The Fiscal Impact of Raising Texas Alcohol Taxes

Transcription

1 Texas Perspectives, Inc. The Fiscal Impact of Raising Texas Alcohol Taxes Presented to January 20, 2002 PAGE 1

2 The Fiscal Impact of Raising Alcohol Taxes in Texas. An Analysis by Texas Perspectives, Inc. MAJOR FINDINGS Bringing Texas beer and liquor taxes in line with the national average and raising the mixed beverage tax by one percent provides a win-win situation that would both increase state revenues and reduce state costs. Bringing Texas beer and liquor taxes in line with the national average and raising the mixed beverage tax by one percent would generate an estimated $91 million in new revenue for Texas state coffers in Alcohol (especially beer) is not an especially price sensitive commodity. In other words, higher alcohol prices do not generally result in substantial drops in consumption. As such, a modest increase in Texas alcohol taxes would generate significant new revenue. In addition to generating new revenue for state coffers, raising Texas alcohol taxes could lead to modest reductions in alcohol consumption and abuse, especially among under-aged youth and young adult drinkers who are typically more price sensitive. A one percent drop in demand for alcohol would yield an estimated positive state fiscal impact of nearly $59 million in This figure includes both direct (e.g., reduced spending on treatment, medical care) and indirect state benefits (e.g., increased productivity). The total fiscal impact of raising Texas alcohol taxes is conservatively estimated at $152 million in 2004 (this amount includes $91 million in new tax revenues plus $59 million in direct and indirect savings related to reduced levels of alcohol abuse). Bringing beer and liquor taxes in line with the national average and raising the mixed beverage tax by one percent would have a marginal impact on the cost of alcohol for Texas consumers. For example, doubling the state excise tax on beer to $12 per barrel would increase the average cost of a beer by only about 2.5 cents. If current trends continue, Texas taxpayers will face $5.81 billion in alcohol-abuse-related costs by 2004 the equivalent of $216 per person. Costs include direct state expenditures like PAGE 2

3 treatment costs, and more indirect costs like increased crime and lost productivity. PAGE 2

4 BACKGROUND Texas collects five alcohol taxes, three of which comprise the vast bulk of alcohol-related revenue to the state. Texas tax levels on alcohol are well below the national average. More than a decade has passed since the Texas Legislature last increased taxes related to alcohol. To restore the same real tax value of excise taxes established back in 1984, lawmakers would need to raise alcohol-related excise taxes by about 77 percent. Alcohol-related excise taxes generated about $520 million in revenue during 2000 representing only 2.1 percent of the state s total tax collections compared to 3.1 percent in 1985 (the year following the last increase in alcohol taxes). In fiscal year 2000, Texans paid an average of $25 per year in state alcohol taxes. The actual tax burden per resident is arguably lower since tourists and visitors pay a considerable amount of the tax. Overall, Texans consume five percent more alcohol per capita than residents in other states. TEXAS ALCOHOL TAXES TAX State Mixed Beverage State Liquor Tax State Beer Tax Note: TAX RATE & BASE 14% on permit holder gross receipts $2.40 per gallon (wholesale) $6.00 per barrel (wholesale) TAX RATES PER SERVING 70 cents per drink 2.7 cents per 1.5-oz serving 1.8 cents per single 12-oz beer. LAST TAX INCREASE COMPARISON WITH NATIONAL AVERAGE 1990 No corresponding federal tax % below national average % below national average The tax on airline and passenger train beverage sales, malt liquor and wine sales were not considered because of their relatively small fiscal impact. Alcohol sold at retail also is subject to the state 6.25% sales tax, and local levies.

5 Overview Taxes on the sale and/or consumption of alcohol are important to policymakers for at least two reasons. First, they have long been a reliable and significant source of revenue to fund government operations of all types. In the year 2000, for example, the State of Texas collected about $520 million through a variety of these alcohol taxes. Second, to the extent that higher prices lead to reduced consumption and/or abuse of alcohol, these taxes thus represent an additional policy variable for decision-makers interested in influencing a wide variety of social problems, such as the rising incidence of fetal alcohol syndrome, traffic accidents and fatalities, domestic and societal violence, underage drinking, labor market productivity effects, and the long-term health care costs of alcohol abuse. Amid rising concern over Texas fiscal status, policymakers are paying close attention to opportunities to both increase revenue and reduce costs. Raising alcohol taxes would appear to accomplish both. Since demand for alcohol appears to be relatively inelastic (i.e., not very price-sensitive), raising the effective price (which is the net effect of a tax increase) will yield only a modest reduction in consumption in the near term, meaning that a significant amount of additional tax revenue will generated. The following table illustrates, and is based on the assumption that beer and liquor taxes are brought in line with national averages while the gross receipts tax on mixed drinks is raised one percentage point. The results are enlightening; this seemingly marginal change in tax rates would net the State approximately $93 million in additional tax revenue in The Fiscal Impact of Increased Alcohol Taxes in 2004 CATEGORY EXCISE TAX IMPACT SALES TAX IMAPCT PRICE QUANTITY IMPLIED SAVINGS IN ABUSE-RELATED SPENDING Raising the Beer Tax 28% $32.1 million $2.0 million 0.87% -0.26% $43.3 million Raising the Liquor Tax 56% $26.2 million ($1.5 million) 3.28% -4.92% $12.9 million Raising the Mixed Drink Tax $32.7 million $1.7 million 1.18% -0.24% $2.6 million 5

