Wholesale Prices, Retail Prices and the Lumpy Pass-Through of Alcohol Taxes
Rao, Nirupama S. (with Chris Conlon)
This paper examines the pass-through of taxation in the market for distilled spirits. By using detailed UPC level data from Nielsen Homescan, as well as state specific wholesale prices from the regulator in Connecticut we are able to measure the pass-through rate of taxation at both the wholesale and the retail level. We find that pass-through of taxes to wholesale prices is incomplete and approximately 70% while pass-through of taxation to retail prices is often excess of 100 and as high as 160%, consistent with other results on the pass-through of excise taxes for spirits. This over-shifting of the tax burden onto consumers is difficult to rationalize with profit maximizing firm behavior and log-concave demand (such as Linear Demand, Logit, or Probit). We offer an alternative explanation which incorporates dynamics in price adjustment, and shows that large pass-through rates are an artifact of small tax increases and lumpy price adjustment via $1.00 increments. When firms follow an (s, S) rule, this has implications for a policy where tax-increases minimize over-shifting behavior that generates additional deadweight loss per unit of government revenue.