Excise Duties on Alcohol in the EU

Minimum levels of excise duties on alcohol in the European Union were laid down in 1992. During the last decade several institutions (both inside and outside the EU) proposed that these minimum rates are obsolete, should be revalorized and probably increased. To better understand the need for a change in policy, this article first provides a brief overview of the current legislation and its implementation in member states and then looks at how current proposals for new minimum rates were formed. Finally, it evaluates whether increasing taxes on alcohol is the best course of action.

Introduction

Certain goods and services are subject to special duties which are commonly justified by a level of harm associated with their consumption. Typical examples of these ‘excise’ goods and services include alcohol, tobacco, fuel and gambling, where the perceived negative externalities of their consumption are given as justification for the payment of a special tax.

While the most common explanation for these excise duties is that they compensate the social costs of the consumption of these harmful commodities, they also provide an important and sizeable source of revenue for national budgets. These two reasons both contribute to the general consensus among nation states and international organizations that excise duties should remain in place and the imposed rates could potentially be increased.

Current EU provisions and member state policies

The current legal framework regulating excise duties in the EU consists of two Council Directives. Council Directive 92/84/EEC provides a structure for the member states to classify alcoholic products into certain categories – these categories are used for taxation purposes. Council Directive 92/84/EEC determines the minimum level of excise duties in the categories. There is no maximum rate set in the directives. Obviously, the effectiveness of the latter directive setting the minimum rates heavily depends on the implementation of the former laying down the structure for classification. Member states using this classification categorize alcoholic beverages into the following categories: Beer, Wine, Other Fermented Beverages, Intermediate Products and Ethyl Alcohol.

Minimum rates of excise duties for the different categories of alcohol are summarized in the table below:

Table 1. Source: European Commission

The rates of excise duties vary from country to country, naturally above the minimum rates set by the aforementioned directives. Substantial differences can be found among member states regarding the products which are subject to higher excise taxes than the prescribed minimum. In the case of beer and spirits, excise duties are substantially higher than the EU minimum in the vast majority of the member states. The average excise duty levied on beer is almost five times higher than the required minimum level and the average for spirits is more than three times above the minimum rate (see Chart 1. and Chart 2.).

Chart 1. source: European Commission¹

Since the minimum level of excise duty levied on wine is 0 €, member state regulation varies even more widely, with many countries taking advantage of the policy. Out of 28 member states, wine is subject of excise duties in only 13 (see Chart 3.).

This overview of excise duty levels shows a lot of variation, but with the exception of wine the overwhelming majority of member states impose significantly higher excise duties on alcohol than the minimum level set by the directive.

It is also important to note that the excise duties are not determined in percentages of the price but in absolute values (€ per hectoliter per degree of alcohol). For this reason, member states with relatively low nominal excise duties and relatively low nominal consumer prices would be the first to experience a price increase – all of the countries with above average nominal excise duties for beer, wine and spirits are new member states from Eastern Europe. These countries tend to have lower standards of living and lower wages than western member states and would probably be affected much more from a dramatic increase in minimum rates, while prices in the better developed regions of the EU would stay the same.

Chart 2, 3. source: European Commission

It is important to note that disparity in consumer prices among member states cannot be explained only with the wide variation in excise duties on consumer prices. They are also amplified by differences in VAT and other relevant taxes common in countries.

Arguments for a change in policy

One of the main triggers of the recent proposals for a change in policy was inflation. The current levels of excise duties on alcohol were determined in 1992 and remained the same ever since. In 2005 the Economic and Financial Affairs Council (ECOFIN) acknowledged that inflation in the last two decades made the minimum levels obsolete and unrealistically low compared to the actual prices of alcohol and that the structure of classification had to be revised².

The most common ideological justification for excise duties imposed on alcoholic beverages is the connected health risks and negative externalities (e.g., costs of healthcare and absenteeism) associated with heavy drinking. The adverse health effects of alcohol abuse are well documented and fighting the harms of excessive consumption is a very legitimate goal shared by the World Health Organization and the European Commission. Increasing the consumer price of alcohol is seen by many as a way to cover these external costs and decrease consumption. Even though this is a widely popular idea, it is interesting to note that according to the ECOFIN documents “the vast majority of Member States do not consider that health and social aspects should be a major determinant in setting rates.”

The minimum level of excise duties is not the only area where ECOFIN identified problems in the legislation. Local alcoholic drinks often fall into several of the categories laid down in the directives and, due to this, identical products may belong to different categories in different member states. This makes effective community level regulation and tax approximation – an important aim of all proposals – impossible to achieve.

