MEMO To: Korn Chatikavanij, Minister for Finance From: Jonathon Flegg, Policy Unit, Ministry of Finance Date: 02/06/11 Subject: Liquor Tax Reform Recommendation The consumption of alcohol in Thailand has become an increasing public health concern. While only 31% of Thais consume alcohol1, annual per person consumption exceeds that of France, where the vast majority of the population consume alcohol2. The economic cost to Thailand has been estimated at 156,105.4 million baht, or 1.99% of GDP3. It is for this reason the Thai Government has sought the advice of the Policy Unit within the Ministry of Finance in reviewing the current policy on liquor taxation.1. What perspectives should the government take into consideration in making the decision? The Ministry of Finance is confronted with the need to balance three competing primary policy objectives of alcohol policy: “to reduce alcohol consumption, protect the local liquor industry and minimize the impact on government revenue from excise collection4.” However there are also a number of other perspectives that should also be considered when deciding on liquor policy. As the burden of the liquor tax inescapably falls on the poor, and given that it constitutes a considerable component (7%) of total government revenue, it is also important to ensure that any reform does not create a more socially regressive taxation system. The issue of alcohol consumption can be considered as an activity that generates social costs unpaid for in the market price of alcoholic beverages. These negative externalities might be direct, such as increased health care costs, costs of law enforcement, and costs of property damage due to road-traffic accidents; or indirect, such as costs of productivity loss due to premature mortality, and reduced productivity. To achieve the socially efficient level of alcohol consumption, traditional economic approaches would therefore consider the need to apply an excise tax equal to the social externalities that alcohol consumption generates. Optimal commodity taxation would also demand that to achieve efficiency, effective excise tax rates are set in proportion to the inverse of the price elasticity of demand of individual alcoholic beverages. Finally, a precondition for a reform proposal is that it must be both politically and administratively feasible. While there is considerable public support for acting on the issue of alcohol consumption 5, the Government is also concerned about the effect that increasing taxation might have domestic producers. 1 Thavorncharoensap, M. et al. 2010. “The economic costs of alcohol consumption in Thailand, 2006”. BMC Public Health 10: 323 – 335. 2 Techajareonvikul, A. 2006. “Liquor Tax Reform in Thailand: Competing Interests and Objectives”. HKS Case Study CR14- 06-1857.0. 3 Thavorncharoensap, M. et al. 2010. 4 Techajareonvikul, A. 2006, pg 2. 5 On the 18th March 2007 a marathon of runners delivered a total of 13 million signatures to Parliament calling for action to curb alcohol consumption. This was the largest petition ever collected in Thai history.
2. How should the government balance different objectives? The primary consideration for any reform proposal is whether it can achieve a significant reduction in overall alcohol consumption while retaining the current level of excise revenue. These goals are not incompatible with each other, if tax rates can be increased in such a way that excise revenue is not adversely affected. The goal of protecting domestic alcohol producers can most effectively be achieved by using import duties rather than excise tax. This approach means that local producers within the domestic spirits and wine industries are not adversely affected by an excise tax regime that attempts to target foreign imports6. There is strong evidence to suggest that the current liquor tax system is inefficient. Beer, a popular segment of the market accounting for 43% of its total value, is taxed quite heavily (see Table 1) despite its high elasticity of demand. When compared with its closest substitute at the cheaper end of the market, domestically-distilled white liquors, there is a nine-fold difference in effective tax rates7. These two segments form a majority of the Thai alcohol market and closing the gap between their effective tax rates is a precondition for efficient liquor tax reform. Under the current excise system traditional producers of white spirits have enjoyed preferential treatment that is now no longer sustainable if alcoholic consumption is to be reduced. Any feasible form of alcohol excise is likely to be socially regressive, because poor Thais tend to spend a greater proportion of their income on alcohol compared with wealthier Thais. For equity reasons the Government should not attempt to collect excessive revenue from liquor tax, particularly from beverages preferred by poorer Thais. Revenue should remain broadly neutral. This goal comes into conflict with an attempt to incorporate the increased social costs of alcohol consumption into the price of alcohol. The