I always told my economics students that while retailers often did not know the elasticity of demand for their products – how sensitive demands are to prices – they could easily infer this information by experimenting with price variations. If prices are increased a bit and firm revenues from a product fall then demands are elastic (they depend sensitively on price in the sense that, for example, a 10% increase in price causes more than a 10% reduction in quantities demanded); if revenues increase then demands are inelastic (a 10% increase in price causes less than a 10% reduction in quantity demanded).
Cigarette products have conventionally been assumed to have inelastic demands – the price elasticity is around -0.4 so a 10% increase in price causes about a 4% reduction in the number of cigarettes smoked. They are assumed to be inelastic because smoking involves an addiction to nicotine, a habit that is notoriously difficult to kick. But elasticities are not fixed numbers – they vary with the level of prices as a consumer operates at different points on their demand curve. At high enough prices all demands will become elastic as consumers substantially reassess the desirability of goods. So if cigarettes are costing $40 per pack, as proposed recently by the Labor Party, this might make people think twice about smoking – a packet per day then costs $280 weekly. Have prices for cigarettes reached levels where demand is elastic? Have cigarette prices become so high that further price increases will produce more than proportionate reductions in cigarette consumption and hence less revenue?
There is now some evidence that this might be the case. Cigarette prices have increased strongly in Australia in recent years because of excise tax increases. These taxes are “specific taxes” that are levied per stick or per cigarette. The ABS’s latest volume measure of tobacco consumption published in early December showed that, since mid-2014, cigarette consumption has declined at double digit pace. This is higher than at any time since 1983 and 4 times the average decline over the past 10 years. Excise revenue is expected to fall by 2.3% from 2015 to 2016 and by a further 4.7% from 2016-2017. Spending on cigarettes fell to a record low of $3.4b in the September quarter of 2015.
The qualifications to the claim that price sensitivities have increased are that, in recent years various non-price disincentives (plain packaging, anti-smoking propaganda) will likely have also had an effect on consumption.
The importance of the view that elasticities have increased is that, if this is so, the labor Party’s plans to fund further expansion of schools by charging higher excises on tobacco, will fail with certainty. They will fail because there will be a reduction in cigarette consumption that is proportionately greater than the excise increase. It might still be a good idea to increase the excise to force more cigarette quitting – with high prices such excise increases will be particularly effective at doing that – but relying on increased excises to fund increased education spending will fail.
I posted this on FaceBook on 27th August, 2015 but current events in world equity markets invite a repost and some further comments. Quote:
“There is hysteria over the alleged “China slowdown”. 7% growth in an economy that has been growing at 8-10% for a decade is substantial growth.
Do the arithmetic.
Incomes of 100 units 10 years ago in China were generating growth in demand of 10 annually. Those incomes are, as a result of compound growth, now worth at least 200 units and 7% growth adds to demand at least 14 which is an increased absolute growth. The difficulty for countries like Australia is that much of this growth is not resource-based. Services in China have grown strongly particularly in recent years and that is where Australia’s export drive needs to focus. Australia’s recent FTA with China helps”.
My own view is that current pessimism regarding the world economy is grossly overdone. The US economy is recovering well and Europe is beginning to move. China may not hit the 7% figure portrayed in the numerical example above but should grow at 6.6%+ in the immediate future until it converges with developed country growth rates around 2050. The basic point remains that China is contributing more to growth in global demand than it was 10 years ago. If course if enough people are pessimistic because of the current wave of pessimism – however poorly based – the expectations will become self-fulfilling and our economic future will be imperilled. But on balance I think this is likely to be unrealistic – it might drive a temporary slowdown in equity markets but the economic fundamentals are sound. There are economic incentives for third rate economists to make repeated pessimistic forecasts in the hope that they will eventually have a higher perceived market value. There are also incentives for large investors to talk down markets in order to generate buying opportunities.
Australians particularly are unduly pessimistic about their economic future. Our growth is forecast by Treasury to be a respectable 2.75% over the next few years rather than 3% as assessed earlier mainly because population is growing slower and people are working less. Yes we have a rather important minerals sector that gets buffeted by Cobweb Cycle imbalances between demand and supply – currently excess supply. We have seen it all before repeatedly. The minerals sector will recover – perhaps on the basis of new strong demands from India and eventually Africa – and and optimists will take over and start to talk again of new never-ending booms,. Remember that the China Boom was forecast to last for a century! Foolish exaggerated views take hold in the community and among CEOs of firms.
Have a cup of tea, a BEX and a good lie down.
Draft of a book review of Gernot Wagner & Martin L. Weitzman, Climate Shock: The economic Consequences of a Hotter Planet, Princeton University Press, Princeton, 2015. Comments very welcome.
This is a brief, non-technical and rather witty introduction to the economic implications of global warming. It will be easy reading for resource economists but taxing, given the density of some arguments, for the general citizen. It was a fun read for me because I fall into the former category and appreciated the basic messages.
