Econ 0.101

Economics lessons from Professor Mark Perry of Carpe Deim.

Lesson One:
From Thomas Sowell: "The first lesson of economics is that we live in a world of scarcity. There is never enough of anything to satisfy all those who want it. The first lesson of politics is to ignore the first lesson of economics."

Lesson Two:
Public Choice Economics: In their short-sighted self-interest to get re-elected, politicians will always favor programs that have immediate benefits that are easily identifiable, even if the long run costs are much greater than the benefits, especially when the costs are hard to identify. Film subsidies are a perfect example. It would have been cheaper for the state of Michigan to simply pay people in the film industry salaries of $50,000 per year not to work, than to fleece taxpayers almost $200,000 per job in the film industry. But there's no political payoff to pay people $50,000 not to work, compared to the huge political payoff, though illusory, of "putting people to work in the Michigan film industry" at a cost of almost $200,000 per job.


Lesson Three:
Tax something and you get less of it


From the New York Post:

"The underground tobacco market is spreading like a fast-growing cancer in the wake of tax hikes that make New York cigarettes the most expensive in the nation -- and it's costing the state tens of millions a month in lost tax revenue.

Illegal cigarettes are pouring into neighborhood bodegas by the truckload from neighboring Indian reservations, lower-tax states in the South and even as far away as China. Government data show that New York state is being smoked out of as much as $20 million a month from all these illegal cigarette purchases -- an estimated 7.3 million packs a month sold off the state tax radar.

Sales of taxed cigarettes have plummeted 27 percent since July, when state lawmakers raised the excise tax to $4.35 a pack on top of the city's tax of $1.50, making the average price of Marlboros here $11.60, with some shops charging as much as $14. About 30 million packs are being sold legally each month -- down from 41 million packs a month before July.

The plunge far exceeds tobacco-control experts' predictions that sales would fall 8 to 10 percent, indicating that smokers are finding other means to get their nicotine fix."

MP: Economic lessons to be learned here:

1. Taxes are always distortionary because people can change their behavior to avoid the tax.  (The only exception: a "head tax," which cannot be avoided.)  Elected officials almost always underestimate the ability of taxpayers to change their behavior to avoid taxes, and the New York cigarette tax example is no exception  - experts predicted a 8-10% reduction in sales vs. the actual 27% decline.  

2. In any discussion about taxes, we have to distinguish between "tax rates" and "tax revenues," especially when we talk about "increasing or decreasing taxes," with the assumption being that increases (decreases) in tax rates and increases (decreases) in tax revenues automatically happen together.  In the case of cigarettes in New York the "tax increase" in rates resulted in a "tax decrease" in revenues because of what happened to the "tax base" (the amount of activity subject to the tax).  In this case (as often happens), the increase in tax rates on cigarette caused the tax base (amount of cigarettes subject to state taxes) to shrink so significantly, that there was a decrease in tax revenue. 

The same outcome often happens, whether the tax increase is on income, dividends, capital gains or retail sales.  See a good overview here of "tax rates" and "tax revenues" by Thomas Sowell on a recent episode of "The Kudlow Report."