current estimate of social costs to the Thai economy are 156 billion baht compared with only 6.9 billion baht collected in liquor tax. To fully incorporate the social costs of alcohol consumption would be both inequitable and infeasible. A more appropriate policy goal is to reduce the social costs by focusing on reducing consumption. Reducing social regressivity can be achieved my retaining higher effective tax rates on beverages consumed by wealthier Thais, such as wine and imported liquors.3. What option should the government choose? Of the plans provided by the Excise Department, only Plan C will succeed in both reducing the overall level of alcohol consumption and maintaining revenue derived taxing alcohol8. The projections produced by the Policy Unit of the effect on average prices (P), consumption (C) and excise revenue (R) can be seen in Table 2 and 39. 6 The domestic Thai wine industry, while still developing by international standards, has experienced considerable growth of over 6% annually. 7 This is despite having similarly high price elasticities of demand. 8 Consumption is based on per litre of pure alcohol to facilitate comparison across beverage categories. 9 In this analysis we assume municipal and health tax as constant, which are calculated as a small percentage of the levied excise tax amount.
The major problem with Plans A and B is that by effectively harmonising the taxation of traditional white liquorswith other low costs beverages, the reduction in consumption of white liquors is more than counteracted by anincrease in sales of both economic beers and blended whiskies. Drinkers at the low-end of the market are highlyprice sensitive and freely move between consuming economic beers, traditional white liquors and cheap blendedwhiskies. Under the current system consumption of beer is disincentivised because it is taxed at the ad valorem ratecompared with its high-alcohol content competition at the low-end of the market. Coming off the ad valorem rate toeither a specific or mixed rate regime makes beer more attractive for consumption because of its low-alcoholcontent. Hence Plans A and B both fail to reduce alcohol consumption due primarily to substitution at the low-endof the market. This is despite excessively large socially regressive increases in revenue. Plan A will increase liquorexcise revenue by 148% and Plan B by 284%, mainly from beverages preferred by low-income Thais.Plan C is quite an attractive option for implementation. It is revenue neutral (see Figure 1 below) and is projected todecrease consumption of alcohol by around 30%. Moreover while white and brown spirits experience similarchanges in consumption to that of Plan B, the white liquor price rise is a lot less pronounced in Plan C and drivessignificantly less substitutionary increases in beer consumption.However, the Policy Unit recommends an alternative reform Plan D to those provided by the Excise Department.Plan C could be improved by harmonising all liquor taxation to the combination of a 250 baht/L specific tax with a100% ad valorem tax. As the majority of revenue comes through the specific tax component, Plan D maintains theminimum necessary for revenue neutrality10, but through an increased ad valorem rate it is able to transfer a greaterproportion of the tax burden to higher priced premium beverages. It also has the advantage over Plan C that it isprojected to further decrease consumption by an additional 14%, and should be simpler to administer given that allalcohol is subject to the same excise tax formula.Criteria PLAN A PLAN B PLAN C PLAN DReduced Consumption No No Yes MostRevenue Neutrality Increased Rev. Increased Rev. Yes YesProtects Industry Import Duties Import Duties Import Duties Import DutiesImproved Efficiency11 Most Yes Yes Yes 12Social Regressivity Least Regressive Most Regressive Moderate Reg. Least RegressiveAdmin. Feasible Most Yes Yes MostPolitically Feasible Devastate White Devastate White Devastate White Devastate White Liquor Industry Liquor Industry Liquor Industry Liquor IndustryPolitically feasibility is more complex. As noted above, the general public expect the Government to take somedecisive action to curb excessive alcohol consumption. However traditional producers of white spirits are expectedto strongly oppose any of the plans because their industry is likely to be reduced down to only a small fraction of itscurrent size. Given the beverage’s iconic cultural status, producers would also garner significant public support in10 As the most widely consumed alcoholic beverages are quite cheap (economic beer and white liquors), the bulk of revenuecomes from the specific taxation component rather than ad valorem. It is difficult to maintain the revenue base with specifictaxation less than 250 baht/L.11 Measured as the variance in effective tax rates per Litre of pure alcohol between the main three beverage categories of beer,white liquor and color spirits.12 Measured as the proportion of liquor tax revenue borne by consumers of beer and white liquor consumers.
