Liquor-law reports sobering

A recent report by the Legislative Auditor’s Office makes clear that Minnesotans pay more for booze than necessary. It is not clear that this is bad for society as a whole, but it does raise the questions of who benefits and if policy changes are needed.

The amount of potential savings for consumers is substantial — $100 million, which is equivalent to a 7 percent tax on alcohol. A tax increase of that size would provoke heated debate in the Legislature. To economists, there’s a fine distinction between a tax directly imposed by government and the equivalent increased costs resulting from government regulation. The difference remains significant politically, especially in an era when pledges of “no new taxes” still attract votes.

The report is clear on one point: Minnesotans pay more for alcohol because state laws restrict competition and, as we know from Economics 101, restricted competition results in higher prices.

Interestingly, the auditor found that while beer and wine prices are 9 percent and 7 percent higher in Minnesota than in Wisconsin because of our laws, distilled liquor is 8 percent cheaper here. The lower cost of distilled liquor results from a Minnesota ban on an anti-competitive practice allowed in other states: exclusive marketing agreements between distributors and retailers. So, not all Minnesota alcohol regulation hurts alcohol consumers.

The report found that prices would be lower if we allowed more stores to sell alcohol, and it implied that wine prices would be lower if grocers were allowed to sell wine. Prices also would be lower if we allowed liquor stores greater latitude in selling food and other items. Finally, municipality-owned liquor stores that have monopolies in many Minnesota towns do raise average prices.

A key question is who benefits from Minnesota’s liquor laws. Some of the extra $100 million that alcohol buyers must pay may translate into higher net profits for the alcohol industry, particularly wholesalers and retailers. There certainly is some of that. But higher consumer prices also can be dissipated into higher costs throughout the system.

That is clear from virtually any study of restricted competition. Companies with monopoly power can make higher profits. They can also become inefficient and spend wastefully because of a lack of competitive pressure. General Motors and pre-1980 IBM are good examples of businesses with market power that became sluggish and wasteful.

If resources are simply being wasted because of Minnesota’s laws, changes in those laws might not only lower prices but also could make the economy more efficient by ending such waste. Change also might reduce monopolistic profits earned by alcohol sellers.

That is not necessarily a net gain for everyone. Many municipalities earn monopolistic profits from their liquor stores and can levy lower taxes as a result. Forcing more competition would help drinkers but hurt taxpayers. These two groups overlap but are far from identical.

All of these observations are of secondary importance, however. The key question is whether alcoholic beverages are too cheap or too expensive in terms of the well-being of society as a whole.

Alcohol is a product with enormous external costs. That is, the consumption of alcohol imposes costs on society that are not necessarily borne by either the producer or consumer of the beverage.

Driving after consuming alcohol causes death, injury and property destruction. Alcohol can harm the user’s health, foster crime and harm families. The social damage from alcohol is obvious and significant.

Experience teaches us, however, that trying to ban alcohol completely causes more problems than it solves. Many people can and do consume alcohol responsibly.

If a product has external costs in a free-market situation, the net welfare of society as a whole suffers. Society can be made better off if the product is taxed. Ideally, the tax should equal the external costs imposed on society by alcohol consumption.

This is not “taxing sin” as is often asserted. It is the socially beneficial response to any situation causing external cost, which British economist Arthur Pigou proposed nearly a century ago.

The overall social cost of alcohol is estimated to exceed $4.5 billion annually — well above the $1.4 billion consumers spend in Minnesota on off-sale purchases. We would be better off as a society if alcohol prices were higher. But the best way to make booze cost more is to raise taxes — not impose liquor laws that waste resources and increase the profits of a narrow set of businesses.

© 2006 Edward Lotterman
Chanarambie Consulting, Inc.