6 One Percentage Point TOTALS $91.0 million $2.2 million 1.41% -1.28% $58.9 million Even the modest reductions in demand observed under this scenario yield an additional positive impact to the state budget in the form of reduced expenditures related to alcohol abuse. As has been well-documented, alcohol and substance abuse costs Texas billions of dollars annually; even the small drop in demand expected under this scenario would save the State an additional $58.9 million, putting the initial total annual fiscal impact in excess of $152 million. As a result, increasing alcohol taxes is one of the clearest win-win options presently available to policymakers, since, depending on consumer price-sensitivity, it either generates substantial tax revenue or causes a significant reduction in abuse-related costs. In either case, Texas is better off than under the current system. 6

7 Introduction Taxes on the sale and/or consumption of alcohol are important to policymakers for at least two reasons. First, they have long been a reliable and significant source of revenue to fund government operations of all types. In the year 2000, for example, the State of Texas collected about $520 million through a variety of these alcohol taxes. Although this amounted to only about 2.1 percent of the state s total tax collections last year, it still represents a substantial program funding source. Between 1980 and 2000, these collections increased at an average rate of almost $90,000 per month. The second principal reason for policy interest in these kinds of taxes is more recent in origin. Over the past two decades, economists have increasingly joined in the alcohol policy debate by observing that consumption and especially abuse of alcohol can be reduced through price increases. Taxes imposed by government agencies represent part of the final price to the consumer of alcoholic beverages. To the extent that higher prices lead to reduced consumption and/or abuse of alcohol, these taxes thus represent an additional policy variable for decisionmakers interested in influencing a wide variety of social problems, such as the rising incidence of fetal alcohol syndrome, traffic accidents and fatalities, domestic and societal violence, underage drinking, labor market productivity effects, and the long-term health care costs of alcohol abuse. The principal purpose of this report is to estimate the immediate, short-term fiscal impacts for the State of Texas of increased taxes on alcohol. The complexities involved in looking deeper into the future are well beyond the scope of this investigation. Nevertheless, we provide some discussion of the longer term adjustments that can be expected from increasing state taxes on alcohol, including not just tax revenue impacts but the potentially larger impacts on the costs of providing various public and private social services. The next section discusses the concept of price elasticity of demand for alcohol, and reviews some of the more significant empirical research in this area. This topic is relevant because price changes will typically lead to changes in the quantity 7

8 demanded of any product, including alcoholic beverages. Taxes are a part of the final price perceived by consumers, and if consumer sensitivity to price changes is high, tax increases could actually lead to decreases in tax revenues collected. As will be seen, this is not the case for Texas alcoholic beverages sales, at least not in the short run. Specific Texas alcohol taxes are then reviewed. Current and historic tax levels are reported and the historic collections from different taxes are presented. This establishes both the relative significance of each tax to state coffers and its relative and absolute contributions to the final price to consumers. The fact that existing state excise taxes represent a relatively small and decreasing part of the final price of alcoholic beverages is established, suggesting that tax increases would have comparatively modest impacts on final consumption levels. Consumption patterns and significant demographic factors in the State are then outlined. This provides additional data needed to both estimate and interpret the magnitude of short-run fiscal and other effects of alcohol tax increases. Forecasts of the short-run fiscal impacts of increasing three of these taxes are then provided. These forecasts show that tens of millions of additional dollars could be collected by this means. The reduction in average consumption levels associated with the tax hikes is then used to provide a rough estimate of how the long-term social costs of alcohol dependence and abuse could be affected. These estimates together show that alcohol excise taxes can be a win-win for policymakers; they can be effectively employed to concurrently increase state revenues and reduce state expenditures, and in a way that is almost surely efficient from the societal perspective. Price Elasticity of Demand for Alcohol When the price of any normal consumer good or service is increased, the typical response of consumers is to reduce the amount of that good or service that they purchase. Conversely, if prices decrease, they will typically purchase more. The actual changes in quantities demanded are a matter of considerable interest to the producers of those goods and 8

