One often hears that taxes passed on businesses will be passed onto consumers. Some dispute this claim. By looking at this in a methodologically individualist fashion, doesn't the answer become clear?
If taxes are raised, say the corporate tax is raised from 25 to 30%, each business would want to make up for the losses by raising their own prices. But how can they? If they raise their price and no one else does, then they start losing out on a share of the market. No business wants to be the first one to raise their prices and scare off customers.
However, if one is able to raise one's prices in response to a tax increase with the cooperation of the rest of the industry, then the tax is indeed passed onto consumers. The standard Libertarian line on cartelization is that industries can cartelize if they use the state to decrease the amount of present and possible future producers within a given industry. If there is just a handful of businesses in a given industry they can come to agreements with each other and can manage to pass the tax onto consumers by acting in concert.
Rothbard pointed out that a raise in taxes on business will tend to reduce the amount of producers within a given industry simply because the increased costs of business will drive some producers out. So in a roundabout (non-BohmBawerkian) sense, increased taxes can manifest themselves as taxes on consumers insofar as they are able to catalyze a cartelization of an industry.
So in conclusion: saying that taxes on businesses are taxes on consumers is an oversimplification. In a purely free market, that would be false. In a market of cartelists, it is not necessarily false. And the action of increasing taxation is to the eventual advantage of cartelists.
The Anarch is to the Anarchist what the Monarch is to the Monarchist. -Ernst Jünger
You assume that they pass them on by raising prices. They can do other things that aren't as visible in the short-term: lower quality of product/support, reduce volume of product (The Consumerist covers this often).
What is the difference between reducing the volume of product and increasing the price as expressed in prices?
Jargon,
...industries can cartelize if they use the state to decrease the amount of present and possible future producers within a given industry.
I thought the laws had to impose price controls as well.
EDIT: The logic being that without price controls the members of the cartel will, despite the agreements, still try to get a larger market share by lowering their prices to what supply and demand dictates.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
Why? Can't they impose price controls or supply quotas privately?
Sorry for not elaborating.
I edited previous post to explain.
In short, what's to stop one fellow from backing out of the agreement and lowering prices in order to make more money?
They can do other things that aren't as visible in the short-term: lower quality of product/support
Consumption taxes in particular are really a haphazard income tax, imputed back to factors of production (wages and returns on capital).
... just as the State has no money of its own, so it has no power of its own - Albert Jay Nock
In the UK they have the sales tax or VAT, where businesses are exempt from paying sales tax on purchases but have to pay sales tax on sales of their goods and services to the government. This type of tax gets passed on to consumers pretty much directly. If the sales tax is increased the price for goods and services increases almost instantly.
"If taxes are raised, say the corporate tax is raised from 25 to 30%, each business would want to make up for the losses by raising their own prices. But how can they? If they raise their price and no one else does, then they start losing out on a share of the market. No business wants to be the first one to raise their prices and scare off customers."
Well, let's be clear about what kind of tax we're talking about. If you're talking about a corporate income tax, then that is essentially a tax on profit. In that case, I'd agree that such a tax would not raise prices in the short run. The reason being that companies would still want make the biggest profit possible just as they would before the tax was imposed, it's just that they would get to enjoy a smaller fraction of those profits as a result of the tax (or more technically, a corporate tax doesn't change the marginal decision making of the firm in the short-run).
But what if we are talking about a per-unit tax, like a cigarette tax? In that case, then i think prices would typically increase. I think the essential thing is that even if firms can't change prices (and I agree that firms operating in competitive markets will have less leeway for doing this), they can still change how much they produce and this will indirectly result in a price change.
Think about it this way.
Suppose that before a cigarette tax is imposed, cigarettes sell for $3 per pack and there are 10 cigarette companies each selling 1,000 packs of smokes per day. Now suppose a $2 per pack tax is imposed on cigarette producers. If the firms do not raise their prices, this means they may charge $3 per pack, but they actually only earn $1 per pack they sell. This will likely lead all firms to want cut back production (they are earning less on each pack, but their costs of production have not changed). For example, say the firms want to cut back from 1,000 packs per day to 500 packs.
