## Sunday, April 18, 2010

### Wine Equalisation Tax, microbreweries and the grape glut

Subtle examples of the unintended consequences of government intervention in markets are not hard to find. Today we follow a path from the introduction of producer rebates for the Wine Equalisation Tax on wine makers, to the grape glut of 2010, to the call for tax relief from microbrewers.

The Australian government introduced a Wine Equalisation Tax (WET) to smooth out price changes when sales tax was abolished and the GST was introduced [A New Tax System (Wine Equalisation Tax) Act 1999]. However, small wineries receive a rebate on the WET for the first $1.7 million of production (a rebate of up to$500,000). Enshrining this rebate into law sheltered small wineries from the rigours of market discipline, and could be a key contributing factor to the current grape glut. At least 1,250ha of vines were abandoned in SA in 2008-09.

Did the rebate contribute to the glut, and should we offer a similar rebate to brewers?

Tracing a path through the decade from winery subsidies to the grape glut is not too difficult. Any subsidy generally results in market inefficiency and an oversupply because producers face artificially higher prices.

One often overlooked reason for the grape glut is that grape vines take some years to establish and are perennial (they are permanent). Unlike other agricultural commodities such as cotton, sorghum and wheat, which are an annual crop and will be planted only if the market price justifies planting, grape vines will continue to produce each year. Growers cannot easily adapt by reducing supply in the short term.

There are many reasonable arguments for this rebate which would have been very powerful at the time of its introduction – encourage domestic wine production, and stimulate competition and innovation in the wine market. These goals have definitely been met, but what about those unintended consequences?

Intervening in the wine market in this way has led to unequal competition more broadly – in the battle between wineries and breweries. Brewers entering the market get no tax relief and face stiff competition from well established players and the subsidised boutique wine market.

The Australia Association of Microbrewers has been feeling the effect of the lopsided Australian beverage market and has launched a petition to give local wineries and brewers equal tax treatment. They have gained some media attention, although strong loyalty to existing brands is probably hindering traction in the public psyche.

This unequal treatment has led to a beer market where boutique beers are mostly hitting the shelves from abroad rather than from domestic competition.

But will a producer rebate for small breweries lead to a barley glut in 2020? I think not. My reasons include that fact that the ingredients for beer are also commonly traded agricultural commodities in global markets, and that barely and other grains that can be used for beer making are annual crops. If beer producers ‘overshoot’ due to the subsidy, grain growers can easily sell grains to other markets and grow different crops the following season if there are significant price changes.

We cannot expect governments to consider all of the infinitely broad possible consequences of market intervention. However, simple rules of thumb can be applied. For example, this examination of the wine producer rebate suggests that isolating just some players in a market for special treatment can be hazardous. Governments could easily apply this even treatment of market players as a rule for future reforms.

Has anyone some interesting examples to share of unintended consequences from government choosing winners with market intervention?

1. Hi Cameron, whilst very off topic thought you might be interested in this post on Michael Burry (sorry, I couldn't see another way to get this to you): http://streetcapitalist.com/2010/04/04/michael-burry-i-saw-the-crisis-coming-why-didn%E2%80%99t-the-fed/ The same blogger has a great profile of a man that is new to me elsewhere on the same site. Wonder if Stevens is now playing caution.

2. Darren,
Thanks for the link. Interesting blog there. There are a few people who saw a crisis coming. But as usual, it's all in the timing.
I do believe that Glenn Stevens will more much more cautious now with interest rates. Whether that means he will be happy to drop them severely should we see asset price declines is yet to be determined.

3. The ideal situation (as a biased non-property owner anyway!) is for the upcoming Fed Budget to drop negative gearing on all but newly built homes (even excluding rebuilds, unless they add more bedrooms), and maybe excluding it from 2nd or 3rd investment properties. Of course this needn't be done overnight, but scaled in over time to reduce the shock factor to the system.

I feel for Stevens, he is trying to deflate the bubble but fiscal policy driven by an election year is inflating it. I personally think Ian Macfarlane wasn't attacked by the media (and Canberra) as much and could truly be independent.