9 services, and for many goods this price sensitivity is also of great interest to shapers of public policy. Economists have developed a measure to reflect the degree of sensitivity of consumers to price changes: the price elasticity of demand. This measure is formally defined as the relative (or percent) change in quantity demanded divided by the relative (or percent) change in price charged. The measure thus incorporates information about the state of the world before the price change (original price and demand levels) and afterwards (changes in price and demand levels). If demand does not change at all when prices rise or fall, it is said to be perfectly inelastic and the price elasticity measure is equal to zero. This situation describes a good that could be called a necessity the same amount is demanded independent of the price level. Most economic goods are not necessities, however, and the price elasticity will be negative because the price and quantity changes move in opposite directions. The actual magnitude of the elasticity determines whether total revenues (including tax collections) will increase, decrease or remain the same following a price or tax increase. For goods with price elasticities between 0 and 1.0, gross revenues following a price change will rise because the quantity decrease is outweighed by the price increase. For more price elastic goods, the quantity change dominates the price change, and total revenues will fall after a price increase, or rise after a price decrease. Economists also distinguish between short-run and long-run price elasticities. In the long run, consumers have more time and information to respond to price changes by substituting other goods and services for the now more costly one. This means that in the face of a permanent price increase, consumers may reduce their demand somewhat in the immediate future, but they will normally make an even larger adjustment after some time has passed. Price elasticities can vary widely from study to study for a particular alcoholic beverage, and for different types of alcoholic beverages as well. In 1993, for example, Leung and 9

10 Phelps 1 reviewed 15 studies that used data aggregated at the state or national levels. Estimated price elasticities for beer ranged from 0.12 to 1.07 in those studies. Similar ranges were found in estimates of price elasticities for wine and spirits. Leung and Phelps concluded that the best point estimates of price elasticities for use in analyzing these beverages were 0.3 for beer, -1.0 for wine, and 1.5 for spirits. These are the most widely cited estimates in the alcohol abuse literature to this day, and they consequently are the values that are employed in the estimations presented below. There may also be considerable variation in the effective price elasticities for different groups of alcohol consumers. The research in this area is mixed and somewhat inconclusive. But there are strong indications that younger drinkers are more sensitive to price changes than others. This finding is particularly germane for the forging of alcohol policies in State of Texas because of its comparatively youthful population. One of the more recent and extensive studies of price elasticity for younger beer drinkers was completed as a part of the NBER Working Paper Series in Focusing on a U.S. panel of drinkers between the ages of 17 and 27 the age range for which the prevalence of alcohol dependence and abuse is highest, the authors estimated a 0.29 short-run price elasticity of demand, and a long-run price elasticity of more than twice that amount. This discrepancy between short- and long-run elasticities is important because it implies two inter-related things: as time passes following a permanent increase in the excise tax, beverage-specific collections will fall because of even further consumption reductions, but so will the myriad of social costs associated with alcohol use. The authors of this last study also found strong evidence of addictive aspects to beer consumption. This finding is of particular interest to Texas policymakers because of the 1 S. F. Leung and C. E. Phelps, My kingdom for a drink? : A review of estimates of the price sensitivity of demand for alcoholic beverages. In: Hilton, M.E. and Bloss, G., eds., Economics and the Prevention of Alcohol-Related Problems. NIAAA Research Monograph No. 25, NIH Pub. No Michael Grossman, Frank J. Chaloupka, and Ismail Sirtalan, An Empirical Analysis of Alcohol Addiction: Results from the Monitoring the Futures Panels. Working Paper No. 5200, National Bureau of Economic Research, July

11 demographic structure of the state s population, discussed in a later section. Texas Alcohol Taxes There are five specific state taxes applied to the sale and/or consumption of alcohol in Texas, as detailed below. 3 In addition, retail sales of alcohol are subject to the 6.25 percent state sales tax, and to additional, varying levies at the county and city levels. 1. Mixed Beverage Drinks Gross Receipts Tax (Revenue Code 3250): A tax of 14 percent is imposed on the gross receipts of a permittee received from the sale of mixed beverages on the premises of the permittee. The tax has been at this level since 1990, when it replaced the 12 percent levy enacted in It was first established in 1971 at the level of 10 percent. There is no corresponding tax at the federal level. This tax is collected by the Texas Comptroller of Public Accounts (Comptroller). 2. Liquor Tax (Revenue Code 3253): A state wholesale tax on the sale of distilled liquors is imposed at the rate of $2.40 per gallon. The tax has been at this level since 1984, when it replaced the $2.00 levy enacted in The federal levy on liquor is $13.50 per gallon, or almost six times the state assessment. A two percent discount is allowed for timely payment, and the tax is collected by the Texas Alcoholic Beverage Commission (TABC). 3. Beer Tax (Revenue code 3258): A state wholesale tax on the first sale or first importation of beer is imposed at the rate of $6.00 per barrel, based on 31 standard gallons per barrel. The tax has been at this level since 1984, when it replaced the $5.00 levy enacted in The federal tax on beer is three times higher at $18.00 per barrel. A two percent discount is allowed for timely payment, and the tax is collected by the TABC. 4. Wine Tax (Revenue Code 3259): A state wholesale tax is imposed on the sale of wine based on alcohol content. The 11

