Economics Questions

Re: Taxation falls on consumers?

Sage — Fri, 22 May 2009 04:41:32 GMT

Stranger:
So if a tax increases the price of a good 100%, either consumers will have to pay the 100% increase, in which case demand for the good will plummet and there will be an inventory surplus that will have to be run down, bankrupting the producers, or the final price to consumers will stay the same while marginal suppliers go out of business.

Yes, that sounds right. And we wouldn't call this shifting, because as Rothbard writes, "shifting implies that the tax is passed on with little or no trouble to the producer. If some producers must go out of business in order for the tax to be “shifted,” it is hardly shifting in the proper sense but should be placed in the category of other effects of taxation."

Re: Taxation falls on consumers?

liberty student — Fri, 22 May 2009 04:29:00 GMT

Sage:
But isn't this view based on the cost theory of prices?

No. Practical real life experience.

I'm sorry, but I don't have the attention span to deal with a wall of Rothbard quotes right now. If you can refine the argument specifically against what I have posted, then my interest level may be raised.

Re: Taxation falls on consumers?

Stranger — Fri, 22 May 2009 04:19:27 GMT

mrwiizrd:

I'm not an economist, but from my albeit limited experience in the business world I would say this is a classic example of where academic theory and real world application diverge. Most private firms have set profit margins that they effectively "mark up" to product costs. They don't go out and survey demand at a multitude of prices. For example, most retail stores are in the ballpark of the following benchmarks:

http://www.retailowner.com/Benchmarks50RetailSegments/tabid/55/Default.aspx

In my experience firms aren't out there actively monitoring aggregate demand in effort to establish an equilibrium price, most seek the lowest cost possible to maximize volume (i.e. wally world)

It doesn't matter how firms set their prices, ultimately they have to price things at the equilibrium between supply and demand. If as you say a firm marks up the cost of a good, then changes in consumer demand will cause them to slow down or speed up their reorders from their suppliers. These suppliers will either have to shut down production or expand production depending on these resupply orders, and if they shut down production then they the price of remaining supplies will rise.

So if a tax increases the price of a good 100%, either consumers will have to pay the 100% increase, in which case demand for the good will plummet and there will be an inventory surplus that will have to be run down, bankrupting the producers, or the final price to consumers will stay the same while marginal suppliers go out of business.

Re: Taxation falls on consumers?

Sage — Fri, 22 May 2009 04:04:49 GMT

mrwiizrd:
I'm not an economist, but from my albeit limited experience in the business world I would say this is a classic example of where academic theory and real world application diverge. Most private firms have set profit margins that they effectively "mark up" to product costs. They don't go out and survey demand at a multitude of prices. ... In my experience firms aren't out there actively monitoring aggregate demand in effort to establish an equilibrium price, most seek the lowest cost possible to maximize volume (i.e. wally world)

I'm not sure what you're getting at here. All Rothbard is saying is that firms attempt to maximize profits, and hence their selling price tends to be where marginal cost equals marginal revenue. So if a tax is imposed, the firm cannot raise prices without losing revenue. Thus, taxes cannot be shifted forward.

Of course no one measures aggregate demand. Why would anyone do that?!

Re: Taxation falls on consumers?

mrwiizrd — Thu, 21 May 2009 23:47:13 GMT

Sage:

But isn't this view based on the cost theory of prices? As Rothbard writes in his section on tax incidence in Chapter Four of Power and Market:

The first law of incidence can be laid down immediately, and it is a rather radical one: No tax can be shifted forward. In other words, no tax can be shifted from seller to buyer and on to the ultimate consumer. Below, we shall see how this applies specifically to excise and sales taxes, which are commonly thought to be shifted forward. It is generally considered that any tax on production or sales increases the cost of production and therefore is passed on as an increase in price to the consumer. Prices, however, are never determined by costs of production, but rather the reverse is true. The price of a good is determined by its total stock in existence and the demand schedule for it on the market. But the demand schedule is not affected at all by the tax. The selling price is set by any firm at the maximum net revenue point, and any higher price, given the demand schedule, will simply decrease net revenue. A tax, therefore, cannot be passed on to the consumer. (p.1156)

I'm not an economist, but from my albeit limited experience in the business world I would say this is a classic example of where academic theory and real world application diverge. Most private firms have set profit margins that they effectively "mark up" to product costs. They don't go out and survey demand at a multitude of prices. For example, most retail stores are in the ballpark of the following benchmarks:

http://www.retailowner.com/Benchmarks50RetailSegments/tabid/55/Default.aspx

In my experience firms aren't out there actively monitoring aggregate demand in effort to establish an equilibrium price, most seek the lowest cost possible to maximize volume (i.e. wally world)

Re: Taxation falls on consumers?

