As a result of the COVID 19 pandemic and the economic shortfalls associated with the recession, the Maharashtra government decided to implement an increase in VAT and Excise Duty on alcohol in the state. The key concept in economics that this relates to is efficiency, which is the idea of the aim to effectively allocate resources without waste and spillover effects, which is a concept visible in the concept of externalities. Excessive consumption of alcohol in Maharashtra creates a negative externality of consumption, which is defined as when the over consumption of a good creates spillover cost on a third party in a free market. Drunk driving occurs as a result of excessive alcohol consumption, which creates a negative externality for the public as accidents and certain emergencies can arise as a result of the overconsumption of the good This pigouvian taxation on alcohol of 220% manufacturing cost, a demerit good, and negative externality of consumption due to its spillover effect on a third party, aims to decrease both production and consumption of alcohol and return the market to the socially optimal level.
As can be seen in the figure above, the market for alcohol in Maharashtra contained a negative externality of consumption. Negative externalities of consumption deal with the consumption of a good, so, in this case, the supply curve stays the same at the equilibrium throughout the situation. The marginal private benefit (MPB) is greater than the marginal social benefit (MSB), meaning that the individual benefit of the action is less than the social benefit of the action in the market, therefore creating the negative externality in the market. The equilibrium price at Pe is higher than the Socially optimal level of price, which impacts the quantity demanded of alcohol. If the Price decreases to the socially optimal level at Pso, the quantity demanded of the alcohol will also fall from the equilibrium quantity of Qe to the socially optimal quantity demanded of Qso, therefore creating the socially optimal equilibrium. As the marginal social cost (MSC) of consumption exceeds the marginal social benefit (MSB) of consumption, the market sees a welfare loss shown in the graph in the shaded triangle, which is calculated through the vertical difference between the marginal social benefit (MSB) and the marginal private benefit (MPB).
With the addition of a corrective pigouvian tax to address the issue of overconsumption of alcohol in the state of Maharashtra, the tax leads to the price of the good for consumers to rise, therefore leading to a fall in quantity demanded from the previous equilibrium of Qe to the socially optimal equilibrium quantity of Qso. The size of the tax is calculated through the size of the external welfare loss, which is shown through the vertical distance between the marginal social benefit and the marginal private benefit.
Through the inclusion of a Pigouvian corrective tax for alcohol sales in Maharashtra, it allows for the market to reach optimal social efficiency. As well as improving the market efficiency, the corrective tax allows for additional funds to be raised for the government which can be used for other programs relating to subsidising welfare programs for positive externalities and merit goods, and through the financial implications resulting a higher equilibrium price at Pse, consumers are more likely to reduce their consumption of alcohol.
Although this corrective pigouvian tax allows for the market to eliminate the negative externality and eliminate the inefficient market, there are certain cons as a result of the addition of a corrective pigouvian tax. As a result of the administration that the government undertakes to implement the corrective tax, there is a cost associated with this implementation, which is relayed to the government. As well as this, due to the reduction of quantity and higher costs, producers will be less likely to hire workers and stimulate business, leading to less job security for workers, and a higher financial burden on consumers. Finally, a corrective tax that increases prices often raises competition from the global economy, as a country without corrective taxation for negative externalities will profit through the reduced price of purchase, while the country with corrective taxation will lose out. The only way to solve this problem would be to impose international regulations that carry over internationally, eliminating the problem.
In conclusion, the negative externality of alcohol consumption in Maharashtra evidently was fixed through the pigouvian corrective tax that increased both the VAT and Excise Tariffs on the state alcohol prices, returning the market to the socially optimal price and quantity equilibrium, however several cons arose as a result of the imposition of the taxation, which makes the cost of implementation high, a higher financial burden on workers in the industry, and international competition, therefore making the debate of the implementation of this taxation far more complicated.
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