During the 1992 Presidential campaign, a small pizza company owner from Missouri
asked then Democrat candidate Bill Clinton if he had considered the impact of the
proposals he was floating as regard national health care and the like on the viability of
small business. Clinton's response was that any business would simply pass along such
necessary additional costs to consumers in the form of higher prices. Unable to
comprehend the import of the suggestion, Clinton demonstrated to the small proprietor
the utter disregard, and ignorance, he had of such mainstays of the American economy.
The gentleman could do little more than look at Clinton dumbfounded and shake his head.
Economists have touted the idea that such necessary costs of government intervention
might be calculable through a device known as tax incidence. On this theory, the share of
the additional cost would be shared, depending upon market conditions, by buyers and
sellers, with some estimation of the relative burden able to be figured. The problem with
the theory is with what it does not consider as much as it is with what it does purport to
measure.
Figure 1.
P | D S2 S1
| \ / /
| \ / /
| \ / /
10 | / /
| / \ /
| / \ /
8 | / \/
| / / \
|___________________________________
30 50 Q
On the above graph, the original price of a product would have been $ 8, but given an
additional cost in the form of some tax or regulation of $ 3, the resultant price increase
the market would bear would cause the price after the new cost to increase to $ 10 per
item. Since the buyer thus bears $ 2 of the $ 3 additonal cost, the seller must absorb the
other $ 1 of the cost. This basically is the idea behind the tax incidence notion.
Dependent on the conditions of the market, the slope of the curves might be less steep,
but that is not really at all an issue in the matter. Certainly with a firm in a monopolistic
competition market, that would be the case. What does need to be considered would be
the opportunity costs involved in the impact on the businesses operating under the added
cost. Determination would have to be made as to whether the opportunity costs were
warranted. But such a decision must rest on analysis which goes well beyond the
immediate and superficial impact.
In the above scenario, the impact of the changed cost structure results in a 40 %
decrease in Q of output. It would not have to be that great to have dilatory effects on the
firms and their employees. Small businesses operated at very thin profit margins, and any
movement in this direction might make their continued existence a matter of some
considerable doubt. Obvious from the start would be the resultant drop in total revenue
from $ 400 at the $ 8 price to $ 300 at the $ 10 one. That might be enough to drive the
operation out of existence, at least in the long run, as it could push the firm's operation
below its average variable cost curve.
It would also result in less demand by the firms for labor, and that could hardly be
termed a justifiable cost. The fact that the buyer would be carrying the greatest share of
the additional cost is precisely the problem. Such an increase in price results in a decrease
in demand. On the demand side, that means that there is less demand for the product,
lowering the standard of living of those effected in the consumer market. It also means
that there would be less income, further complicating that picture. This would also effect
higher governmental costs as these newly unemployed became burdens on the costs of
public programs and a drain on revenue collection since they now pay less -- or no --
taxes.
However, even less apparent in a superficial analysis such as tax incidence are the
supply side impacts of the altered cost and price and profit structure. The firms affected
will obviously also have reduced revenue, and on that, the government will collect less
revenue. They might even be driven out of business, further complicating the above
analysis and increasing public safety net program costs. Less obvious, but even more
critical from the standpoint of the overall impact of such changes in policy on the economy
would be the 'cost' of the decreased profitability of the firms in the effected market.
Understanding this point requires a comprehension of the role of profit -- social surplus
-- in the market system. In this nation where most employees work for small business, this
theory of tax incidence is one which is critical to public policy. The idea that if businesses
do not pay 'enough' taxes is a dangerous one for our economy. Anytime anyone suggests
that any business does not pay its fair share of taxes, the best plan would be to do what
Bush told us to do if Clinton won the election, "Grab your wallet." Businesses, despite
what is purported by the theory of tax incidence, do not pay taxes. That does not mean
that they should not be taxed. But when they are, we must be fully aware of the
consequences and costs involved. It may even be good policy if it evokes investment that
is productive. That is not always, or even usually the case, however. What tax incidence
really means is how much tax is hidden.
We have recently seen an excellent example of the exigencies to which government
will go to hide taxes. The matter involves the tobacco companies, which seem to be bad
guys in reality because they have made money. Whatever one thinks of the allegations
involved, what is certain is that the government does not seem likely to outlaw tobacco.
Short of that, however, governments are working out deals for billions of dollars to be
paid to them from tobacco companies. Where will this money come from? Some of it is
likely to result in lowered profits for the firms involved. Of course, reduced profits means
less social surplus/capital/investment, and the burden of such reductions is on those who
will not reap the benefits of the induced economic activity. The rest of it will be paid by
those who continue to use tobacco products -- at higher prices. This is in reality a huge
tax increase on smokers! But then, they have a dirty habit and probably deserve to pay
higher taxes.
If one is to believe the Clinton administration, however, and it is true that tobacco use
causes premature death, then what they are up to is increasing the costs of health care for
the elderly -- those who live longer because they stop smoking. That illustrates the real
motivation here -- increased government caretaking of the poor people of the US who
cannot handle their own lives without the government's all-seeing and all-knowing
intervention.
Tax incidence may have a useful purpose, but it must be understood if it is not to
be an instrument of tremendous abuse by government.
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