The Price of Liquor is Too Damn High: State Facilitated Collusion and the Implications for Taxes

Rao, Nirupama S. (with Chris Conlon)

Alcohol markets are subject to both heavy regulation as well as excise taxes at the federal and state level. We examine the impact of particular state regulations on the structure of the alcohol market. We show that post and hold and meet but not beat pricing regulations at the wholesale level eliminate competitive incentives among whole-sellers and minimum retail markup rules at the retailer level e ectively allow whole-sellers to set retail price floors. Our model suggests that without any competitive incentives at the wholesale level, firms will set prices as if they were a single monopolist. Wholesalers will tend to mark up premium brands relative to call or well products. Regression results indicate that states featuring post and hold regulations consume 4% to 10% less alcohol than other states, suggesting that the regulations may over-restrict quantity. Tabulations suggest that premium products comprise a smaller share of consumption in post and hold states. This output gap due to collusive pricing leads any taxes levied on the liquor market to entail greater deadweight loss relative to a competitive wholesale market. We conduct an empirical analysis, where instead of providing wholesalers with market power, the state increases taxes to keep the overall level of alcohol consumption fixed. We also compute the deadweight loss of increasing taxation under both the existing scheme, and one with a competitive wholesale market. We find that the state of Connecticut could substantially increase taxes and tax revenues without affecting aggregate quantities if it repealed post and hold. Back of the envelope estimates suggest that Connecticut is forgoing over $300M in potential revenue from alcohol taxes in a competitive wholesale market.

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