Sage — Thu, 21 May 2009 22:31:02 GMT

liberty student:
Taxes are priced into the cost of the good.

Tax is just another overhead from the perspective of a businessman. When costs go up, he raises prices to compensate, he doesn't absorb every expense increase from his profit margin. Ultimately, he runs into a price ceiling where his costs are greater than he can raise prices, and thus the industry becomes uncompetitive to be in (less profitable), and competition dwindles.

But isn't this view based on the cost theory of prices? As Rothbard writes in his section on tax incidence in Chapter Four of Power and Market:

The first law of incidence can be laid down immediately, and it is a rather radical one: No tax can be shifted forward. In other words, no tax can be shifted from seller to buyer and on to the ultimate consumer. Below, we shall see how this applies specifically to excise and sales taxes, which are commonly thought to be shifted forward. It is generally considered that any tax on production or sales increases the cost of production and therefore is passed on as an increase in price to the consumer. Prices, however, are never determined by costs of production, but rather the reverse is true. The price of a good is determined by its total stock in existence and the demand schedule for it on the market. But the demand schedule is not affected at all by the tax. The selling price is set by any firm at the maximum net revenue point, and any higher price, given the demand schedule, will simply decrease net revenue. A tax, therefore, cannot be passed on to the consumer. (p.1156)

If it were possible to raise prices when costs go up, then I could sell, e.g. a table, for a million dollars by building it really inefficiently and hence raising my costs. This is the kind of reductio that is used against the labor theory of value. If businessmen could raise prices, why do they have to wait for the tax to do so?

More Rothbard:

A general sales tax is the classic example of a tax on producers that is believed to be shifted forward. The government, let us say, imposes a 20-percent tax on all sales at retail. We shall assume that the tax can be equally well enforced in all branches of sales. To most people, it seems obvious that the business will simply add 20 percent to their selling prices and merely serve as unpaid collection agencies for the government. The problem is hardly that simple, however. In fact, as we have seen, there is no reason whatever to believe that prices can be raised at all. Prices are already at the point of maximum net revenue, the stock has not been decreased, and demand schedules have not changed. Therefore, prices cannot be increased. (p.1157)

Rothbard argues that sales taxes are shifted backwards to the owners of the original factors (land and labor):

In fact, this is precisely the effect of a general sales tax. Its immediate impact lowers the gross revenue of firms by the amount of the tax. In the long run, of course, firms cannot pay the tax, for their loss in gross revenue is imputed back to interest income by capitalists and to wages and rents earned by original factors—labor and ground land. A decrease in the gross revenue of retail firms is reflected back to a decreased demand for the products of all the higher-order firms. (p.1159)

Thus, Rothbard's analysis and the mainstream analysis are similar in that the effects of a tax are the same: producers are hurt by increased costs and consumers are hurt by increased prices. However, for Rothbard the businessman cannot raise prices, but must accept lower profits; hence, marginal producers go out of business, and the reduced supply increases the price. As Murphy writes in the MES Study Guide:

Both the neoclassical and Austrian would agree that the equilibrium price of a radio could be higher after the imposition of a tax on sellers, and that (in a sense) consumers are bearing some of the tax burden. However, Rothbard emphasizes that the price rise is not “caused” by the tax, but rather the tax puts marginal sellers out of business, and then the marginal utility of the smaller supply of radios allows sellers to charge a higher price. The typical treatment of tax incidence subtly relies on a cost theory of prices. (p.214)

Re: Taxation falls on consumers?

hayekianxyz — Sun, 17 May 2009 15:47:40 GMT

Stranger:

Supply and demand graphs are unsophisticated and cannot explain true tax incidence. The reason consumers are least affected by taxes is that they are not invested in the supply until they make their purchase. Suppliers are invested. Raising taxes does not change the equilibrium price of the existing supply, it makes it unprofitable to resupply to the current level. Capital that was invested to produce the current level of supply becomes worthless and is gradually shut down, leaving industrial rust belts as a consequence of the tax.

So yes consumers become poorer over the long run as a consequence of the tax, but it is not an expropriation for them, while it is an expropriation for suppliers. Consumers only become poorer because suppliers go out of business.

Right, a government tax doesn't influence the demand curve, therefore the old price charged by producers is still profitable.

Re: Taxation falls on consumers?

liberty student — Sun, 17 May 2009 06:32:55 GMT

Stranger:

Supply and demand graphs are unsophisticated and cannot explain true tax incidence. The reason consumers are least affected by taxes is that they are not invested in the supply until they make their purchase. Suppliers are invested. Raising taxes does not change the equilibrium price of the existing supply, it makes it unprofitable to resupply to the current level. Capital that was invested to produce the current level of supply becomes worthless and is gradually shut down, leaving industrial rust belts as a consequence of the tax.

