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Wednesday, May 02, 2012

Taxes and Inelasticity of Demand

The article Rolling back the nanny state: Live free and pay more tax, featured in the Economist, focuses on the government loosening its grip on liquor stores, gambling and fireworks as a response to its dire need to raise revenue. Instead of increasing income or sales taxes, some state and local governments have focused on obtaining extra revenue from excise taxes and fees. In Washington state alone, the licenses to 167 state-run liquor stores will be auctioned off into the private business sector by June 1, 2012. Several other states are minimizing alcohol regulations. For example, more states have recently lifted bans on liquor sales on Sundays. Several counties in Texas that were previously “dry” are now “wet”, meaning that it is now legal to sell liquor in these areas. Nearly half the states in the U.S. now allow casinos. Several states have lifted restrictions on the types of fireworks that may be sold and some states that previously banned the sale and possession of all fireworks now allow consumers to buy and sell certain fireworks.

It makes more efficient for governments to gain revenue through excise taxes and fees than through higher income and across-the-board sales taxes. There are two main reasons for this. First, the inelasticity of demand associated with liquor, gambling and fireworks (among other things) provides a relatively guaranteed source of income, with few consumers cutting consumption when changes in prices occur, even when the changes are due to rises in the taxes or licensing fees for the distribution of these products. There is also, of course, the fact that by increasing income and/or sales taxes, consumers have less money to circulate through the economy via personal consumption and for investing.  

Not only do these measures allow for a more sensible and economically efficient way for the government to raise money, but by loosening regulations, the free market is allowed to operate in a manner more aligned with the ideals of a capitalist society. This is sure to bring about a more appropriate market equilibrium with each good in the affected areas than exists when government is heavily involved.

It may be a bit of a stretch, but by loosening regulations and raising more revenue through taxing larger amounts of inelastic goods instead of raising income and across-the-board sales taxes, we may be moving toward an era of raising government revenue through consumption taxes, rather than income, and perhaps even sales, taxes. The excise taxes could even remain in place in this case, which may help lower the consumption tax paid by individuals/households every year.  The idea of paying consumption taxes instead of income taxes is more economically efficient, as it does not discourage individuals from obtaining higher wages and potentially being placed in a higher tax bracket, which can sometimes make an individual’s net income less than it was at the lower wage.

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