Friday, August 28, 2009

types of taxes

Such a list as I will formalize below would be mind-numblingly boring to someone who understands economics, but unfortunately only 14% of legislators understand the law of supply and demand (People buy less when it costs more! That's not even the law of supply of supply and demand, just demand, but it's already too much for these people!), and I'm sure far fewer in the general population (god bless representative democracy), so I'm going to write it anyway. (At least so my roommate can read it and hopefully have one more source of economic logic in her life than personal anecdotes on This American Life.)

There are some types of taxes, categorized by intent, that are easily confused and have very different pragmatic requirements/implications. Let's get them straight for once.
  1. Taxes to price in negative externalities: Also known as Pigou taxes. If driving your car to work costs you five dollars, and costs society 3 dollars in pollution and road congestion, you should be taxed by 3 dollars in order to correct the market failure that will result. This shifts the equilibrium from one in which too many people drive to work back to one in which the socially optimal number of people drive to work. Practical issues of calculation and enforcement can be complicated but I'm all in favor of these types of taxes when they can be done well.
  2. Taxes to punish "bad" behavior. For example, a tax on soda or fast food or SUVs. If you just want to slap people on the wrist for doing something, whether or not they keep doing it, it doesn't matter what the target is. But if you really want to curb consumption, you need demand to be very elastic. A tax on soda may cause a lot of people to switch to juice or water, but a tax on heroine is not going to get anyone to break the habit and stop shooting up. These types of taxes are paternalistic bullcrap.
  3. Taxes to raise revenue. This can be levied on anything you want, but it needs to be something with very inelastic demand, so you won't just kill the market and fail to collect any tax revenues. These types of taxes are a necessarily evil but can be done in very good or very bad ways. Bad, mostly by failing to remember the "inelastic demand" qualification, but also by having undesirable implications on wealth distribution. This leads to:
  4. Taxes to redistribute wealth. This would be a secondary goal along with #3. If you can raise as much money by taxing private jets as by taxing bread, clearly the former is much better at transferring money from the rich to the poor. That's sometimes a good goal and sometimes not, but if it is the goal, that's what you should do. Note that this is very different from taxing "conspicuous consumption" or something like that. That falls under #2. Inelastic demand is again important for these taxes. If you want equality, you want rich people to spend their money so it gets transferred back to poorer people, and it doesn't much matter what they spend it on (and a tax on luxury goods with very elastic demand could just make them hoard it in their bank account or stick it in a trust fund to create more rich people, exactly the opposite of spreading the wealth.)
Let's consider an example... Tolls on the Bay Bridge. If you want the toll to compensate for the negative externalities of using the Bay bridge, charge the per user cost of bridge maintenance, plus the cost of increasing road congestion by one car (this cost varies based on current congestion. Tolls should automatically increase during rush hour.) Additionally, the toll should be much higher for cash payers than Fastlane payers, since the latter hold up traffic less, lower for motorcycles, higher for semis, etc.

Say, on the other hand, you want to keep people off the bridge, polluting the air and clogging the highway, and put them on the BART. You should just raise the toll until few enough people want to use the bridge, however many you decide that is. Cars should be taxed MORE than semis, since the drivers of cars are making a "bad" decision to drive, whereas truck drivers have no choice. Hybrid cars should be taxed less than regular cars, since they're being more "responsible" about gas usage, and motorcycles taxed even less, since they're more responsible about both gas usage and traffic congestion.

Now how about the case where you just want to use the bridge as a holdup to raise as much money as possible. Then it doesn't matter what kind of vehicle it is, you just adjust the toll upwards until your revenue is maximized (for awhile you can increase the toll without many cars stopping using the bridge, but eventually people will switch to BART and revenue will decrease. Just before that is where you set the toll.)

Now say you just want to redistribute wealth. Then you put higher tolls on more expensive and emptier cars and make sure you're not just killing your wealthy consumer base, so you actually raise money to give to poor people. City busses don't have to pay (remember that taxes on businesses are just passed on to customers - higher bus tolls translate to higher fares for their poor riders.)

Luckily, it looks like the toll structure most closely follows an effort to correct externalities. Taxes are higher for larger vehicles, and carpools are free during rush hours. Not perfect, but in the right direction.

So, next time someone tells you they want to tax SUVs to offset vehicle pollution, call their bluff. If they wanted to do that, they would tax gasoline by the gallon (which, lo and behold, already charges SUVs drivers more since they use more gas.) All an SUV tax does is spitefully punish "bad" behavior, and redistribute wealth.