Because most philosophies that frown on reproduction don't survive.

Wednesday, October 17, 2007

When "Incentives" are Inelastic

As I wrote about a while back, one of the things I sit around and do all day is price a couple thousand personal and business electronics items. One of the key factors in deciding how to price a product is its price elasticity. Briefly put, the price elasticity of a product is how responsive that product is to changes in price. A highly elastic product will see many more sales if the price goes down, and many fewer if the price goes up. An inelastic product will sell roughly the same number of products no matter how you price it (within a certain reasonable band -- it's always possible to find elasticity if you go far enough.)

It struck me recently that this is an interesting property when it comes to taxes that are supposed to provide people with an incentive to change their behavior.

So for instance, it's often suggested that the Federal Government put an additional tax on gasoline in order to incent people to drive less and/or buy more efficient cars. That in particular is an interesting suggestion, though, because although the price of gas has nearly doubled in the last 4-5 years, gas consumption has not changed notably. Some people have bought more efficient cars, some people have arranged to work from home or live close to work, but mostly people just shrug, grit their teeth, and pay. Gas prices have proved fairly inelastic over the last 4-5 years.

Why is kind of an interesting question. I suspect that a lot of it has to do with the methods of changing your gas consumption often being expensive. Selling your old car and buying a more efficient one is a major capital investment. Moving closer to work or finding a new job closer to your home is also, usually, a very costly (or at least troublesome) operation.

This would seem to suggest that adding a $0.50 or even $1.00/gal tax might well simply collect lots of government money without actually reducing gas consumption much. (A cynic might suggest that this is exactly what advocates are hoping for.)

Further, if the theory that capital investment is the main thing keeping people from reducing their gas consumption is correct, then the people who would actually reduce their consumption would be the value-conscious middle to upper class group -- while poorer citizens without the ability to move or buy a new car would simply buckle down and pay the higher prices. If that were correct, what was intended to be an incentive to reduce consumption would turn into a tax on people with low capital resources.

Two other interesting examples are cigarette taxes and state lotteries.

Smoking has decreased over the last twenty years -- though how much of that is the result of the taxes that now make up as much as 50% of the sticker price of cigarettes in some states is unclear. However, it's also pretty clear by this point that smoking is primarily become a working class phenominon. People who are still serious smokers at this point are pretty clearly price inelastic -- whether it's because they're too hooked, too stuborn, or simply too price-unresponsive to quit. So I think there's a legitimate question: goes raising the taxes further really stand much of a chance of decreasing smoking, or does it simply soak a generally low-income group for more money?

State lotteries are possibly the worst of all. The idea was that this was a voluntary tax: no one has to spend money on the lottery, but if you do most of your money will go to the government (generally public schools.) Yet really, lotteries primarily appeal to people who do not exect to ever see any large amount of money through the course of their normal lives. People with comfortable incomes, large annual bonuses, investment portfolios, and good prospects for advancement don't buy lottery tickets. People who can't imagine how they'd ever come into a large sum of money do. I would like to think it was not consciously planned this way, but the state lotteries as they stand now seem well calibrated to take spare money from people in a manner inversely proportional to their ability to afford it -- taking the most from those who have least hope of building capital resources any other way (and least knowledge of the statistics arrayed against them.)


Kate said...

I agree with you that both cigarette taxes and state-sponsored gambling tends to hit the lower class hardest. Parly because these populations are more likely to indulge in these behaviours, and partly because the risk-taking personality drawn to these activities often does not have the qualities necessary to advance economically (there are some interesting studies about the type of people most likely to smoke/become addicted).

I would have to see some research re: gas taxes though. IMO, middle-upper and upper class folks shrug off or budget extra when gas prices rise. It's the people at the bottom who simply take the bus, move into an apartment in the city, or find other ways to do without (because those people are more likely to live flexible, less rooted lives). The people feeling the crunch would be those who are most invested in their car, residence, etcetera and least able to change it - not the poor or disadvantaged, but the truly middle class - the same folks who make just too much for state assistance, but too little for good insurance, who make huge sacrifices to move into good school areas, and often end up commuting as a consequence.