But this is going to cause problems. Since the price is $3 per pack, consumers will want to buy 10,000 packs. However, the 10 cigarette companies combined are only willing to sell 5,000 packs at that price. As a result, we have a shortage of cigarettes (quantity demanded exceeds quantity supplied). So there is no guarantee that when you go to the store you will find a pack of cigarettes waiting for you.
Of course, the market process doesn't stop here. There will be some consumers that are willing to pay more than $3 per pack for cigarettes. So they may offer the cigarette producer more money to ensure that they can buy with cigarettes with certainty. These sorts of offers will bid up the price of cigarettes. As a result, some portion of the tax will passed along to consumers in the form of higher prices. In some extreme cases, *all* of the tax burden will be passed on to consumers (if demand is perfectly inelastic or supply is perfectly elastic). But that isn't all that important for the economic logic of what's going on.
Ambition is a dream with a V8 engine - Elvis Presley
1. ...a corporate tax doesn't change the marginal decision making of the firm in the short-run... 2. ...they may charge $3 per pack, but they actually only earn $1 per pack...This will likely lead all firms to want cut back production (they are earning less on each pack, but their costs of production have not changed).
1. ...a corporate tax doesn't change the marginal decision making of the firm in the short-run...
2. ...they may charge $3 per pack, but they actually only earn $1 per pack...This will likely lead all firms to want cut back production (they are earning less on each pack, but their costs of production have not changed).
Why does the logic of 2 not apply in case 1?
Smiling Dave: Sorry for not elaborating. I edited previous post to explain. In short, what's to stop one fellow from backing out of the agreement and lowering prices in order to make more money?
I always thought that the problem with free-market cartelization wasn't that pool-members would back out, but that the pool would be challenged by an outsider after a period of intolerably high prices.
Student: "If taxes are raised, say the corporate tax is raised from 25 to 30%, each business would want to make up for the losses by raising their own prices. But how can they? If they raise their price and no one else does, then they start losing out on a share of the market. No business wants to be the first one to raise their prices and scare off customers." Well, let's be clear about what kind of tax we're talking about. If you're talking about a corporate income tax, then that is essentially a tax on profit. In that case, I'd agree that such a tax would not prices in the short run. The reason being that companies would still want make the biggest profit possible just as they would before the tax was imposed, it's just that they would get to enjoy a smaller fraction of those profits as a result of the tax (or more technically, a corporate tax doesn't change the marginal decision making of the firm in the short-run). But what if we are talking about a per-unit tax, like a cigarette tax? In that case, then i think prices would typically increase. I think the essential thing is that even if firms can't change prices (and I agree that firms operating in competitive markets will have less leeway for doing this), they can still change how much they produce and this will indirectly result in a price change. Think about it this way. Suppose that before a cigarette tax is imposed, cigarettes sell for $3 per pack and there are 10 cigarette companies each selling 1,000 packs of smokes per day. Now suppose a $2 per pack tax is imposed on cigarette producers. If the firms do not raise their prices, this means they may charge $3 per pack, but they actually only earn $1 per pack they sell. This will likely lead all firms to want cut back production (they are earning less on each pack, but their costs of production have not changed). For example, say the firms want to cut back from 1,000 packs per day to 500 packs. But this is going to cause problems. Since the price is $3 per pack, consumers will want to buy 10,000 packs. However, the 10 cigarette companies combined are only willing to sell 5,000 packs at that price. As a result, we have a shortage of cigarettes (quantity demanded exceeds quantity supplied). So there is no guarantee that when you go to the store you will find a pack of cigarettes waiting for you. Of course, the market process doesn't stop here. There will be some consumers that are willing to pay more than $3 per pack for cigarettes. So they may offer the cigarette producer more money to ensure that they can buy with cigarettes with certainty. These sorts of offers will bid up the price of cigarettes. As a result, some portion of the tax will passed along to consumers in the form of higher prices. In some extreme cases, *all* of the tax burden will be passed on to consumers (if demand is perfectly inelastic or supply is perfectly elastic). But that isn't all that important for the economic logic of what's going on.
