One Markup to Rule Them All: Taxation by Liquor Pricing Regulation

Government often chooses simple rules to regulate industry even when firms and consumers are heterogeneous. We show this practice is sub-optimal for a large class of empirically-relevant consumer preferences. We evaluate the implications of in the context of alcohol pricing where the regulator uses a single markup rule that does not vary across products. We estimate an equilibrium model of wholesale pricing and retail demand for horizontally differentiated spirits that allows for heterogeneity in consumer preferences based on observable demographics. We show that the single markup increases market power among upstream firms, particularly small firms whose portfolios are better positioned to take advantage of the policy. For consumers, the single markup acts as a progressive tax by overpricing products favored by the rich. It also decreases aggregate consumer welfare though $16.7\%$ of consumers are better off under the policy. These consumers tend to be older, less wealthy or educated, and minorities. Simple policies therefore generate significant cross-subsidies and may be an effective tool for government to garner favor of key constituencies.