The 5% water doesn't seem much but it can cause the shellac to go slightly milky in color. This can be quite noticeable if you're trying to match colors during the touch up of some old work. The transparency of the schellac isn't the same so even when you match the color you can still notice the difference. Also, if there's too much water in the alcohol then the shellac won't harden properly - or you'll notice a textural difference in the finished surface.
Also: not applicable to your situation, but the lighter (in color) grades of shellac are processed in a way that means that non-fresh shellac sometimes doesn't dissolve or harden properly.
Specialty stores for woodwork, art supply etc sell high quality denatured alcohol for use in shellac which is higher purity and smells less bad. I haven't tried that.
It was banned in my country after a dozen people died and more went blind after someone made a bad batch of something. Not superstition.
Methanol only occurs in home distilling if you are trying to recreate certain heavy-cellulose mashes (I've heard there's some Italian one that uses a particular wood, for example) or, more commonly, if someone is trying to de-denature alcohol, which was common during the Prohibition, which lead to the belief that moonshine was apt to blind you.
is to make sure alcoholics don't drink untaxed booze.
Fact 1: If you drink alcohol that has been denatured with an essentially nontoxic bitterant such as Bitrex/denatonium then with sufficient quanties you'll suffer ethanol/acetaldehyde poisoning and in the long term you'll likely liver cirrhosis - but you won't likely go blind.
Fact 2: If you drink ethanol denatured with methanol (and likely pyridine that usually accompanies it) then you'll likely go blind - and if you drink enough of it for long enough then you will definitely go blind. No ifs or buts, just scientific fact - that's if the methanol doesn't first kill you outright. https://en.m.wikipedia.org/wiki/Methanol_toxicity
Fact 3: Ethanol denatured with nontoxic bitterants (denatonium) is considered to have a better public health outcome as alcoholics will still suffer the short and long term effects of ethanol whether they drink whiskey or industrial ethanol but those negative outcomes, whilst bad, are not as bad as combined ethanol/methanol/pyridine mixtures.
Consumption of as little as 30/40ml will blind you and if you double that then it's curtains.
Methanol can cause cumulative damage and unlike ethanol it absorbes easily though the skin.
The reason I mention methanol is that in the past when rules were more lax I've used an ethanol/methanol mixture for shellac and some jurisdictions may still allow its use. As with ethanol, methanol works perfectly as a shellac solvent, also it's often very difficult to distinguish between these solvents without a proper chemical test.
Whilst many of these formulations were deliberately introduced to denature ethanol so that it could be sold without having duty added, overall they've had a serious delitarious effect in that the negative outcomes from a public health perspective were much, much worse than various governments losing a few dollars in excise duty. After about a century or more, more enlightened regimes have come to the conclusion that if nothing else it's cheaper not to poison citizens who insist in imbibing the poison and they've now swapped out the methanol, etc. for Bitrex/denatonium as a non-toxic denaturant alternative.
I don't know where you live but where I do the methanaion of ethanol was commonplace until recent years. Moreover, toxic pyridine was added to make the mixture stink and yet people still drank it. Although never having been tempted myself, even I'm happy the methanol has gone as I regularly use many litres of ethanol as a cleaning agent. Before the methanol was removed I had to use the less dangerous isopropyl alcohol (propan-2-ol) for safety which was much more expensive.
The fact that methanol/ethanol mixtures were (and are) so commonplace and the fact that they've been around for so long - and that trade between jurisdictions with different poison standards is common - we cannot assume any nonfood ethanol (or ethanol as solvent, i.e.: in shellac) is pure or that the only 'additive' is water unless marked BP/pharmaceutical/lab grade, etc. Essentially, the longstanding practice of mixing these two alcohols for industrial use hasn't entirely been forgotten and that habit/old practice lingers. We've seen evidence of this recently when temporary ethanol shortages led to unscrupulous suppliers substituting methanol in hand sanitizers and the CDC having to take action.
Note that I drink very rarely so this is not coming from being a heavy drinker.
Apart from smelling nice, is it something that is actually okay to breathe in?
Shellac is not particularly harmful.
Afaik the final product is pretty safe but handling the chemicals while working with it needs precautions.
That nitrocellulose form is only really a problem in bulk form, like back when it was used for movie projection film.
Flakes of the lacquer just burn fast and may continue burning without additional oxygen, but the thin film inhibits any detonation waves across the surface, while the liquid lacquer form inhibits such by dilution in a solvent.