collateral damage comes from consumption reductions among light to moderate drinkers who prefer cheaper product. I'm not comfortable with the collateral damage, especially in the absence of strong evidence that heavy drinkers disproportionately choose bottom cost-tier products. I'd also expect reasonable substitution into home brewing and home distillation if prices got anywhere near $2/standard drink.

What can we do if minimum price is a poor instrument and excise is blunt? Combine excise with measures directly addressing the harms imposed by harmful drinkers. For example:

• a drunk tank with medical attendants for those drunk and disorderly;
• greater investment in treatment for those whose offending seems related to addiction issues, albeit with the caveat that effects at the margin are likely lower than effects on average among the cohort of those who have thus far been able to access treatment;
• drunkenness isn't a defence to a drink-driving charge; making "while intoxicated" an exacerbating factor in sentencing for other offences might help;
• At least some of the public pressure for increasing the alcohol purchase age comes from that drunk teenagers are annoying. Instead of increasing the alcohol purchase age, implementing a minimum age for being in possession of alcohol without parental permission can do wonders in making drunken teenage parties more discreet. Note too, though, that there is no demonstrable increase in youth alcohol consumption since the alcohol purchase age was reduced to 18.