The effect of changes in alcohol tax differentials on alcohol consumption

Gehrsitz, Markus and Grossman, Michael (2021) The effect of changes in alcohol tax differentials on alcohol consumption. Journal of Public Economics. ISSN 0047-2727 (In Press)

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    We show that tax-induced increases in alcohol prices can lead to substantial substitution and avoidance behavior that limits reductions in alcohol consumption. Causal estimates are derived from a natural experiment in Illinois where spirits and wine taxes were raised sharply and unexpectedly in 2009. Beer taxes were increased by only a trivial amount. We construct representative and consistent measures of alcohol prices and sales from scanner data collected for hundreds of products in thousands of stores across the US. Using several difference-in-differences models, we show that alcohol excise taxes are instantly over-shifted. That is, a $1 tax increase translates into a price increase of up to $1.50. We find evidence suggesting that consumers react by switching to less expensive products. In particular, they increase purchases of beer, thus significantly moderating any tax-induced reductions in total ethanol consumption. Our study highlights the importance of tax-induced substitution, the implications of differential tax increases by beverage group and the impacts on public health of alternative types of tax hikes whose main aims are to increase revenue.