An Economic Analysis of Alcohol Prohibition

Article excerpt

The use of government prohibitions to address economic and social problems related to substance abuse is widespread, but this policy is surprisingly difficult to justify on economic grounds. Standard economic models suggest that prohibitions can have substantial undesirable consequences and that they may fail to accomplish their primary objective: reduced consumption of the prohibited commodity. Economic reasoning also suggests that moderate sin taxes on the commodity in question, possibly combined with various types of regulation, are likely to reduce consumption more effectively than prohibition while avoiding many of the negative consequences of prohibitions. Evidence from the U.S. experience with the prohibition of alcohol, 1920-33, is consistent with the predictions of the economic analysis of prohibition: neither alcohol consumption nor alcohol prices changed substantially, while violent crime increased.

Introduction

The use of government prohibitions to address economic and social problems related to substance abuse is widespread. Despite the popularity of this policy, however, it is surprisingly difficult to justify on economic grounds. Standard economic models suggest that prohibitions can have substantial undesirable consequences and that they may fail to accomplish their primary objective: reduced consumption of the prohibited commodity. More particularly, economic reasoning suggests that moderate sin taxes on the commodity in question, possibly combined with various types of regulation, are likely to reduce consumption more effectively than prohibitions while avoiding many of the negative consequences of prohibition. If this analysis applies to current prohibitions of abused substances, the implications for policy are striking: the substitution of a sin tax for prohibition would simultaneously increase tax revenues, lower government expenditure, and increase economic welfare. It is, therefore, important to examine the economic analysis of prohibitions critically and to attempt to confirm or contradict this analysis with empirical evidence.

This paper provides a summary of the economic analysis of prohibitions and illustrates the empirical validity of this analysis using evidence from the U.S. experience with the prohibition of alcohol, 1920-33. Although not strictly comparable to other prohibitions, this particular episode is a useful case study from several perspectives. To begin, the data necessary for empirical examination of this period are, while necessarily incomplete, better than those available for many other prohibitions. Further, both the creation and demise of prohibition are reasonably taken as exogenous with respect to the behavior of alcohol consumption, which makes it possible to correctly gauge the impact of this prohibition on alcohol consumption and other variables. And unlike most other prohibitions, alcohol prohibition was repealed, which allows for comparison of conditions both during and after the prohibition. Thus, even though alcohol prohibition differed in some respects from many later prohibitions, examination of this episode is a useful starting place for assessing the validity of the economic analysis of prohibitions generally.

The remainder of the paper is organized as follows. Section 2 presents the standard economic analysis of government prohibitions. I explain that the effects of prohibitions on the price and quantity of the prohibited commodity are not necessarily large or even necessarily in the desired direction, and that in any event prohibitions are likely to have numerous other effects. This analysis is for the most part a "positive" one; it identifies the direction and likely magnitude of various effects without evaluating the desirability of these effects individually or of prohibitions generally. The analysis, nevertheless, suggests why economists tend to be skeptical about the value of prohibitions, and I conclude this section by discussing why moderate sin taxes are worth considering as an alternative policy. …