The Cost of Curbing Externalities with Market Power: Alcohol Regulations and Tax Alternatives
Products with negative externalities are often subject to regulations that limit competition. The single-product case may suggest that it is irrelevant for aggregate welfare whether output is restricted via corrective taxes or limiting competition. However, when products are differentiated, curbing consumption through market power can be costly. Firms with market power may not only reduce total quantity, but distort the purchase decisions of inframarginal consumers. We examine a common regulation known as post-and-hold (PH) used by a dozen states for the sale of alcoholic beverages. Theoretically, PH eliminates competitive incentives among wholesalers selling identical products. We assemble unique data on distilled spirits from Connecticut, including matched manufacturer and wholesaler prices, to evaluate the welfare consequences of PH. For similar levels of ethanol consumption, PH leads to substantially lower consumer welfare (and government revenue) compared to simple taxes, because it distorts consumption choices away from high-quality/premium brands and towards low-quality brands. Replacing PH with volumetric or ethanol-based taxes could reduce consumption by 10-11% without reducing consumer surplus, and roughly triple tax revenues.
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