On Tuesday, we discussed the above paper, which was our second (the first being Saul Levmore, week 1) to discuss the choice and interplay between "tax" and "regulatory" instruments. The paper concerns the measures states take to limit or control alcohol consumption, often with evident secondary (or should I say primary) aims of empowering cartels and favoring local over out-of-state producers.
Alcohol clearly is a good subject for Pigovian taxation. Drunk driving accidents are certainly the clearest example of negative externalities resulting from alcohol consumption, but not necessarily exclusive. One could also make internalities arguments, especially with regard to young drinkers.
As a theoretical matter, Pigovian taxes are easier to design in some cases, harder in others. An article called "Taxation and the Financial Sector," which I coauthored with Douglas Shackelford and Joel Slemrod, makes the point that the negative externalities imposed by financial firms when they risk failure that may lead to bailout and/or horrendous macroeconomic consequences, are very context-specific and hard to capture accurately in a tax instrument. One institution compared to another, or one state of the world compared to the other, may make all the difference in determining what the tax level ought to be. On the other hand, for carbon taxation that is aimed at global warming, while the overall harm measure may be difficult to nail down, at least we know that all carbon molecules are relevantly the same.
Alcohol arguably is somewhere in the middle. On the one hand, it's true that each unit of wine, beer, or spirits has a determinate amount of alcohol in it. But even sticking to the externalities, it matters who is drinking, as well as how much that person is drinking at the same time. One could imagine a sci fi dystopia in which everyone is equipped with monitors for alcohol in the blood that permits the imposition of personalized Pigovian taxes. But since, in the real world, purchase not consumption of liquor is the occasion for levying the tax, we can't come close to doing that. Thus, moderate drinking that may improve one's physical and mental state is hard to except from the regime that is aimed at drunk drivers and self-destructive alcoholics.
There are some fallback methods available. For example, we (try to) ban under-age drinking. And differential taxes on wine versus beer versus spirits can proxy for the things we'd like to measure directly. For example, if we think that young drinkers tend both to prefer beer and to impose the highest drunk driving externalities, we might for that reason subject beer to a higher tax relative to alcohol content. Not surprisingly, however, the states turn out to view things a bit more parochially. California, with its big wine industry, is very nice to wine. Pennsylvania, with its blue collar tradition that we hear about ad nauseum in every presidential election year, is nice to beer.
Explicit excise taxes on alcohol are mainly federal, and only secondarily (by dollar value) state and local-level, and most experts would probably say that, on balance, and despite the variability that we can't capture very accurately, they are set too low, rather than just right or too high. Arguably this reflects the cultural difference in today's world between alcohol and, say, cigarettes. I would speculate that "sin" taxes which are best rationalized on externalities grounds are highest when the sin is one that "we" don't indulge in - only "they" do. By "we" I mean representative voters, with "they" being the Other in such voters' eyes.
Evidently, in the era that led to Prohibition, to some extent there was a view that only "they" drink - "we" don't. Then if you go the Mad Men era, evidently "we" both drink and smoke. Today, however, smoking is declasse while drinking is not. So "they" smoke and let's tax it a lot, but "we" drink so let's not tax it so much.
OK, onto the state regulatory structures that the paper discusses. The front part of its title, "The Price of Liquor is Too Damn High," might more accurately be stated as "The Pre-Tax Price of Liquor is Too Damn High, Albeit That the After-Tax Price Might Conceivably Be Too Low." States do a number of cartelizing things in the market for alcohol sales that end up raising the price. These measures may have Pigovian benefits if they suitably reduce alcohol consumption, and they apparently do reduce it. But doing this through the creation of market inefficiencies means that the Pigovian revenues are either lost in pure waste or handed off to wholesalers who are aided by the state regulators in realizing monopoly profits.
A case in point, and the paper's main focus, is Pennsylvania's "post and hold" regime with lookback. Here's how it works. Pennsylvania has a lot of rules in the alcohol market that at least ostensibly are aimed at protecting small retailers, in particular against the likes of Costco. (In an unregulated market, Costco would likely be able to get a better wholesale price, reflecting either cost-saving from the scale that it offers and/or its exercising monopsony power.)
To this end, Pennsylvania requires wholesalers to state in advance the uniform wholesale price that they will charge to all retailers for one month after the posting. That is "post and hold." It facilitates collusion in pricing between wholesalers, and apparently helps result in Pennsylvania's having significantly higher liquor prices than Massachusetts, an adjoining state without post and hold rules.
"Lookback" is the crown jewel of post and hold, so far as permitting wholesalers to reap cartel profits is concerned. Under lookback, once you have posted your price for the month, you can lower it to match a competitor's posted price. This makes it really attractive to aim high on your Stage 1 price, knowing that if someone undercuts you it won't be a problem, and that, for the same reason, you can't undercut them. Especially with repeat players and monthly posting, this is simply a great device from the standpoint of wholesalers who want to collude in ways that would land them in jail for antitrust violations (or else make sufficient cooperation between would-be cartelizers unstable), but for the state's facilitating role.
Anyway, if the alcohol price would otherwise be too low from a Pigovian-plus-internalities standpoint, higher prices from post and hold plus lookback at least have the virtue of reducing alcohol consumption, conceivably closer to its optimal level. But it's equivalent to the state's converting the Pigovian tax revenues into a combination of handouts to liquor wholesalers plus dissipation through waste. The paper makes this case, in addition to showing (both theoretically and empirically) how post and hold plus lookback operate to raise retail prices for alcohol.