Vice Squad
Monday, May 28, 2007
Trading Vice and Income Taxes

Estonia has elected to increase its taxes on alcohol and tobacco (and fuel), while decreasing the income tax rate from 22 to 18 percent. Given the low levels of vice taxes that already exist in Estonia, and the high likelihood that the alcohol tax, in particular, does not fully account for external costs, this sounds like a good trade-off to me. Even if the externalities were accounted for, the "welfare costs" of taxing income (and thereby dissuading work in the official sector) might well be higher than the inefficiencies brought about by taxing alcohol, when it comes to raising a fixed amount of revenue.*

In any event, the tax hike comes as good news to Finland, which reluctantly felt compelled to lower its own alcohol tax upon the impending accession of Estonia to the European Union; since then, alcohol-related problems in Finland have increased. The prospect of higher alcohol prices in Estonia has the Finns thinking of re-raising domestic alcohol taxes.

*For an argument along these lines, see Larry G. Sgontz, “Optimal Taxation: The Mix of Alcohol and Other Taxes.” Public Finance Quarterly 21(3): 260-275, July 1993.

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