When Basic Economics Eludes Elected Officials

Under Franklin Delano Roosevelt the Supreme Court shifted in composition and jurisprudence.  Now referred to by many as the “Switch in Time,” this marked the beginning of the end of the Commerce Clause as a limited congressional power.  Now there are few areas of protection in Constitutional law that prevent federal intrusion on economic matters.

This 80-year retreat by the Court has given Congress almost exclusive power to determine economic matters. Thus when a Congressional delegate exhibits ignorance on economic matters, we should take notice.  Enter Congressman Jason Chaffetz of Utah.  The current Chairman of the House Oversight Committee and Republican has generally been a consistent conservative voice, tolerable by even the most liberty oriented voter. But as of late his grasp of economics appears to be lacking.

The questionable economic reasoning, or even the evidence of a lack of any economic understanding, comes from the web page for Congressman Chaffetz. His released explanation for the Remote Transactions Parity Act (RTPA), an effort to allow states to tax out-of-state retailers and merchants  doing business online with the state’s respective residents, states:

The current tax loophole skews the free market. It allows businesses that employ fewer people and contribute to the economies of fewer states to avoid collecting sales taxes. This not only forces more brick-and-mortar stores to close their doors and lay off their employees, but also requires consumers to shoulder the burden and liability of the sales tax themselves – taxes that the consumer is by current law required to compute and pay as a part of their yearly taxes. The RTPA would close this loophole in a way that is generous to small remote sellers and puts our neighborhood retailers on a level playing field – without completely changing our current state sales and use tax structure.

The economic ignorance is staggering. Instead of aligning with established economic principles, this post uses buzzwords and tortured economic terminology in an effort to support the proposed bill.

This “loophole” is more about which government entity is able to tax the transaction and has jurisdiction over the merchant. If this is a loophole than so is any movement across state lines associated with the purchase of goods or services, not just those that occur in the comfort of home with online shopping.  Consumers and residents have long sought legal means to pay less taxes, though this is likely not the primary motivation for online shopping from out of state retailers.  Still, taxes influence where people live, shop and work. Increased tax burdens do impact behavior.  For more on this I recommend How Money Walks -which tracks the impact of taxes and how people avoid them. Especially recommended to all those curious about the real world impact of tax policy particularly elected officials.

However, the tax policy or revenue argument was hardly made. Instead Chaffetz claimed the market is skewed. He is wrong. This is a matter of tax policy and not a market correction. This abuse of the term “free market” should make anybody cringe. Taxes are the antithesis of the free market. They are government imposed and compulsory. Freedom is not found in tax policy.  This highlights a major misunderstanding about the purposes of taxes. Generally they do not correct markets. Only in rare circumstances does a tax or penalty compensate for a market failure.  Less tax revenue  is not one of those rare circumstances.  If revenue is the justification, then that argument should be laid out.

Though Mr. Chaffetz addresses potential state revenue rationales, he also laments that less taxes on online merchants “only forces more brick-and-mortar stores to close their doors and lay off their employees.” This is not a free market argument, it is a protectionism argument and appears to be about protecting local retailers. Such an effort would result in dedicating resources unnecessarily to running stores and hiring people which creates higher priced goods and services. All of this delivers less to the consumer in a comparatively inefficient manner.

People shop online in response to a better priced and more convenient good. This is not a skewed market, but instead a free market. Taxes have a negative impact on a market; they raise the cost of a good or service above the equilibrium between supply and demand. Taxes may be necessary for revenue, but it is not a market correction.  Raising or placing taxes on items, in fact, excludes purchasers thereby decreasing the amount of potential participants.  A few basic economic concepts, primarily subjective value, supply and demand, and dead weight loss, explain some of the impact taxes have on a free market and where Rep. Chaffetz went wrong.

SUBJECTIVE VALUE

Subjective value describes the relationship between consumers and the products they purchase.  This is observed on a daily basis. Consumers constantly value items subjectively.  Assume I want a new 4k 60″ LCD TV (I could go for that). However, I perform an online search and find the bottom (hypothetical) market price for said TV to be $1245.  I then must decide, which do I value more: $1245 or the TV? I may not be willing to purchase that TV at that price at this time; the reasons may be varied. Maybe I don’t have enough in my account, or I have a TV that works fine and consider this less than necessary, or perhaps I would never value any TV at $1245, or in other words, I prefer the $1245.  I understand someone does, and perhaps that is as cheap as that TV will ever be.

Now suppose the price is dropped to $800. Not just me, but others as well would be more likely to purchase that TV.  It is intuitively obvious that when a price goes down more people are able to purchase.  Lets further assume that I value that TV at $850, which means I receive the TV in exchange for $800, which I value less than the TV, and keep $50.  But if there is a tax on the TV that brings the cost up to $855, I am not going to buy it.  I have already decided that I would rather have $855 dollars than a nice, new, super high definition TV.   This is subjective value.  Note that economic circumstances may also effect subjective value. Often those with less money are most likely to assign a lower value to a good than those with more financial means. This suggests that raising the costs hurts low income consumers more than high income consumers.