The core premise is that anthropogenic climate change raises serious risk management problems because of potential catastrophic effects linked to climate change. These management issues are difficult to resolve because switching from traditional carbon-based fuels is not straightforward. High carbon taxes are viewed as essential and energy transitions may not be smooth unless technologically optimistic forecasts pan out. The problem of climate change will however be even more difficult if left unaddressed. On balance, there is a convincing case for immediate decisive action. Without substantive action we will likely face a more hostile and erratic climate with, at non-negligible probability, dramatically adverse implications for all human and non-human life and particularly for agriculture and human use of the oceans. Continue reading Book review of “climate Shock”
The discussion of company tax and firms that don’t pay it often seems to me to be confused. Company tax is a tax on profits, on income earned after costs. These profits could be distributed as dividends to shareholders or held in firms as retained earnings and eventually paid out as dividends. When they are paid out as dividends (now or in the future) to residents they are subject to the income tax paid by residents but, under the imputation system, to avoid these dividends being double taxed, a credit is given for any tax paid by the firm as company tax. Thus resident shareholders are only levied the generally positive difference between their marginal tax rate and the company tax rate of 30%. Thus the firms as as acting as “withholding tax” agents for the government.
Thus reducing the rate of company tax will make very little difference to total taxes paid by residents. More will then simply be paid by resident shareholders as personal income tax since their personal tax rates invariably will exceed those of companies. .
The only difference cutting company tax rates will make is to the taxes paid by non-resident shareholders who will now pay less tax since they generally do not benefit from dividend imputation. Thus cutting company taxes can only be motivated as a means for cutting the taxes paid by foreign shareholders in Australian-based companies. This effectively increases the rate of return foreign shareholders receive on Australian equity investments. Are there arguments for reducing taxes on foreign investors in Australia? The main argument is that such increases in the rate of return on equity will increase the foreign capital flows that enter Australia thereby promoting business and, in particular, increasing the returns to Australian workers who will, therefore, be better equipped with physical capital. This depends on how mobile capital is internationally and therefore how responsive capital flows are to the rate of return improvement. It is difficult to believe differential tax rates are a major issue in driving investment given that most of our mining industry and much of our industry anyway is foreign owned.
Of course if local firms already transfer price most of their profits into inflated costs borne overseas then the effects on capital inflows will be zero since there will be no effect on returns on equity of tax reductions since the firms pay no tax.
My own view is that the company tax-cum-imputation system has that the two great advantages of (1) providing just tax treatment to residents and, (ii) bringing foreign shareholders into the Australian tax base. Impact (ii) is more important the more the transfer pricing games paid by multinationals can be stopped and it seems to me that tax reform efforts should concentrate on this rather than reducing a rate which falls only on foreign holders of Australian equity.
The claim that the Australian company tax rate – and taxes generally – exceed those payable in China (including Hong Kong) and Singapore seems to me a point of irrelevancy. We do attract plenty of foreign investment from these countries which suggests that high rates of tax are not having a strong deterrent effect.
This book by George Akerlof and Robert Shiller, “Phishing for Phools” deals with the deep issues that arise in rejecting the “rationality” assumption in economic theory. If, as economic actors, we are rational and well-informed then free markets make a lot of sense. If we make irrational choices (choices that create an unforeseen disadvantage for us) and this disadvantage can be turned into profits by someone else then, applying the rationality assumption to this other person, means that they will take advantage of our stupidity. That is clearly unless they have ethics that go beyond self-aggrandisement. Then the view that free choice works in the sense of guaranteeing social optimality then becomes a theoretical point of zero practical interest. Continue reading Foolishness (by Phools) & its exploitation (by Phishers)
This nit complains that Uber charged him a 3.6X multiple of the ordinary taxi fare during a period of high demand – namely Melbourne Cup day. The alternative was for the usual flat fare to be charged and therefore for the excess demand to remain unmet on this day with some punters in urgent need of a taxi consequently being left stranded at Flemington. Continue reading Optimality of pricing high when there is an excess demand
I drafted this paper for the forthcoming Beijing Forum at Peking University. Preliminary. Comments very welcome.
Climate Policy Decisions Under Uncertainty
Honorary Visiting Fellow, Department of Economics, University of Melbourne, Parkville, Vic, 3052.
Abstract: The economics of climate mitigation decisions is discussed when there is imperfect knowledge of likely future climatic changes, of policy effectiveness and of the policy responses of other countries. Simple frameworks recognizing the role of pure uncertainty are derived from heuristics based on classical decision rules. These frameworks are analytically imprecise but offer plausible decision rules that are not informationally demanding. Continue reading Climate Change Policy Under Uncertainty
I’ll present this paper in a week or so at the Water Forum, Wodonga. Comments more than usually welcome.
Drought, Uncertainty and Water Supply Planning
Visiting Fellow, Department of Economics, University of Melbourne, Parkville 3052.