12 tax is 20.4 cents per gallon for alcohol volume of 14 percent or less, 40.8 cents per gallon for alcohol volume above 14 percent, and 51.6 cents per gallon for sparkling wine. The corresponding federal tax rates are four to six times higher than these levels. A two percent discount is allowed for timely payment, and the tax is collected by the TABC 5. Malt Liquor (Ale) Tax (Revenue code 3265): A state wholesale tax of $0.198 per gallon is imposed on malt liquor containing alcohol in excess of four percent by weight. The tax has been at this level since 1984, when it replaced the $0.165 levy enacted in In this case, the federal rate is about three times higher at $0.58 per gallon. A two percent discount is allowed for timely payment, and the tax is collected by the TABC To put these levies into a more familiar context, consider the different tax rates per serving data presented in Table 1. The beer tax in Texas adds some 1.8 cents to the cost of a single 12- ounce beer. This is about 24 percent below the average for all states. The Texas wine tax adds only about 0.9 cents to a 5- ounce serving, or just under one-third the national figure. At 2.7 cents per 1.5 ounce serving, the Texas liquor tax is about one-third lower than the U.S. state average. Clearly, just in comparison with other states, there would appear to be ample room and reason for increasing Texas alcohol levies. 3 A sixth tax of $0.05 per drink on airline and passenger train beverage sales is not considered here, both because its magnitude is relatively small and it is not readily amenable to modeling within the scope of this study. 12

13 Table 1: Excise Tax per Serving Comparison BEVERAGE CATEGORY TEXAS ALL STATE AVERAGE FEDERAL TEXAS AS PERCENTAGE OF 50- STATE AVERAGE Beer (12 oz.) $0.018 $0.023 $ % Wine (5 oz.) $0.009 $0.029 $ % Liquor (1.5 oz.) $0.027 $0.042 $ % By the time the Texas Legislature next convenes, almost two decades will have passed since most of these state taxes were last increased. In 1985, the first full year following increases in all of these tax rates, combined alcohol taxes accounted for about 3.1 percent of all state tax collections. By 2000 their relative contribution fell by one-third to 2.1 percent, despite an additional increase of two percent in the Mixed Beverage Tax enacted in Over the same period, the purchasing power of a tax dollar declined by 38 percent due to inflation. If the Legislature were to wish to restore the same real tax value established in 1984, these excise taxes should be increased by about 77 percent in the next session. Figure 1 shows how the relative importance of these different taxes has changed over the last two decades. 4 The Mixed Beverage Tax has grown from just over half of all collections in 1981 to almost 70 percent by The share of the Beer Tax was cut by one-third, from 28 to 19 percent, while the relative contribution of the Liquor Tax was halved, from almost 19 percent to just over 9 percent. Together, these three taxes accounted for 97.7 percent of alcoholic beverage consumption taxes in Figure 1: Alcohol Tax Revenues by Type as a Share of Total The declining shares of the beer and liquor taxes are primarily due 70% to the fact that they are calculated on the basis of the physical quantity sold rather than the final price to the purchaser. 60% This means that they are inherently insensitive to inflation following their implementation. In contrast, the Mixed 50% Beverage Tax is calculated as a percentage of the gross receipts 40% 4 30% The Wine and Malt Liquor taxes are excluded from this graph because they collectively represent only about two to three percent of state alcohol consumption tax collections 20% throughout the period. 10% 0%

14 of the vendor, so when sellers raise prices to account for inflation this tax is automatically indexed. In fiscal year 2000, all six of these state alcohol taxes combined averaged just under $25 per resident of the state, or about $2 per month. When it is recognized that many of these levies are collected from out-of-state visitors, the actual tax burden on the typical Texas resident is even lower. Furthermore, because federal levies are several times higher for all categories of alcoholic beverages, the excise taxes imposed by the State of Texas represent a relatively small part of the final price of alcohol to the user. It would thus appear that there is a considerable opportunity to increase these state taxes without unduly burdening Texas consumers. Consumption Trends and Demographic Conditions in Texas The Texas Alcoholic Beverage Commission (TABC) provided data shown below on per capita consumption of different types of alcoholic beverages for fiscal years 1991 through Figure 2: Per Capita Alcohol Consumption FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 Beer Other 14