It'd be interesting to try to pin down exactly what income bracket that is...these are the people, after all, that pretty much every politician for the last 50 years claims to be representing. :-)

CMinor said...

Lottery commercials always intrigue me--they always try to frame the game as "fun" and "entertainment."

Does anybody really buy lottery tickets because they find scratching little squares off a card fun?

Donald R. McClarey said...

Lotteries are in essence a stupidity tax. I am not including in that category the people who buy lottery tickets every now and then for amusement, but rather people of modest means who every week send money they can't afford to lose down a lottery rat hole. They are the source of the profit for lotteries. This is a vile way to raise revenue. Additionally the lottery advertisements can only increase cynicsm about government among the thinking population since this is the state engaging in a flim flam with worse odds than most of the old organized crime numbers rackets.

j. christian said...

The demand for gasoline is pretty price inelastic. I don't remember the exact estimates, but a quick Internet search shows it's in the range of -0.25 in the short run to -0.5 in the long run. So there would definitely be some reduction in gasoline consumption with a 50-cent carbon tax, but if it will actually reduce greenhouse gas emissions significantly is another matter.

As to whom would be affected: A carbon tax is almost certain to be regressive. In general, lower income groups spend a higher proportion of their income on consumption goods, including gas. Most economists know this, so when they propose more "Pigouvian" taxes (on things like carbon, cigarettes, etc.), they tend to pair it with reductions in income tazes for lower income groups.

PB said...

I also agree that this hits the lower class the hardest, but does this mean that we should ban the lottery since these poor people are too stupid to stop buying lotto tickets which keep making themselves more poor in the process?

Rick Lugari said...

But you see, PB, one can argue that the entire existence of the state lottery is to exploit the poor. It would be a failed enterprise if it weren't for the poor (and certain number of working class people who have some legitimate discretionary funds). I've always considered the lottery an unfortunate gimmick but do from time to time buy an "easy pick" just for the heck of it. Now, we know that it is literally a waste of money and that someone who is struggling is unwise to buy lottery tickets, but I think as we consider the human condition that it might not be fair to summarily dismiss it as stupidity. I say that because they may very well know it's a stupid thing to do, but have as little discipline as they do genuine hope.

Maybe I could characterize it like this: A con man generally succeeds in his craft by playing off someone's greed. Similarly the state is playing off someone's despair. I admit that in the context of the poor I'm making unfounded assumption that despair or a misplaced hope is the motive rather than outright greed, but it seems the most likely explanation to me.

I also find it dubious that most states have used their power to establish a monopoly on gambling - one that as has been pointed out is considerably more skewed than most others.

Darwin said...


It probably depends a lot of the region too. I'll admit, most of my knowledge about living close to the edge comes from LA, which has a terrible (to in places non existant) public transportation system and is so sprawling (and has such high rents) that most people have some sort of commute.

A car is often absolutely essential to any hope of a job in LA, so I knew a few people who'd spent brief periods living out of their cars when they couldn't afford both rent and other expenses.

In other cities, however, I'm sure you could be much more gas-independant.

j. christian,

Agreed, though at this point the people (at least with any dependants) making much below twice the poverty line generally pay no federal income taxes anyway. It seems like if one were going to carbon tax, it would need to come with some sort of minimum allowance. But beyond the "hitting the poor hardest" element, it strikes me that it would be very hard to actually reduce gas usage much by increasing taxes (which the elasticity you quote seems to back up.) I think, all things considered, it's really more of a PC way to raise money for an environmental cause than a viable way to reduce greenhouse gases enough to make a difference.


I'm generally pretty down on the idea of banning things to protect people from themselves, but in the case of the lottery it strikes me as more of a case of actively preying on the poor rather than just letting people make bad decisions.

If instead of actively "taking it away" the programs switched to lower and more frequent payouts and mandated a much higher percentage paid out rather than kept, I'd have less of a problem with it, but it strikes me overall as a predatory business to be in.