Rejig Gujarat liquor policy for good economics to meet good politics

The recent liquor tragedy in Gujarat, which claimed over 150 lives and left more than 300 people hospitalised, has renewed the debate over the relevance of the Bombay Prohibition (Gujarat Amendment) Act, 1949, aimed at minimising alcohol-related social and economic ills in the state.

Gujarat has enforced the prohibition of liquor since 1961, soon after it became a state. Policymakers in Gujarat have justified prohibition in the name of following Mahatma Gandhi’s philosophy, even as other states have shifted away from it. As similar tragedies occurred under the then Congress-ruled governments in Ahmedabad in 1977, Vadodara in 1989, and Junagadh district in 1990, prohibition policy should not be viewed as a partisan issue.

The key challenge for Gujarat is whether the objectives of the prohibition policy can be attained more effectively and equitably, without corrosion of social and political norms, with a different public policy approach. The Gujarat government has set up a 4-member commission to probe the recent deaths, and to suggest ways to more effectively enforce prohibition. This suggests that the terms of reference don’t envisage replacing the prohibition policy with policies that make good economics consistent with good politics.  

In this context, it is important to incorporate the implications of the principle of substitution and of opportunity costs in reforming the current prohibition policy.

Principle of substitution
This principle states that any consumer or producer will substitute relatively cheaper good, intermediate input, or a factor of production for a relatively more expensive one. Prohibition of liquor implies that there are no regulations governing the production, distribution, and consumption of legally-produced alcoholic beverages and no taxes levied on these activities. This gives rise to the substitution of relatively-cheaper, often harmful inputs in production and distribution of illicit liquor for relatively more expensive inputs. In the current tragedy, higher price of jaggery has been suggested as one of the reasons for its substitution by methanol, whose consumption is fatal. There are more subtle implications of the principle of substitution. It is well known that even in states where there is no prohibition, taxes on alcoholic products are many and high. The All India Distillers Association estimates that the alcohol industry pays around Rs 25,000 crore as state taxes on net revenues of just Rs 6,000 crore.

Moreover, each state has its own complex taxation structure, impeding the emergence of an all-India market in these products, preventing economies of scale, and more efficient production-distribution chain. The tax laws often result in much higher prices for products such as beer, which have lower alcoholic potency, ironically providing incentives for the consumption of products where potency is higher. This undermines the objective of discouraging liquor consumption.

In Gujarat, the prohibition has led to some of the more potent alcoholic products such as whisky and rum being illegally sold at prices lower than prevailing in some of the other states. In relative terms, prices for India made foreign liquor (IFML) are also relatively lower when measured in terms of alcoholic content than products with low alcoholic contents such as beer. Indeed, the taxation structure encourages beer with much higher alcoholic content than international norms.

Some of the charges levied on exceptions to the current prohibition policy also have the same impact. These provide perverse incentives to the consumers to consume more potent alcoholic products, or to consume in greater quantities.

A larger public policy implication of the above analysis for the country as a whole (and for Gujarat when it finally abolishes prohibition) is the urgent need for rationalising the taxation structure of alcoholic products. Subtleties of economic reasoning suggest that excessive taxation of alcoholic products may actually be counterproductive in moderating the consumption of these products than moderate and rational taxation policies, combined with appropriate educational measures and other incentive/ disincentive structures.   

Opportunity costs
This concept focuses on what is foregone when a particular activity or policy is pursued. It is estimated that the state annually foregoes Rs 3,000 crore in excise revenues alone. This is equivalent to 7.5% of the state’s revenue receipts in 2008-09. As income from liquor products is illegal, though illegal consumption is widespread, the state and the country also forego revenues from other taxes, such as income tax. The foregone revenue could be used for the government’s other priorities such as social sector needs and infrastructure.

While the state foregoes revenue, much of the differential between the price paid by the consumers and the cost of products (less taxes) accrues to those engaged in illegal activities relating to alcohol, which have become a massive underground business. This has not only corrupted law enforcement agencies but has also given rise to a rent-seeking bureaucratic and political class with vested interest in the illegal business. This in turn has corrosive effects on social and political norms and on the authority of law-making and enforcement agencies.

Another important opportunity cost is from the expenditure side. A large police force is required to implement prohibition. Gujarat has proven itself to be quite competent and proficient at establishing special economic zones (SEZs), where the prohibition policy has been relaxed. This has added another complication to enforcement of current prohibition policy.

As Gujarat develops further and experiences inward migration from other parts of the country and the world, pressure for exceptions will grow, and so will enforcement costs, as well as concomitant gains for evading the prohibition policy.

Recurrent liquor tragedies being experienced by the state also result in net loss of economic and social benefits as productive lives are cut short, and family structures are disrupted. Legalising liquor will not reduce such losses to zero, but at least these can be dealt with in a more open and effective manner.

The liquor tragedy has underscored the urgent need of rigorous empirical analysis of not just the costs and benefits of current prohibition policy and its implementation strategies, but also whether a different approach (not excluding abandoning current prohibition policy) would serve public interest better. Desirability of the current prohibition policy can no longer be simply asserted or assumed.

It is time to restructure Gujarat’s prohibition policy so that it becomes consistent with good economics becoming good politics, as it has done with considerable success in other areas such as health policy, infrastructure, and urban management.

Mukul Asher is professor of public policy, National University of Singapore, and Amarendu Nandy a PhD candidate in public policy, National University of Singapore.