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It’s Not Really a Taxingly Difficult Subject

Among the most economically naive calculations that people (including government officials) make is to estimate the growth in tax revenues based on the assumption that nothing changes beyond a hike in the tax.  So, for example, if 10,000 pounds of apples are sold each week in Hometown, USA, and the government of Hometown imposes a 50-cent per pound excise tax on apple sales, it’s tempting for the economically uninformed to conclude that this tax will raise the weekly revenues of Hometown’s government by $5,000.  A staple of any decent principles-of-microeconomics class is to show that such a static calculation is mistaken.  Any such static calculation is arithmetic masquerading as economics.

Another naive belief about excise taxes is that any such tax simply raises the price of the taxed good or service by the full amount of the tax – so that, in the above example, the price of apples will rise by $0.50 per pound.  (I’ve also encountered people, including students, who assume that if the excise tax is formally imposed on sellers that the sellers of the good or service will simply absorb the full value of the tax.)

Economics shows that higher excise taxes will practically always yield less revenue than the revenue figures you get by merely multiplying the dollar value of the taxes by the quantity of the good or service regularly bought and sold before the taxes are implemented or raised.  Economics also shows that the price of the taxed good or service will indeed rise because of the tax, but practically never by the full amount of the tax.

The reason for these outcomes is that people respond predictably to incentives – in this case, to incentives created by higher taxes.  Obliged, for example, by such a tax to pay a higher price for apples, consumers will not buy as many apples as they bought before the tax hike.  Similarly, obliged – because of the tax – to accept a lower take-home price on each pound of apples sold, sellers aren’t willing to sell as many pounds of apples with the tax as they were before the tax was raised.

The above analysis is basic, foundational stuff.  In the classroom this analysis is demonstrated with supply and demand curves, and it is raised to a higher level of realism and complexity by assuming different degrees of relative elasticities of supply and demand.  Discussions of deadweight loss and relative tax burdens ensue.  But even then this analysis remains well within easy reach of any respectably competent freshman enrolled in a course in the principles of microeconomics.

The point of such an analysis in an undergraduate classroom is not only to teach students a bit of what we economists are quite confident that know about the incidence and other consequences of taxes but, more importantly, to drive home the importance of looking beyond the obvious.  Arithmetic is not economics.


I was led to ponder here the basic economics of excise taxation by reading various blog posts, media reports, and personal e-mails regarding proposals to raise the legislated minimum wage.  Much of this discussion – even by people trained in formal economics – takes place in an entirely different way than do discussions about the consequences of raising excise taxes.

For example, there seems to be a widespread presumption that a higher minimum wage can simply be absorbed by employers – as if employers are either unwilling or unable to adjust on other margins to the legislated higher input costs.  (This presumption, by the way, reveals a strange, deeper presumption – namely, that the very same profit-hungry and ‘powerful’ companies thought to require legislation to force them to pay their workers appropriate wages are either too lazy or too incompetent to find other ways to reduce their exposure to the higher mandated input costs, or have ‘power’ only to keep their employees’ wages ‘too’ low, with no ‘power’ on any other margins to act in profit-enhancing ways.)

Sometimes this presumption is offered with the claim “Acme Corp. has a large net worth, so it can afford to pay its workers more!”  Or sometimes this presumption is offered with the quite opposite claim that “All that Acme Corp. must do is to raise the prices of its final output by some small amount and it will be able to recover the extra expense it incurs because of the higher minimum wage.”  (I haven’t checked, but I wouldn’t be surprised if several people have made both claims to justify their naive prior that raising the minimum wage will do nothing to harm low-skilled workers.)

But either way – with whatever claim one offers to ‘explain’ why a higher minimum wage will not diminish the employment opportunities of low-skilled workers – such claims represent bad economics.  Such claims mistake arithmetic for economics. (“Acme Corp. is worth $999 gazillion dollars, so it can afford to pay all of its current low-skilled workers the full amount of the higher minimum wage without taking any steps beyond simply paying these workers, in full, the higher wage.”  Or “If only Acme Corp. would raise the prices of the stuff it sells by Y percent, it would recover in full its extra expenses from paying the higher minimum wage.”)

Such claims are not economics; such claims are arithmetic.  Uttering such claims reveals an ignorance of the large numbers of margins on which firms in even the most competitive industries can and will adjust along, and an ignorance of the large numbers of margins upon which consumers, as well as workers and other inputs suppliers, can and will adjust along.

Clever folks can (and do) devise explanations for how that which is highly implausible might in fact occur in reality.  And other clever folks are often impressed by such explanations.  But too often cleverness crowds out wisdom or good sense.

It’s certainly possible, for example, that imposing higher excise taxes on tobacco products will only cause tobacco-companies’ profits to fall by the amount of the tax – that is, with no higher prices for consumers of tobacco products to pay.  Likewise, it’s possible that a higher excise tax on tobacco products will be passed along in full to tobacco consumers but have zero effect on these consumers’ actions (beyond their simply paying more for tobacco products).  Possible.  But who would take such claims seriously?  Who would discuss proposed higher excise taxes on tobacco products with the presumption that such a tax hike will have an effect only along one margin – either that the tax will simply cause tobacco-company profits to fall by the amount of the tax (end of story) or that the tax will simply be passed along in full to tobacco consumers (end of story)?

No one would entertain such an ‘analysis.’  Yet those kinds of ‘analyses’ are common in discussions of legislated minimum wages.