Taxes passed on to consumers

Economics Economics Questions
21

Student.

I follow your reasoning about the corporate tax. But why can we not make the same analysis for a tax per pack, as follows. I’ll basically be copy pasting your argument, and bolding where I make a change.

Think about it this way. Let’s say that a cigarette manufacturer decides that producing 1,000 packs per day is the production level that will maximize his profits (say he earns $1 million in profit). His profits are their MAXIMUM at 1,000 packs. This means that if he reduces production he will lower his profits. For example, say if he reduces production to 900 packs he only earn $0.9 million. Likewise, if he increases production he will lower profits. For example, say if he increases production to 1,100 packs he will only earn $0.9 million in profits.

Now, let’s say a 25% tax is imposed on every pack. What will the firm do? If keeps producing 1,000 packs he will now only earn $0.75 million in profits ($1*(1-0.25)=0.75). Similarly, if he either cuts production by 100 units or increases production by 100 units he will only earn $0.675 million in profits ($0.9(1-0.25)=$0.675). In other words, he will just earn even lower profits than if he didn’t change production at all.

22

Producers produce so they can consume. Consumers can only consume after producing first and exchanging their product for the goods/services they wish to consume. The whole producer/consumer dichotomy is nothing but a collectivist/socialist/Keynesian smokescreen, pitting one imagined segment of society against another. Pure propaganda towards perpetuating Orwellian doublethink.

23

Smiling Dave,

If you change the tax from a tax on profit to a tax on every pack, then my previous argument no longer makes sense. The per pack tax would essentially increase the cost of producing each pack. And this will change the profit maximizing production level.

Why? Think about it this way. A per pack tax is the same as if an input into production got more expensive–essentially it has become more costly to take your good to market and sell it. So the consequence of the tax should be exactly the same as the consequence of an increase in factor prices.

For example, say that the price of tobacco increased because a large percentage of the crop was eliminated by disease. Unless demand is perfectly elastic, the ONLY ways that the price of cigarettes would not change as a result of tobacco becomming more expensive is if suppliers produced and sold exactly the same amount of cigarettes using exactly the same amount of tobacco as before (assuming a competitive market as Jargon did).

But if this is actually what happened, then intermediate good prices would not be doing their job. They are supposed to signal to intermediate good consumers that the input has become more scarce and that they must economize on its use. This is one of the points Hayek made in his AER paper “The Use of Knowledge in Society” (see his tin example).

http://www.econlib.org/library/Essays/hykKnw1.html

Now, this is just an analogy to make my original point clearer. I don’t want to pursue the analogy too far because I am sure it will lead us down unrelated tangents. If this does not help your understanding of my original point could you refer me back to the part of my initial post to Jargon that you disagree with? I think that is where I made things most clear.

24

@Z

No need for a dichotomy Z (or an inference, at that).

25

I didn’t quite understand the meaning of this.

26

Amen!

Some taxes are passed on to consumers and some are not. Most are a bit of both.

Essentially, what you are asking is this: One often hears that the butterfly’s wings creat a typhon somewhere on the planet – where? we do not know – how much of an effect? … ??

Nobody can answer that.

It is not clear at all precisely because you can NOT look at this in a methodologically individualist fashion because taxation is NOT methodologically individualist at all.

Sure. Government can impose restrictions and market control policies.

Meanwhile, time passes and more malinvestment ensues while people are waiting in line and money is being printed willy-nilly and given to the malinvestors…

The problem with taxation policy is not just that money is redirected. Time and resources are wasted!!!

27

The whole producer/consumer dichotomy is nothing but a collectivist/socialist/Keynesian smokescreen, pitting one imagined segment of society against another. Pure propaganda towards perpetuating Orwellian doublethink.

How would you state Say’s law without using Orwellian doublethink words like “producer” and “consumer”?

you can NOT look at this in a methodologically individualist fashion because taxation is NOT methodologically individualist at all.

Let’s not Orwelllian doublethink ourselves here. We are talking about individual reactions to taxation, which is subject to study under meth. ind.

Would you say that we cannot talk about how an economy will respond to, say, an earthquake or a war or inflation of the money supply because those things are NOT methodologically individualist at all?

28

Student,

We have to agree to disagree here, because I don’t see how the two methods of taxation make a diff. Both are taxes on the bottom line.

Unless a corporate profit tax is on all industries, not just cigarettes, as opposed to the per pack tax.

29

Here’s how I understand Student’s explanation Dave:

A corporate income tax is basically a tax on the bottom line. So if a corporation increases output and earns more, or decreases output and earns more, it makes no difference because those extra earnings will be taxed.

Something like a cigarette tax, is not a tax on the bottom line but on a factor of the whole process. A tax on the production of cigarettes would induce a perceptive entrepeneur to cut down on his whole operation, reducing costs and output. Because the bottom line isn’t taxed, he can make a greater profit in this scenario by producing less, whereas if he were under an income tax he couldn’t do anything because those extra earnings would be taxed anyways.

30

Jargon,

I agree with everything you write, but I think it makes an assumption, mainly that the manufacturers have no option but to make cigarettes, and the only variables at their command are how many to produce and how much to charge.

But AE assumes, given a free market, that they have a third option, closing down and going into another industry. The idea being that if Industry A is less profitable than Industry B, then people will move out of A and into B until profits equalize for both industries.

Here’s page 82 of HA:

Every firm and every branch of business is in the short run interested in
increased sales of its products. In the long run, however, there prevails a
tendency toward an equalization of returns in the various branches of
production. If demand for the products of a branch increases and raises
profits, more capital flows into it and the competition of the new enterprises
cuts down the profits.

Which means, as I understand it, that if any kind of tax is imposed on the cigarette industry, whether per pack or on profits, since it reduces profits in Industry A [=cigarettes], then some people will move on to Industry B [=anything else]. This means reduced supply of cigarettes, which means higher prices, which means the tax has been passed on to the consumer, albeit indirectly.

I think it is also implicit in the assumptions of every supply and demand curve that this will happen. When we look at a demand curve, the two axes are Amount Bought and Price Charged. This is accurate, because the buyer cares about the price, since it is the hit he has to take for buying his cigarette. But in a supply curve, strictly speaking, the two axes should be Amount Supplied and Profits Made, i.e the second axis should not be Price Charged, but Profits Made. The seller doesn’t care about the price per se. He cares about Profits. It’s only because we have to draw the supply and demand curves on one graph that we label one axis Price. But strictly speaking, Price only matters to the supplier in that the higher the price, the higher [presumably] the rate of profit. If a tax is imposed, no matter where, that reduces the rate of profit, and supply will be diminished.

In other words, if a given supplier is resolved to stay in the business, come what may, then your analysis will be correct. But a supply curve assumes that when profits are too low, for any reason, including a profit tax, some suppliers will drop out.

31

I’m in mixed agreement.

If it’s a general corporate income tax then there won’t be as strong an inducement to switch industries. If there’s a cigarette tax then yes. You also have to weigh the consideration of the entrepeneurs decision between scrapping everything and waiting/lobbying for lower taxation. With a general tax like the corporate income tax, it becomes a question of relative profitability. It’s not as though investors’ risk-preferences have changed overnight. So if cigarette production still remains relatively profitable compared to other industries affected by new taxation, then they will keep their capital in there. Same with entrepeneurs.

Rothbard made that case too and that it not only can cause entrepeneurs to switch industries but to avoid them all together due to entry barriers, thus ultimately lowering supply.

32

Yep, agree to all you wrote, J.