15 Consumption of all types of alcohol appear to be steady or rising early in this decade, abruptly decreasing during the middle of the decade, and turning back upwards by the end of the decade. The trends shown here are consistent with national patterns, and somewhat difficult to explain at first glance. The real total price (including excise taxes) of most alcoholic beverages has been declining over the last two decades. The last over haul of federal excise taxes occurred in 1991, and of state excise taxes in Since these taxes are not indexed to inflation, their real value has been declining steadily ever since. According to economic demand theory, this decline in real price should lead to increases in consumption, yet virtually all trend data of this sort show a dip in consumption during the mid- to late-1990s, with some moderate increases thereafter. The principal explanation for this apparent anomaly is the changing demographic profile of the domestic population. Put most simply, tastes and preferences change as people grow older. With the aging of the baby boom generation, more and more individuals are moving into higher age brackets that typically tend to consume less alcohol. By the mid-1990s baby boomers were in the age group, and had largely passed their peak alcoholic consumption years. In addition, some researchers have taken these mid-1990s consumption dips as an indication of the long-run response of consumers to the excise tax increases implemented several years before. By the end of the decade, the decline in real prices began again to take precedence, and consumption rates started to rise. The demographic situation in Texas is much different from that of the U.S., however. As Figure 3 shows, the Texas population is much younger than the nation as a whole. In the year 2000, Texas had a higher proportion of its population in all age groups up until the age of 40, and a lower proportion in all age groups thereafter. Throughout the 1990s, the average age of the Texas population was about 2.3 years less than the U.S. mean, and the gap has been modestly increasing. This demographic difference has several important policy implications for the State of Texas. Figure 3: Age Distribution of the Population 15

16 First, the 33.0% alcoholic beverage of 30.0% 27.0% 24.0% choice for younger persons is beer. Not surprisingl 21.0% y, then, the 18.0% 15.0% distributio n of alcohol Texas United States consumption in Texas differs markedly from the typical United States consumer. On a per capita basis, Texans consume about 25 percent more beer, 26 percent less wine, and 19 percent less distilled spirits than U.S. consumers as a whole. Taking all beverages together, Texans consume about five percent more alcohol per capita than their national counterparts. 5 This is due both to the generally younger population and the depressed level of state excise taxes. Second, the generally younger population in Texas presents a great opportunity for public policymakers. Economic theory provides several explanations for why youths and young adults would be more sensitive to price changes than older age groups. The proportion of disposable income which goes towards alcohol expenditures is likely to be much higher for youths and young adults, mainly because of their lower overall incomes. They are much more responsive to peer pressure and less addicted than adult alcohol consumers, and they tend to discount the future much more heavily. All of these factors combine to suggest a higher price elasticity of demand for younger drinkers, so that perceptible excise tax increases could well deter many of them from becoming alcohol-dependent or abusive, with the attendant large social and private costs. 5 National Institute on Alcohol Abuse and Alcoholism, Surveillance Report #55: Apparent Per Capita Alcohol Consumption: National, State and Regional Trends, December

17 Fiscal and Economic Effects of Increased Alcohol Taxes This section first looks at the effects of increasing three of the five state taxes described above; the beer tax, the liquor tax, and the gross receipts tax applied to on-premises consumption at licensed commercial establishments. 6 Following that, the estimated reductions in alcohol consumption are used to produce aggregate estimates of reductions in future alcoholrelated costs to society that can reasonably be expected. Figures are forecast for the single year 2004, which is the first full year after the Texas Legislature next convenes. The estimated population for that year is obtained by applying the average growth rate over the last decade to the Census 2000 count for the state. Per capita consumption is estimated using the average of annual figures for the last decade as reported by the TABC, and shown earlier in Figure 2. These estimates further assume that wholesalers pass all taxes along to retailers, and that retailers include these taxes in their markups establishing final prices to consumers. An average retail markup rate of 40 percent is employed here. Price elasticities used for beer and liquor are as reported in the Leung and Phelps study cited earlier. Beer Tax Effects Based on a limited telephone survey of industry representatives, it was determined that the average wholesale cost of beer is presently about $180 per barrel. The estimated wholesale price was then forecast for 2004 using the average annual increase in the Producers Price Index over the past decade, resulting in a figure of $ per barrel, including the existing state excise tax of $6.00 per barrel. Applying the 40 percent retail markup to this figure produced the estimated retail price of $ per barrel in With no change in the excise tax on beer, the retail price in 2004 is estimated to average about $4.89 per six-pack. A doubling of the state excise tax to $12 per barrel would raise this average just 16 cents to $5.05 per six-pack. This would represent a 3.1 percent increase. 17