So yes consumers become poorer over the long run as a consequence of the tax, but it is not an expropriation for them, while it is an expropriation for suppliers. Consumers only become poorer because suppliers go out of business.

This is profound, but reflects what happens when tax rates change. When tax rates are static, inventories and entrepreneurs are adjusted to taxes. Producers add the fixed cost of taxes into their prices.

Re: Taxation falls on consumers?

Jonathan M. F. Catalán — Sun, 17 May 2009 06:31:09 GMT

Stranger:
Raising taxes does not change the equilibrium price of the existing supply, it makes it unprofitable to resupply to the current level.

The only thing you've done is explain why the supply curve shifts to the left. You haven't refuted the value of the supply and demand graph as a valuable tool for showing who really pays the tax. Of course, it's not likely to be 50/50, because there wouldn't be equilibrium, but it shows how tax does only cost the supplier. That's its only purpose; it was not to accurately pinpoint who pays the tax, but to give a general picture.

So yes consumers become poorer over the long run as a consequence of the tax, but it is not an expropriation for them, while it is an expropriation for suppliers. Consumers only become poorer because suppliers go out of business.

The graph assumes a tax on the entire industry, not just certain businesses which form part of that industry. So yes, suppliers would go out of business, but that doesn't mean that the consumer is also poorer because the consumer is paying more for the product, on average.

Re: Taxation falls on consumers?

DanielMuff — Sun, 17 May 2009 06:21:49 GMT

Jonathan M. F. Catalán:

This is a basic macroeconomic principle, illustrated by a supply and demand graph.

S1 is the original supply curve. The examle assumes that the original equilibrium price for the product was $15, and the government imposes a $1 tax. That is represented by the $16. This model assumes equilibrium, but is simply used to establish a point. The tax shifts the supply curve to the left; the distance between S1 and S2 is $1. The new equilibrium is at $15.50, which shows that half of the tax was paid by the producer and the other half by the consumer. Therefore, the lesson is that government can tax whomever, but in the end it's the market which decides who really pays that tax.

To expand, since the tax raises the price, it, thereby, prices-out some would-be buyers out of the market.

Re: Taxation falls on consumers?

Stranger — Sun, 17 May 2009 06:17:06 GMT

Supply and demand graphs are unsophisticated and cannot explain true tax incidence. The reason consumers are least affected by taxes is that they are not invested in the supply until they make their purchase. Suppliers are invested. Raising taxes does not change the equilibrium price of the existing supply, it makes it unprofitable to resupply to the current level. Capital that was invested to produce the current level of supply becomes worthless and is gradually shut down, leaving industrial rust belts as a consequence of the tax.

So yes consumers become poorer over the long run as a consequence of the tax, but it is not an expropriation for them, while it is an expropriation for suppliers. Consumers only become poorer because suppliers go out of business.

Re: Taxation falls on consumers?

Jonathan M. F. Catalán — Sun, 17 May 2009 06:10:42 GMT

This is a basic macroeconomic principle, illustrated by a supply and demand graph.

S1 is the original supply curve. The examle assumes that the original equilibrium price for the product was $15, and the government imposes a $1 tax. That is represented by the $16. This model assumes equilibrium, but is simply used to establish a point. The tax shifts the supply curve to the left; the distance between S1 and S2 is $1. The new equilibrium is at $15.50, which shows that half of the tax was paid by the producer and the other half by the consumer. Therefore, the lesson is that government can tax whomever, but in the end it's the market which decides who really pays that tax.

Re: Taxation falls on consumers?

nazgulnarsil — Sat, 16 May 2009 20:55:13 GMT

with a payroll tax and a sales tax you're getting hit a lot.

once straight out of your paycheck

once out of the tax your employer pays on your paycheck instead of to you

once when you buy something

once because the price of the good is higher than it would be if producers were taxed less

now figure in inflation and you're getting hit with a fifth tax

if you invest in a business you get hit with an additional tax for any dividends

how much does your dollar buy you at the end of this?

this is the "free market" that has "failed us".

Re: Taxation falls on consumers?

liberty student — Sat, 16 May 2009 20:49:16 GMT

Dondoolee:
If that post is refering to me, so was I.

If you click REPLIED ON next to my name on my post, it will show you who I was responding to. Just letting you know for future reference if you are unsure who is responding to which post. I was replying to Juan btw.

Re: Taxation falls on consumers?

William — Sat, 16 May 2009 20:13:34 GMT

liberty student:

Income tax is equal on all producers. I believe Bastiat is referring specifically to taxes on business profit, before it is paid out in dividends.

If that post is refering to me, so was I. Perhaps I was unclear of that. Usually when I use the word "producer", I usually mean where the money supply/ production starts (so the business owner, investor) not that others aren't producers or people of lesser fabric, it is just a habit of mine to use the word "producer" in that term.