On the  supply side of the transaction, a producer would be unwilling to sell that TV below the cost of producing the good, which is the cost associated of getting that item from being nothing to the Best Buy shelf.   Where the cost of producing and the demand meet is the equilibrium.  To apply the previous example, if I value that TV at $800 and it costs $799 to get that television on the shelves (and is so priced) that means that I am likely one of the consumers who is closest to the lowest possible price for the TV. This is to my benefit, as I have already decided that I value this sweet portal of entertainment bliss more than I do $800.

Understanding the value we assign goods or services is a good first step. When examined with supply and demand, price becomes less of a mystery, and the impact of increasing the cost becomes more obvious.

 SUPPLY AND DEMAND

3-3 Equilbrium_13

[all graphs are from BYUI Econ 150L: Microeconomics slides, available here}

Supply and demand help explain why goods are priced the way they are. The demand can be thought of as the declining value of the product as more quantity is produced, or as it is available to more consumers. Remember that with subjective value we know there are people who value goods differently, this graph has simply plotted the decline in value. As the quantity increases, the value of the next item produced decreases.  In above example the first unit produced was valued at $50, but the tenth is valued at $30. This is because there is a hypothetical consumer willing to pay $50, but by the time you get to the tenth unit, the tenth consumer is only willing to pay $30. The rising red line represents the cost change in supply, which is largely, but not entirely, a result of the production cost. The point where these lines cross is the equilibrium of supply and demand and produces a price. (Read above link for more).

Now consider simply two implications of setting the market price differently than the equilibrium. If the price is below the equilibrium more consumers may be able to purchase, but a producer would go out of business or find a round-about way to make up the difference.  If priced above this point, it would exclude potential purchasers.  This is lost wealth for those consumers and a loss to society as a whole. This lost portion of social benefit is called dead weight loss (labeled DWL in the graphs).

DEAD WEIGHT LOSS

3-4 Market Intervention_06

[credit: BYUI Econ 105]

You can see dead weight loss illustrated above. This example uses a price floor to demonstrate dead weight loss, but anything that raises the price above the equilibrium creates the same problem.  Price floors were quite common in the past, but have largely been abandoned. They are mandated market prices for goods; a seller is able to sell for more, but no less. A common example of price floors nowadays is  in some agricultural goods. Illustrated above, the price has been set well above the equilibrium.  The yellow and green sections together represent the social benefit, which is split between consumer and producers. This is also called surplus. Think of surplus in the context of the TV example. If the TV is sold for $800 and I value it at $805, I have a surplus of $5 and a TV.  (If you are interested in this further, follow the provided links. If you are a Congressional delegate consider it required reading).

Note that a dotted line has been drawn from the price floor to the bottom of the graph.  The triangle created to the right of the dotted line is the dead weight loss (labeled DWL). This represents those who would have participated in the market, both consumers and producers, but were excluded because of the artificially raised price.

A tax also raises the price above the equilibrium as previously explained.  This chart demonstrates the impact of the tax on price and distribution of goods.

3-4 Market Intervention_08

[BYUI Econ 105]

The blue lines represent the difference in price as a result of the tax. As you can see the tax is the gap between the two lines.  This results in P1, the price for the consumer, and P2 the price for the producer.  P0 is the price at the equilibrium.  In this illustration the cost of the tax is split between the consumer and producer. This is not always the way a tax is split, however.

  3-4 Market Intervention_09

[BYUI Econ 105]

The above graph includes the dead weight loss, the consumer and supplier surplus, as well as the surplus that is tax revenue.  As expected, the tax creates the same dead weight loss as a price floor. (Dead weight loss is also the primary harm created by monopolies).  Increased taxes will increase dead weight loss.  Dead weight loss means people are unable to participate in the market, both as consumers and producers.

Stating that this is a market correction is therefore completely erroneous.  Excluding potential purchasers of legitimate goods is not a desired policy outcome unless it cannot be avoided.  Granted, government requires funds – funds that are largely generated by taxes. But this is not an article about what the best tax policy should be – it’ an observation of economic illiteracy. This is a story of exclusion, raising the cost of a some goods above the equilibrium excludes people from markets they would otherwise enter, a loss to society.

Increasing the price of goods above the equilibrium is not to the benefit of consumers nor is it to the overall benefit of producers, but it is to the benefit of some producers. Rep. Chaffetz stated that brick and mortar locations were at a disadvantage – expressing a preference for which type of retailer gets business. Raising the cost for online merchants means brick and mortar locations do not have to compete as much against some of the lowest cost retailers.

There are legitimate tax arguments to be made. Unfortunately Chaffetz did not make them, but instead used misapplied party-focused lingo to be persuasive. Sadly this showed off his economic ignorance – a matter that should be of grave concern to the average voter. With a highly deferential Commerce Clause allowing Congress to act in a near limitless fashion, economic comprehension is an essential element for a competent Congressional delegate.  A short time ago a petition was circulated on change.org pleading that Bernie Sanders, a Vermont senator and Democrat Presidential primary contender, read at least one book on economics. Perhaps this should be expanded to all those who seek or hold office. Just one. Please.

James C. Devereaux is an attorney and freedom fanatic. Questions, complaints and hysterics can be sent to james@reasonedliberty.com or follow him on twitter @jcdevereaux1 .

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