Deposit return scheme for Scotland: business and regulatory impact assessment

19.0 Annex E: Cost pass-through

1. The potential for the producer fee to be passed on to consumers was assessed based on insights from economic theory, empirical studies of price effects of sugar/alcohol excise tax and evidence from comparable Deposit Return Schemes (DRS) in other countries.

2. Under conditions of perfect competition, the theoretical models predict a high rate of pass-through when demand is inelastic^[79] relative to supply^[80]. Available evidence (such as mean elasticities of demand for selected alcoholic drinks^[81] and assumptions made in the literature^[82] about the elasticity of supply in the beverage sector) suggests a relatively high potential for producers to pass through the majority of the costs.

3. In a monopoly case, the pass-through rate in the benchmark linear model is 50% and diverges either up or down depending on the curvature of the demand curve, potentially exceeding 100% in some cases (i.e. over-shifting).

4. In practice, most segments of the Scottish drinks market will lie somewhere in-between the monopoly and perfect competition cases. However, the available oligopoly models do not provide a prediction of the extent of pass-through.

5. All in all, the theoretical models appear to support the expectation that a large part of the producer fee will be passed on to consumers, although the precise extent of the pass-through depends on the specificities of each market segment. These models also suggest that, in some instances, over-shifting may occur. However, the models do not account for real-world pricing relationships, which may involve complex negotiations between producers, wholesalers and retailers.

6. A number of studies measure or estimate the pass-through of sugar and alcohol taxes in France and several locations in the United States. On balance, the empirical evidence in these studies suggests that taxes are generally passed on to consumers, although the extent of the pass-through varies widely.

7. The extent to which the pass-through rates described in the studies of excise taxes are likely to be replicated in the Scottish drinks market is uncertain. It is reasonable to expect that producers will attempt to pass the producer fee on to consumers. However, it is clear that, in some instances, the pass-through will be less than the producer fee; on the other hand, it cannot be ruled out that over-shifting may also occur. Finally, it should be noted that the purpose of sugar/alcohol taxes is to reduce consumption by increasing prices, which may have an impact on the manner in which producers and retailers react.

8. No systematic empirical evaluation/price monitoring appears to have been carried out in the European countries that have in place a DRS similar to the proposed Scottish scheme. However, the general view of the scheme administrators is that the costs for producers have been (in full or in part) passed on to consumers.

9. In Australia, a report^[83] for the government of New South Wales (NSW) found that, on average, 82% of the additional costs for producers were passed through.

10. In conclusion, the evidence from comparable Deposit Return Schemes further supports the expectation that there is a significant potential for the producer fee to be passed through.

11. The cost implications for consumers also depend on the overall magnitude and duration of the additional costs for producers. Exemptions from environmental taxes or expectations of a reduction in the producer fee can act as a disincentive to increasing prices (although the limited available evidence suggests that producers are more likely to take a short-term perspective and increase prices rather than absorb some of the higher short-term costs in the expectation that the producer fee is reduced over time).