Well, let's be clear about what kind of tax we're talking about. If you're talking about a corporate income tax, then that is essentially a tax on profit. In that case, I'd agree that such a tax would not prices in the short run. The reason being that companies would still want make the biggest profit possible just as they would before the tax was imposed, it's just that they would get to enjoy a smaller fraction of those profits as a result of the tax (or more technically, a corporate tax doesn't change the marginal decision making of the firm in the short-run).
Ok that makes sense: taxes on income, after all is said and done, will have to be humped by producers, given the scenario that they aren't able to form and hold a cartelistic agreement. Taxes on the product, before anything is done, will induce them to restrict supply because their costs of production have gone up. He likely wouldn't choose to reduce production under an increasing income tax because he would still be taxed on the increased profits from cutting costs.
http://media.mises.org/mp3/Rothspeak/Cartels.mp3
That's where I got it from.
I don't usually feel like i know enough to chime in, but this time I think I recognize something! Arent u missing the whole "price sensitivity" thing? Didn't Rothbard say:
"Prices, at all times, tend to be set at the maximum net revenue point for each seller. If the sellers can simply pass the 20 percent increase in costs onto the consumers, why did they have to wait until a sales tax to raise prices? Prices are already at highest net income levels for each firm. Any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers."
(I can't take credit for this, I remembered it from John James Greatest Hits, which made ti easy to find again.)
It seems to me that would only be valid for a market with one seller. With multiple sellers, part of the cap on prices is the potential for lost market share when another seller offers the product for less. Increasing the price by 20 percent might maximize revenue, but only if everyone increases their prices - which you may see with a tax increase.
See Rotbhard's explanation of this phenomenon in Power & Market the section on Binary Intervention (Chapter 4, I believe).
If the sellers can simply pass the 20 percent increase in costs onto the consumers, why did they have to wait until a sales tax to raise prices? Prices are already at highest net income levels for each firm. Any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers.
By this logic, a 90% tax wouldn't result in anything passed on to consumers. I think the argument is flawed because the stability before was in a different set of circumstances; the new tax changes the context and therefore the prices. It's like any other increase in source materials cost.
Blargg:If the sellers can simply pass the 20 percent increase in costs onto the consumers, why did they have to wait until a sales tax to raise prices? Prices are already at highest net income levels for each firm. Any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers.By this logic, a 90% tax wouldn't result in anything passed on to consumers. I think the argument is flawed because the stability before was in a different set of circumstances; the new tax changes the context and therefore the prices.
But why should a price change not affect buying decisions? doesnt the thing we're talking about have to be 'inelastic' or something? How many products have a demand that is inelastic?
It's like any other increase in source materials cost.
don't those kind of increases affect the bottom line? Isn't that the whole reason businesses try to 'cut costs', so they can increasetheir profit? If costs go up, the biz may try to raise its prices, but i don't see why we should expect the same quantiy sold.
Smiling Dave,
Because you have to keep in mind that these are two different kinds of taxes. The first tax is a tax on profits. Such a tax does not alter which level of production is most profitable. It only affects how much of the profits you earn you get to keep after you pay your tax bill.
Think about it this way. Let's say that a cigarette manufacturer decides that producing 1,000 packs per day is the production level that will maximize his profits (say he earns $1 million in profit). His profits are their MAXIMUM at 1,000 packs. This means that if he reduces production he will lower his profits. For example, say if he reduces production to 900 packs he only earn $0.9 million. Likewise, if he increases production he will lower profits. For example, say if he increases production to 1,100 packs he will only earn $0.9 million in profits.
If this was not the case he would no be maximizing profits.
Now, let's say a 25% corporate income tax is imposed. What will the firm do? If keeps producing 1,000 packs he will now only earn $0.75 million in profits ($1*(1-0.25)=0.75). Similarly, if he either cuts production by 100 units or increases production by 100 units he will only earn $0.675 million in profits ($0.9(1-0.25)=$0.675). In other words, he will just earn even lower profits than if he didn't change production at all.