18 Table 2 presents the projected price, quantity and tax changes estimated for beer excise tax increases of 28, 50 and 100 percent. The 28 percent figure would bring Texas in line with the national average on a per serving basis. Table 2: Short-term Effects of Increases in the Beer Excise Tax in 2004 IN EXCISE TAX TAX RATE PER BARREL RETAIL PRICE PER BARREL PRICE QUANTITY EXCISE TAX SALES TAX No Change $6.00 $ % $7.68 $ % -0.26% $32,057,129 $1,979,835 50% $9.00 $ % -0.47% $57,125,806 $3,525, % $12.00 $ % -0.93% $113,710,396 $7,002,647 ASSUMPTIONS: Population: 22,175,480 Per Capita Consumption: barrels per year Base Quantity: 18,920,377 barrels Wholesale Price: $ per barrel Retail Markup: 40% Price Elasticity: Baseline Beer Excise Tax Collected in 2004: $115,875,260 With a short-run price elasticity for beer demand of just -0.3, a 10 percent price hike would reduce demand by only 3 percent. This means that both excise and sales tax collections would immediately rise with any price increase. While beer retailers would surely resist any additional excise taxes, their opposition would be somewhat muted by the fact that their gross revenue collections would increase by more than $112 million. After deducting the additional excise tax payments, however, their actual margins would decline by a small amount ($1.7 million) equal to about 0.03 percent of baseline revenues. Clearly, the effect of raising the beer excise tax in line with national averages would be a boon to the state s revenue base. Combined increases in the excise and sales taxes would reach more than $60 million, a gain of over 50 percent over the baseline excise tax collection. 6 The wine and malt liquor taxes are not considered here both because of their relatively small scale and the unavailability of suitable data. 18

19 Liquor Tax Effects Using data provided on the Distilled Spirits Council of the United States website, 7 it was determined that the federal excise tax of $13.50 represented about 25 percent of the final retail price of distilled spirits in The estimated retail price was then forecast for 2004 using the average annual increase in the Producers Price Index over the past decade, resulting in a figure of $57.37 per gallon, including the existing state excise tax of $2.40. With no change in the excise tax on liquor, the retail price in 2004 is estimated to average about $15.16 per liter. An increase to bring Texas in line with national averages would increase the state excise tax to $3.74 per gallon would raise this average by 50 cents to $15.66 per liter. This would represent a 3.3 percent increase. Table 3 presents the projected price, and tax changes estimated for distilled spirits excise tax increases of 25, 56 and 100 percent. Once again, the 56 percent figure would bring Texas in line with the national average on a per serving basis. Table 3: Short-term Effects of Increases in the Liquor Excise Tax in 2004 IN EXCISE TAX TAX RATE PER BARREL RETAIL PRICE PER BARREL PRICE QUANTITY EXCISE TAX SALES TAX No Change $2.40 $ % $3.00 $ % -2.20% $12,067,183 ($619,109) 56% $3.74 $ % -4.92% $26,203,604 ($1,459,157) 100% $4.80 $ % -8.78% $44,696,357 ($2,789,020) ASSUMPTIONS: Population: 22,175,480 Per Capita Consumption: gallons per year Base Quantity: 22,134,012 gallons Wholesale Price: $40.98 per gallon Retail Markup: 40% Price Elasticity: Baseline Liquor Excise Tax Collected in 2004: $54,222,691 The sales tax collection drops with any increase in the liquor excise tax a consequence of the high price elasticity of demand for distilled spirits. With an elasticity of 1.5, a 10 percent 7 See 19

20 price increase would lead to a 15 percent decline in demand. Under these circumstances, gross revenues following the price hike necessarily decrease, as must the sales tax collected on those purchases. But the drop in sales tax collections does not approach the magnitude of the increased excise tax collections. As healthy as this may be for the state treasury, any proposed increase in the distilled spirits tax can be expected to be resisted strongly by the industry because the dollar value of retail sales and aftertax margins will fall. Gross Receipts Tax Effects The analysis here is somewhat more speculative because of the nature of the data that are available. While the total dollar sales subject to this tax can be easily calculated, no data exist on the average retail price or volume of consumption subject to this tax. Similarly, there has been no research specifically dedicated to the price elasticity of demand for on-premises consumption of alcoholic beverages. Accordingly, we make two significant simplifying assumptions. First, it is assumed that consumers are somewhat less sensitive to the price of these beverages than they are to purchases of alcoholic beverages for off-site consumption. For one thing, many of these purchases are made in combination with the purchase of meals at commercial establishments. Accordingly, they represent only a fraction of the total bill the consumer will be paying, and any increase in the gross receipts tax would be diluted by the other (principally food) items on the final bill. In addition, many of these sales are to business customers who are less concerned with price because they can generally expense these purchases. Accordingly, for the purposes of this analysis, a price elasticity of 0.20 is assumed. Second, it is assumed that the average price of an alcoholic beverage subject to this tax is $5.00 in the year This figure is undoubtedly low, but it will serve to reduce the magnitude of the projected fiscal impacts of any increase. Finally, it is assumed that retailers incorporate the anticipated gross receipts tax directly into their pricing structures. What 20

