Economics in Action

In the latest of our podcasts supporting the Royal Economic Society Conference 2008 Romesh Vaitilingam talks to Ben Lockwood about the effect of the European Single market on alcohol and tobacco taxes.

In the wake of Alistair Darling’s swingeing increases on duty on alcohol in Wednesdays budget comes a new report examining why duty may not have been increased as much as governments would have liked and implying that these new duties may not raise as much revenue as the Chancellor is expecting.

The research by Giuseppe Migali and Ben Lockwood, presented at this Royal Economic Society’s 2008 annual conference, finds that the completion of the European Unions single market which removed all restrictions on trade in goods between member countries meant that the UK government has not been able to raise alcohol and tobacco duty as much as it might like.

The single market benefited smokers and drinkers who were able to go to France and take advantage of lower taxes. But the study shows that even those who did not travel benefited. This is because the government could not raise taxes without encouraging more people to shop or shop more frequently abroad. So duty is lower than it might be otherwise, which benefits all smokers and drinkers.

The single market may also explain why (at least until Wednesday’s budget) alcohol taxes in particular have failed to keep pace with inflation since the introduction of the single market. If so, the single market has reduced the governments ability to tackle binge drinking through higher taxes.

The completion of the EU’s single market in 1993 resulted in the removal of trade barriers between member states. It also meant a change in commodity taxation. Specifically, EU residents buying goods in another EU country were now taxed at the rate of the country of purchase, not where they resided.

This change allowed cross-border shopping. High taxes on portable goods in one country might not raise as much money, or deter as much consumption as they did before as shoppers could simply shop abroad. Many UK smokers and drinkers took advantage of the opportunity to buy alcohol and tobacco in France, which has much lower taxes on these products than the UK.

In particular, high taxes on certain products (tobacco and alcohol) may drive shoppers from high-tax countries such as the UK, to buy portable goods in low-tax countries, such as France. There is in fact evidence that both cross-border shopping and smuggling are occurring on a large scale across some borders. The rates of excise duty on alcoholic drinks and tobacco products in the UK are significantly higher than those in most other EU member states, notably France.

Five years after the start of the single market, the estimated loss of revenue to the UK government from legal cross-border shopping was around £375 million a year. In 2003/04, 10.5 billion cigarettes were successfully smuggled and a further 6.5 billion were purchased across a border with a loss of £3.1 billion to the UK Treasury.

There is concern that governments have been cutting rates of excise tax or at least not raising them in line with inflation in response to such behaviour. The authors study the setting of excise taxes on still and sparkling wine, beer, spirits and cigarettes by 12 EU member countries over the period 1997 to 2004. They investigate whether the way a particular country say the UK responded to the excise taxes set in other EU countries differed before and after the single market.

The report finds little evidence that governments were concerned with taxes in their neighbours before the creation of the single market in 1993. Indeed, it finds that there is evidence of this only for the tax on cigarettes.

The picture is different after 1993, when all five taxes seem to be influenced by tax levels in neighbouring countries. Specifically, a 1% increase in the weighted average of foreign taxes increases the home (UK) tax by the following amounts: 0.43% for still wine, 1.21% for sparkling wine, 0.31% for beer, 0.68% for spirits and 1.32% for cigarettes. Even the influence of foreign cigarette taxes on home cigarette tax is more than double the level it was before 1993.

These results are not sensitive to how much weight is placed on taxes of different foreign countries taxes. But the researchers assume that countries only react to taxes in other countries where there is a shared geographical border that shoppers can cross.

Finally, the researchers investigate the effect of minimum tax rates set by the EU on actual taxes set by governments. There is some evidence that higher minimum tax rates increase the amount of strategic interaction between countries.

Notes for editors: Did the Single Market Cause Competition in Excise Taxes? Evidence from EU Countries by Giuseppe Migali and Ben Lockwood was presented at the Royal Economic Society’s conference at the University of Warwick, 17-19 March 2008. Migali is at Lancaster University. Lockwood is at the University of Warwick.

For further information: contact Giuseppe Migali on 015 2459 4221 (email: g.migali@lancaster.ac.uk); Ben Lockwood on 024 7652 3277 (email: b.lockwood@warwick.ac.uk); or Romesh Vaitilingam on 07768 661095 (email: romesh@compuserve.com).

Read more papers by Ben Lockwood at EconPapers and search for more Internet resources on this topic at Intute: Social Sciences which has more on taxes and taxation.

This entry was posted on Tuesday, March 18th, 2008 at 10:31 am and is filed under In the News, Politics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.