opposing the reforms. It is unknown whether this industry, without realising economies of scale, could recoverfrom the implementation of Plan A were prices to rise over six-fold. Plan C would do the least damage to thistraditional industry but would still decrease it to 25% of its former size. Currently to devastate this iconictraditional industry with such a rapid policy reform will be politically costly, if not completely infeasible.In contrast domestic beer and blended whiskey producers are likely to support any reform over the status quo asconsumers switch across to their products in large numbers. Large beer and whisky producers have diversifiedinterests across both types of products and could adapt to the new market possibilities provided by the reforms.Plans A and B would offer the large beer and whiskey producers the greatest opportunities for increased sales.In summary the Policy Unit of the Ministry of Finance is of the position that the Government should implement anew alcohol excise tax policy that combines a 250 baht/L specific tax together with a 100% ad valorem component.This policy is superior to the plans proposed by the Excise Department because compared with Plan C it furtherreduces alcohol consumption, is less socially regressive without increasing overall taxation and more simple inimplementation. While the Government can expect opposition from traditional white liquor producers, this isinevitable with any reform as currently these producers are enjoying an unsustainable level of preference. Thistreatment is one of the major factors facilitating the availability of cheap, hard liquor across Thailand. If theGovernment proceeds with any of the reforms it should be aware of this inevitable community opposition and seekpolicy measures to soften its impact on small-scale white liquor producers.TABLE AND FIGURES Tax Per Litre of Tax Per Litre of Beverage Alcohol Elasticity (baht/L) (baht/L) of Demand Color Spirits 145 371 -1.56 Blended 160 400 Compounded 84 240 White Liquors 28 70 -2.73 Beers 39 613 -2.68 Imported Liquors 283 708 -0.61 Wine 409 3030 -0.6 Table 1: Effective Tax Rates and Price Elasticity of Demand for Major Alcoholic Beverage Categories PLAN PLAN PLAN PLAN A B C D ∆P/P ∆C/C ∆R/R ∆P/P ∆C/C ∆R/R ∆P/P ∆C/C ∆R/R ∆P/P ∆C/C ∆R/R Beer -18% 235% 174% 123% 221% 431% 109% -11% 12% 144% -57% -4% Wine -83% 50% -75% 107% -64% -57% 100% -60% -60% 128% -77% -60% White Liquors 614% -87% -9% 389% -79% 186% 202% -75% 34% 237% -83% 18% Color Spirits 35% 249% 370% 202% 77% 316% 89% 57% 34% 100% 71% 70% Imported Liquors -29% 18% -17% 144% -88% -72% 115% -70% -57% 145% -89% -100% Table 2: Projected Percentage Change in Price, Consumption and Revenue for Major Alcoholic Beverage Categories
Revenue from Overall Alcohol Alcohol Excise Consumed (bns of baht) (mns of litres) STATUS QUO 6.9 19.43 PLAN A 17.1 34.28 PLAN B 26.6 26.94 PLAN C 7.2 13.62 PLAN D 7.1 10.78 Table 3: Comparison of Projected Liquor Tax Revenue and Overall Alcohol Consumed Liquor Excise Revenue By Source (bns of baht)3025201510 5 0 Status Quo Plan A Plan B Plan C Plan D Color Spirits White Liquors Beers Imported Liquors Wine Figure 1: Liquor Tax Revenue, By Source