21 this means in practice is that to recover their other costs and target profit, they must inflate the price to the consumer by something more than the level of the gross receipts tax. At the present 14 percent tax level, their prices would have to be increased by percent to accomplish this. If the tax rate were to increase to 15 percent, they would have to tack on another percent to break even. Table 4: Short-term Effects of Increases in the Gross Receipts Tax in 2004 IN EXCISE TAX TAX RATE PER BARREL RETAIL PRICE PER BARREL PRICE QUANTITY EXCISE TAX SALES TAX No Change 14% $ % Increase 15% $ % -0.24% $32,735,578 $1,683,050 2% Increase 16% $ % -0.48% $66,085,983 $3,395,886 ASSUMPTIONS: Price Elasticity: Baseline Liquor Excise Tax Collected in 2004: $401,747,594 Table 4 presents forecasts of price, quantity and tax changes if the Mixed Beverage Gross Receipts tax is increased to 15 and 16 percent. Roughly speaking, each one percent increment in this tax would add an additional $34 to $35 million to state tax collections. At the same time, each one percent increase would decrease demand for mixed beverages by about one-fourth of a percentage point. Costs to the State of Texas Associated with Alcohol Abuse Alcohol abuse traditionally has been considered primarily a social problem. However, the economic implications are equally substantial. In a study for the National Institute on Drug Abuse (NIDA), it was estimated that the combined economic costs alone of alcohol and drug abuse in 1995 exceeded $276 billion for the United States as a whole. Adjusting for price and population increases since then, the current estimated economic cost of substance abuse in America is in the vicinity of $340 billion per year. This amounted to almost 4 percent of the gross domestic product (GDP), or about $1,200 per person nationwide. Significant as they are, these statistics reflect only measurable economic costs - just a portion of the total costs of substance abuse to society. Primarily because of methodological 21

22 limitations, quantitative analyses of the impact of substance abuse do not account adequately for a potentially significant volume of non-economic costs simply because they are either difficult or impossible to measure accurately. For example, the human and social costs of fractured family and community relationships with substance-abusers are substantial, but such costs are generally excluded from these analyses. Categories of Costs Three principal categories of costs of substance abuse are considered in the literature: (1) expenditures incurred in attempting to prevent substance abuse or treating its health consequences, (2) productivity effects resulting from premature death, elevated morbidity rates, or the secondary consequences of criminal activity, and (3) other societal effects. From an economist s perspective, many if not most of the benefits of substance abuse programs are actually avoided costs - costs that would have been incurred had the program not been in place and effective. Treatment Costs This is the most immediate and easily identified type of cost attributable to alcohol and drug abuse. This category also encompasses the costs associated with treating the medical consequences of alcohol abuse that are incurred by public and private agencies other than drug and alcohol treatment programs hospitals, in particular. These medical consequences add up to about twice the amount expended annually on drug and alcohol treatment programs. Productivity Losses By a large margin, the most significant economic costs of substance abuse are reflected in reduced production and productive activity in the economy. The increased mortality, morbidity and crime rates stemming from alcohol abuse take actual and potentially productive workers away from their jobs or out of the legitimate labor force entirely, both temporarily and permanently. 22

23 Other Social Costs Significant property losses and incremental criminal justice system expenditures can also be related to substance abuse. Vehicle crashes and fires cost substantial amounts of money to individuals, insurers and government. The costs of police protection, adjudication, and incarceration of individuals for crimes that are derivative of substance abuse are similarly impressive. Cost Levels in Texas TCADA has estimated the costs associated with substance abuse during 1997 at $19.3 billion, with alcohol abuse representing $11.1 billion of that total, or $ per capita. After allowing for population increases and inflation, this figure is projected to rise to $14.9 billion by 2004, equivalent to $ per Texan. 8 Table 5 provides more detail. Table 5: Texas Costs Associated with Alcohol Abuse CATEGORY Core Costs (in billions) $9.28 $12.45 Treatment $0.47 $0.63 Morbidity (lost productivity) $6.12 $8.21 Mortality (premature death) $2.69 $3.61 Other Related Direct Costs $1.83 $2.45 TOTAL $11.10 $14.90 Source: TCADA for 1997; for 2004 estimates Distribution of Costs Four major groups bear the costs of alcohol abuse: (1) abusers and their immediate family and friends, (2) government, (3) private insurers, and (4) crime and accident victims. Taken together, these latter three groups can be considered the nonabusing segment of society, although this is somewhat of an oversimplification. The non-abusing sector collectively pays about 55 cents of every dollar in direct substance abuse costs, and its share increases somewhat because of indirect transfers. Costs primarily absorbed by abusers cover lost legitimate earnings and household productivity due to impaired or curtailed 8 For purposes of this analysis, annual inflation is assumed to be 2.5 percent. 23