The goal of approximating excise duties in member states is to prevent trade distortions in the Single Market and to provide an environment for fair competition. Proponents of a policy change in this direction hope to decrease illicit trade and cross-border shopping for alcoholic beverages.³

As an answer to these challenges, proposals usually argue for an increase in the minimum level of excise duties: for example, in 2006 the Commission proposed a 31% increase in the minimum rates (COM(2006) 486) in line with inflation between 1992 and 2005. The question is: do we really think an increase in taxes is the right way to handle these problems?

Realities of a possible increase in minimum rates

While the prevalent proposal is an increase in the minimum rates, this solution has a number of negative aspects which suggest that it might not be the best course of action for the EU to take.

1. Inefficiency of minimum rates for preventing market distortions

Among 28 member states, excise duties for beer are above 150% of the minimum levels in 23 countries. Excise duties for spirits are above 150% of minimum rates in 26 countries. For a new policy to have a substantial effect on consumer prices, it has to include an extremely high increase in rates. Even then this type of regulation seems to be redundant because the majority of member states impose high taxes on alcoholic beverages on their own, without any pressure from the EU. If the goal is the approximation of prices and tax rates to protect the Single Market from distortion, laying down maximum rates would be much more efficient.

2. Inefficiency of minimum rates for health protection

Alcohol is a convenient subject of excise duties because it is generally perceived as a good which has price inelastic demand, meaning that price changes have a relatively small effect on the quantity of alcohol consumed. Alcohol consumption does not decrease in proportion with price increase thus tax revenue usually increases. This is also the reason why excise duties cannot effectively control excessive consumption of addicts while at same time they cause welfare losses to non-harmful consumers.⁴ There are several more effective ways to combat alcohol related health problems, such as education, awareness raising campaigns, and strict protection of minors.

3. Competitiveness of EU produced alcoholic beverages

Alcohol production and trade is an important part of the EU economy. European Union member states account for a quarter of the world’s alcohol production and half of the world’s wine production.⁵ A dramatic increase in the taxation on these products can be detrimental to the competitiveness of the EU economy as a whole. While protecting the Single Market is important, it should not be achieved at the expense of successful industries. However, most of the proposed increases in minimum rates are usually not radical enough to cause a substantial change in prices, which means they would have no effect on either competitiveness of EU alcohol production or duty rate approximation.

A better alternative for the current duty system

Increasing the level of excise duties on alcohol seems to be an ineffective instrument in itself both for decreasing price disparity and for decreasing excessive consumption. It would also raise duties at the expense of member states which have lower level of prices and, in many cases, lower levels of income. Thus, it is questionable what advantages higher minimum rates could provide in their current form, and member states apparently do not need the European Union to enforce minimum levels since the overwhelming majority imposes considerably higher rates anyway. Of course, this can partially be explained by the fact that current minimum levels are obsolete. Prices are also influenced by VAT and other relevant taxes, which means that rate approximation has a somewhat limited influence on consumer prices.

To reduce the price disparity, the EU has to somewhat increase duty levels laid down and a maximum rate should also be introduced. Providing both a floor and a ceiling will probably be more effective over time in achieving the convergence of prices. To further improve the system, minimum rates in their current form should be done away with. Instead of setting rates in absolute nominal terms, a system where the level of excise duties imposed can freely move in a range that is relative to the EU28 average should be introduced. This way rates would not require periodical revalorization and would be effective in achieving long term duty approximation.

A 40% to 50% increase in minimum excise duties would only cause a marginal rise in the excise duty levels of the member states (provided that wine retains its special position with 0€ minimum rates) and would account for the inflation of the past 20 years. This revalorization could be used for creating the proposed, relative boundaries. Finding the right level of maximum rate seems to be somewhat more of a challenge because of the current tax regime in several countries. Some member states have rates 10-15 times the EU28 average. Setting the maximum rate too low would be a very drastic change in these countries, and this seems to be the most difficult question regarding this proposal. A possible solution would be setting an asymmetric range where the maximum is further away from the average than the minimum. In this system it would still be possible to preserve the special position of wine, with zero percent minimum rates.

This system would be less focused on increasing minimum levels and would emphasize rate approximation. It would be more future proof since boundaries would be adjusted to EU28 nation rates. This solution is also supported by the London Economics study⁶ prepared for the Commission and by the EU spirits industry.⁷