This should make sense. It still costs the company the same ammount as before to produce cigarettes as before. And the demand schedule for cigaretted has not changed. So why would the profit maximizing production level?
This is not the case with a per-pack tax on cigarettes. As Jargon notes, such a tax essentially makes cigarettes more expensive to produce. So the consequences of such a tax should be the same as if the cost of an input of production increases.
Student.
I follow your reasoning about the corporate tax. But why can we not make the same analysis for a tax per pack, as follows. I'll basically be copy pasting your argument, and bolding where I make a change.
Now, let's say a 25% tax is imposed on every pack. What will the firm do? If keeps producing 1,000 packs he will now only earn $0.75 million in profits ($1*(1-0.25)=0.75). Similarly, if he either cuts production by 100 units or increases production by 100 units he will only earn $0.675 million in profits ($0.9(1-0.25)=$0.675). In other words, he will just earn even lower profits than if he didn't change production at all.
Jargon: One often hears that taxes passed on businesses will be passed onto consumers.
One often hears that taxes passed on businesses will be passed onto consumers.
Producers produce so they can consume. Consumers can only consume after producing first and exchanging their product for the goods/services they wish to consume. The whole producer/consumer dichotomy is nothing but a collectivist/socialist/Keynesian smokescreen, pitting one imagined segment of society against another. Pure propaganda towards perpetuating Orwellian doublethink.
If you change the tax from a tax on profit to a tax on every pack, then my previous argument no longer makes sense. The per pack tax would essentially increase the cost of producing each pack. And this will change the profit maximizing production level.
Why? Think about it this way. A per pack tax is the same as if an input into production got more expensive--essentially it has become more costly to take your good to market and sell it. So the consequence of the tax should be exactly the same as the consequence of an increase in factor prices.
For example, say that the price of tobacco increased because a large percentage of the crop was eliminated by disease. Unless demand is perfectly elastic, the ONLY ways that the price of cigarettes would not change as a result of tobacco becomming more expensive is if suppliers produced and sold exactly the same amount of cigarettes using exactly the same amount of tobacco as before (assuming a competitive market as Jargon did).
But if this is actually what happened, then intermediate good prices would not be doing their job. They are supposed to signal to intermediate good consumers that the input has become more scarce and that they must economize on its use. This is one of the points Hayek made in his AER paper "The Use of Knowledge in Society" (see his tin example).
http://www.econlib.org/library/Essays/hykKnw1.html
Now, this is just an analogy to make my original point clearer. I don't want to pursue the analogy too far because I am sure it will lead us down unrelated tangents. If this does not help your understanding of my original point could you refer me back to the part of my initial post to Jargon that you disagree with? I think that is where I made things most clear.
@Z
No need for a dichotomy Z (or an inference, at that).
Jargon: No need for a dichotomy Z (or an inference, at that).
I didn't quite understand the meaning of this.
z1235: Jargon:One often hears that taxes passed on businesses will be passed onto consumers. Producers produce so they can consume. Consumers can only consume after producing first and exchanging their product for the goods/services they wish to consume. The whole producer/consumer dichotomy is nothing but a collectivist/socialist/Keynesian smokescreen, pitting one imagined segment of society against another. Pure propaganda towards perpetuating Orwellian doublethink.
Jargon:One often hears that taxes passed on businesses will be passed onto consumers.
Jargon: One often hears that taxes passed on businesses will be passed onto consumers. Some dispute this claim.
Essentially, what you are asking is this: One often hears that the butterfly's wings creat a typhon somewhere on the planet -- where? we do not know -- how much of an effect? ..... ??
Nobody can answer that.
Jargon: By looking at this in a methodologically individualist fashion, doesn't the answer become clear?
Jargon: Why? Can't they impose price controls or supply quotas privately?
Meanwhile, time passes and more malinvestment ensues while people are waiting in line and money is being printed willy-nilly and given to the malinvestors....