24 functioning in the labor market, incarceration, and the pursuit of criminal rather than legitimate economic careers. These costs account for the balance of the total, but they are shifted somewhat to different groups. For example, reduced legitimate earnings results in a loss for government through reduced tax revenues, which then translates into increased taxes or reduced services for the remainder of society. Incremental government services that can be traced to substance abuse include many of the costs of substance abuse programs themselves, supplemental criminal justice and highway safety expenditures, and various social insurance mechanisms. Obviously, these costs are passed along to abusing and non-abusing taxpayers alike, with the abusing population paying even less than their per-capita share because of reduced earnings. Impact on the State Of Texas It is estimated that approximately 39 percent of the total cost of abuse is borne by state government, both in terms of direct treatment expenditures and indirect fiscal effects associated with increased crime, lost productivity, etc. 9 Applying this figure to the data on total costs presented in Table 5 suggests that, if present trends continue, the State of Texas will bear the burden of $5.81 billion in alcohol-related abuse in 2004, the equivalent of $216 per person. 10 However, if demand for alcohol were to be reduced one percent, the corresponding reduction in abuse would have a positive fiscal impact on the State of approximately $58.1 million. Results and Conclusions Amid rising concern over Texas fiscal status, policymakers are paying close attention to opportunities to both increase revenue 9 Harwood, H.; Fountain, D.; and Livermore, G. (1998). The Economic Costs of Alcohol and Drug Abuse in the United States, Report to the National Institute on Drug Abuse and the National Institute on Alcohol Abuse and Alcoholism. NIH Publication No This estimate is consistent with other findings. For example, a recent study by the National Center on Addiction and Substance Abuse (CASA) at Columbia University estimated that, on average, state governments across the U.S. spent $277 per person dealing with the impact of substance abuse in 1998, a figure that would grow with inflation to $321 in 2004 ( Shoveling Up: The Impact of Substance Abuse on State Budgets. January Assuming that alcohol abuse represents between 50 percent and two-thirds of the total cost of substance abuse, the findings from TCADA are reinforced by the data from CASA. 24

25 and reduce costs. Raising alcohol taxes would appear to accomplish both. Since demand for alcohol appears to be relatively inelastic (i.e., not very price-sensitive), raising the effective price (which is the net effect of a tax increase) will yield only a modest reduction in consumption in the near term, meaning that a significant amount of additional tax revenue will generated. Table 6 provides an illustration, and is based on the assumption that beer and liquor taxes are brought in line with national averages while the gross receipts tax on mixed drinks is raised one percentage point. The results are enlightening; this seemingly marginal change in tax rates would net the State approximately $93 million in additional tax revenue in Table 6: The Fiscal Impact of Increased Alcohol Taxes CATEGORY EXCISE TAX IMPACT SALES TAX IMAPCT PRICE QUANTITY POSITIVE FISCAL IMPACT DUE TO REDUCTION IN ABUSE Raising the Beer Tax 28% $32.1 million $2.0 million 0.87% -0.26% $43.0 million Raising the Liquor Tax 56% $26.2 million ($1.5 million) 3.28% -4.92% $12.6 million Raising the Mixed Drink Tax One Percentage Point $32.7 million $1.7 million 1.18% -0.24% $2.5 million TOTALS $91.0 million $2.2 million 1.41% -1.28% $58.1 million Even the modest reductions in demand observed under this scenario yield an additional positive impact to the state budget in the form of reduced expenditures related to alcohol abuse. As has been well-documented, alcohol and substance abuse costs the Texas economy and state treasury billions of dollars annually; even the small drop in demand expected under this scenario would have a positive fiscal impact to the State of an additional $58.1 million, putting the initial total annual fiscal impact in excess of $152 million. As a result, increasing alcohol taxes is one of the clearest win-win options presently available to policymakers, since, depending on consumer price-sensitivity, it either generates substantial tax revenue or causes a significant reduction in abuse-related costs. In either case, Texas is better off than under the current system. 25