Does every drink impose a social cost?

Document Details
AUTHOR Anupam Manur
DATENovember 7, 2026
CATEGORIES Economic Policy

Karnataka has introduced a radical reform of its alcohol excise policy. Instead of taxing alcohol based largely on its price and category, the government is moving towards taxation based on the amount of pure alcohol in the beverage, a move that has been done in a few other countries. The underlying principle is that alcohol imposes a cost on society and the tax should reflect this cost. The committee advising the government estimates that alcohol-related harm costs Karnataka approximately ₹51,000 crore annually and proposes a benchmark of ₹2,000 per litre of pure alcohol. The idea is still rooted in good economics - for any activity that imposes a social cost, internalise the externality by imposing a tax equivalent to the externality .

A few problems though

1. Private costs vs Social Costs

Not every cost associated with drinking is an external cost that needs to be corrected through taxation. Consider someone who drinks excessively, damages his liver, misses work frequently and eventually loses his job. These are unfortunate consequences, but they are primarily private costs. The drinker bears them through poorer health and lost income. A decline in someone’s productivity does not automatically constitute a cost imposed on others.

The term negative externality necessarily means these are costs imposed on third parties who were not involved in the original transaction. Someone drinking at home does not necessarily impose such costs. But if he drives afterwards and injures a pedestrian, that certainly is an externality. Domestic violence, public disorder and burdens on taxpayer-funded healthcare are other examples.

To its credit, the committee recognises this distinction and attempts to exclude private costs. However, using that to come to a precise tax is a much tougher task.

2. Marginal vs Average

The average external cost of drinking is not the cost imposed by every additional drink.

I have a fundamental problem with treating alcohol the same way as other items that cause a negative externality. A cigarette smoked or car emissions will always harm the environment marginally and can therefore attract a compensatory Pigouvian tax. But, there are plenty of instances where alcohol can be consumed with zero externality. A person drinking at home or even a pub, but taking a cab home and sleeping exerts zero external costs. This is where the difference between marginal and average is important.

Suppose ten people consume alcohol. Nine drink responsibly, while one drives recklessly and causes an accident. The total external cost could be enormous. Dividing this by the total alcohol consumed would produce an average cost per litre. But it would be absurd to conclude that all ten individuals imposed identical costs on society.

Yet, a uniform tax based on average external costs essentially does this. Each person pays according to the amount consumed, irrespective of the harm they cause.

3. Targeted interventions vs blanket tax

This leads to a fundamental question then: Why tax alcohol consumption when what we really want to discourage is the harmful behaviour associated with it?

The problem with drunk driving is not drinking but driving while intoxicated. Someone who takes a taxi has avoided precisely the behaviour society wants to discourage. Yet both individuals pay the same excise tax. Similarly, if alcohol contributes to domestic violence, surely stronger enforcement against violence is a more direct response than treating everyone buying a bottle as a potential offender.

In effect, responsible drinkers are penalised for the actions of irresponsible ones. The state is compensating for its lack of capacity to address the negative outcomes by taxing the triggers.

4. Substitution Effect - Beer vs Spirits

There is another problem. Consumers respond to incentives, but not always in the way policymakers expect. A strength based-taxation will make spirits more expensive and beer slightly cheaper. One can imagine people increasing their beer consumption and Karnataka’s experience is already interesting. Beer sales increased by nearly 50% in volume terms during July–September 2026, compared with the previous year. This could indicate consumers substituting beer for stronger spirits.

But lower alcohol concentration does not necessarily mean lower alcohol consumption. Someone might substitute one drink of whisky with several bottles of beer, consuming the same quantity of pure alcohol, or even more. Whether the policy reduces alcohol-related harm depends on actual drinking patterns, not merely the strength of beverages sold.

Of course, there is also the possibility of substitution towards illegal alcohol. If legal alcohol becomes sufficiently expensive, consumers may turn to illicit liquor and bootleggers. India has witnessed repeated tragedies involving spurious liquor, with hundreds dying from alcohol poisoning over the years. A policy intended to reduce alcohol-related harm could inadvertently create incentives for a far more dangerous market.

Raise revenue or change behaviour?

The reason for taxing alcohol is, more often than not, a way to raise revenue for the state. Especially in India’s situation where alcohol sits outside of GST and states have full taxation authority and can retain the taxes, taxing alcohol becomes a very tempting prospect.

The Ramsey rule suggests that, when governments need to raise revenue, goods with relatively inelastic demand can be taxed at higher rates because consumers change their behaviour less in response to prices. Alcohol is a useful revenue source for precisely this reason.

But this creates an interesting tension. If alcohol demand is relatively inelastic, taxing it can generate substantial revenue without significantly reducing consumption. That makes sense from a revenue perspective, but is less compelling as a strategy for discouraging harmful drinking. The two objectives should not be confused.

This is not to say that alcohol should not be taxed nor that the move towards alcohol-content-based taxation cannot work. But the existence of negative externalities is a reason to examine how best to correct them, not a licence to impose their estimated average cost on everyone. Stronger drunk-driving enforcement, meaningful penalties for violence and better policing of public disorder address the harmful actions more directly.