The problem with taxation policy is not just that money is redirected. Time and resources are wasted!!!
The whole producer/consumer dichotomy is nothing but a collectivist/socialist/Keynesian smokescreen, pitting one imagined segment of society against another. Pure propaganda towards perpetuating Orwellian doublethink.
How would you state Say's law without using Orwellian doublethink words like "producer" and "consumer"?
you can NOT look at this in a methodologically individualist fashion because taxation is NOT methodologically individualist at all.
Let's not Orwelllian doublethink ourselves here. We are talking about individual reactions to taxation, which is subject to study under meth. ind.
Would you say that we cannot talk about how an economy will respond to, say, an earthquake or a war or inflation of the money supply because those things are NOT methodologically individualist at all?
Student,
We have to agree to disagree here, because I don't see how the two methods of taxation make a diff. Both are taxes on the bottom line.
Unless a corporate profit tax is on all industries, not just cigarettes, as opposed to the per pack tax.
Here's how I understand Student's explanation Dave:
A corporate income tax is basically a tax on the bottom line. So if a corporation increases output and earns more, or decreases output and earns more, it makes no difference because those extra earnings will be taxed.
Something like a cigarette tax, is not a tax on the bottom line but on a factor of the whole process. A tax on the production of cigarettes would induce a perceptive entrepeneur to cut down on his whole operation, reducing costs and output. Because the bottom line isn't taxed, he can make a greater profit in this scenario by producing less, whereas if he were under an income tax he couldn't do anything because those extra earnings would be taxed anyways.
I agree with everything you write, but I think it makes an assumption, mainly that the manufacturers have no option but to make cigarettes, and the only variables at their command are how many to produce and how much to charge.
But AE assumes, given a free market, that they have a third option, closing down and going into another industry. The idea being that if Industry A is less profitable than Industry B, then people will move out of A and into B until profits equalize for both industries.
Here's page 82 of HA:
Every firm and every branch of business is in the short run interested in increased sales of its products. In the long run, however, there prevails a tendency toward an equalization of returns in the various branches of production. If demand for the products of a branch increases and raises profits, more capital flows into it and the competition of the new enterprises cuts down the profits.
Which means, as I understand it, that if any kind of tax is imposed on the cigarette industry, whether per pack or on profits, since it reduces profits in Industry A [=cigarettes], then some people will move on to Industry B [=anything else]. This means reduced supply of cigarettes, which means higher prices, which means the tax has been passed on to the consumer, albeit indirectly.
I think it is also implicit in the assumptions of every supply and demand curve that this will happen. When we look at a demand curve, the two axes are Amount Bought and Price Charged. This is accurate, because the buyer cares about the price, since it is the hit he has to take for buying his cigarette. But in a supply curve, strictly speaking, the two axes should be Amount Supplied and Profits Made, i.e the second axis should not be Price Charged, but Profits Made. The seller doesn't care about the price per se. He cares about Profits. It's only because we have to draw the supply and demand curves on one graph that we label one axis Price. But strictly speaking, Price only matters to the supplier in that the higher the price, the higher [presumably] the rate of profit. If a tax is imposed, no matter where, that reduces the rate of profit, and supply will be diminished.
In other words, if a given supplier is resolved to stay in the business, come what may, then your analysis will be correct. But a supply curve assumes that when profits are too low, for any reason, including a profit tax, some suppliers will drop out.
I'm in mixed agreement.
If it's a general corporate income tax then there won't be as strong an inducement to switch industries. If there's a cigarette tax then yes. You also have to weigh the consideration of the entrepeneurs decision between scrapping everything and waiting/lobbying for lower taxation. With a general tax like the corporate income tax, it becomes a question of relative profitability. It's not as though investors' risk-preferences have changed overnight. So if cigarette production still remains relatively profitable compared to other industries affected by new taxation, then they will keep their capital in there. Same with entrepeneurs.
Rothbard made that case too and that it not only can cause entrepeneurs to switch industries but to avoid them all together due to entry barriers, thus ultimately lowering supply.
Yep, agree to all you wrote, J.