Abstract. Water supply planning when there is a threat of uncertain drought is discussed in terms of anticipatory and adaptive policies as well as the links between these classes of policy. Sound anticipatory policies tend to be low cost and to have complementary effects in enhancing the productivity of adaptive policies as well as in promoting policy flexibility. Continue reading Droughts & climate change: Some ideas about policy
I have never understood why events such as this happen. 267 apartments were sold in Glen Waverley in 90 minutes for $70m. It doesn’t seem to me to maximize profits to the developer – charging higher prices and stretching out the period of sale (or using a simple auction procedure) would make more sense. It isn’t socially efficient either since this queue-based first-in, first served system does not allocate the units to their highest valued uses.
I have heard many explanations but none satisfy me. Comments welcome particularly from those with real estate expertise.
Around 1992 the Spanish wildlife publisher Lynx began its 16 volume Handbook of the Birds of the World. It is an extraordinary achievement with hundreds of photographers and artists contributing and with a vast amount of general as well as specific ornithological information supplied. It is the only animal family to be completely chronicled in this way and is a major scientific undertaking. At several hundred Euros per volume I indulgently started off by adding a volume every year or so but a few lean years (private school fees etc) left me 4 volumes short of the complete collection. In addition an add-on volume of new species has been published. Volume 11 – which I own – has just gone out of print and it seemed likely that my chance to complete the collection was fading. Fortunately Lynx have offered the 4 volumes I want (along with the add-on volume of new species at a substantial discount so I snapped them up. Still not cheap but, for a bird enthusiast such as myself, it is a happy acquisition. In conjunction with the online resources made available by Lynx it provides all the general information one could conceivably require about the world’s avifauna. I like the species distribution maps.
I also have the 8 volume series of Australian, New Zealand and Antarctic Birds that was prepared over 20 years by what is now called Birds Australia. This is a much more detailed account of all the birds I am likely to encounter in Australia. I use it occasionally for specialised information but, despite its glorious colour plates of bird paintings, it does not quite offer the excitement of the Handbook.
The development of the welfare state in the Western economies between 1930 and 1990 coincided with a puzzling pattern in the taxation of top incomes. Effective tax rates at the top increased sharply but then gradually decreased, even as social transfers continued rising. These authors propose a new theory of the development of the welfare state to explain these facts. Our main insight is that social insurance and top income taxation are substitutes for averting social conflict. They emphasize the role of the Great Depression as a source of aggregate risk, and argue that the rise of the welfare state can be understood as a process of exploiting efficiency gains in response to gradual technological improvements in the provision of social insurance. Their detailed arguments build on the policy histories of the United States, Great Britain, and Sweden. Full paper in pre-print form here.
I have been a recreational bird watcher for about 20 years although I do less birdwatching these days than in the past.
In Australia, up to at least 1935, bird observers recorded their exploits by shooting birds with guns and laying out their carcasses on the ground after an expedition. This was accompanied by collecting “skins” and bird eggs: See the history by Robin (2001) *. Obviously this destructive activity led to a decline in populations. Eventually (and fortunately) “sighting” a bird became just that – you saw it and recorded the observation – indeed, sometimes “hearing” a bird was enough to declare an “observation”. Photographic records of bird nests and eggs began around 1900 but there were few photographs of birds because of the slowness and complexity of the photographic equipment. However there was some limited photography. Lessor Noddies were photographed in 1899 by A.J. Campbell – the earliest published bird photograph. Also photos were taken of the now extinct Paradise Parrot in the 1920s (Robin, p. 118). These days with the advent of digital photography, of high quality relatively inexpensive telephoto lens and with zero cost processing of photos “sighting” has often come to mean gaining a photograph of a species. Of course too, with a photo there are fewer arguments about whether a bird was actually seen.
Most bird watching clubs and societies (e.g. Birds Australia) have photography chapters and even chapters devoted to particular types of bird photography such as seabirds. I pursue this hobby myself in a limited casual way – I don’t have the patience and care of others who pursue this hobby and who are happy to spend days gaining a single shot. The quality of much of the amateur photography is extraordinary and the work of professionals, such as Varesvuo et al (2011)**, is a serious art form.
* A history is provided by Libby Robin, The Flight of the Emu: A Hundred Years of Australian Ornithology 1901-2001, Melbourne University Press, 2001.
** See Markus Varesvuo, Jari Peltomaki & Bence Mate, The Handbook of Bird Photography, Rocky Nook, Santa Barbara, 2011.
One of the first decisions of Prime Minister Turnbull is to transfer responsibility for national water policy to the Nationals, specifically to Barnaby Joyce. Apart from the fact that this puts water in the hands of a particular interest group – water-using farmers – this makes me uneasy for two interrelated reasons. First, the main state impacted on by the Murray Darling Agreement is South Australia and the Nationals hold no seats in South Australia. Second, water policy has significant environmental implications an area where the Nationals have a terrible reputation.
I assume the move is designed to sure-up Turnbull’s support within the Coalition but it does seem to be a case of giving away a lot too early in order to gain support. There are 150 seats in the Australian Federal Parliament’s House of Representatives and 90 of these are held by Coalition members of which only 16 are National-Country National Party (NCNP) members. In terms of power index measures the NCNP members are barely pivotal to forming a majority although they would gain greater power by alligning themselves with the more reactionary elements of the Liberal Party. But the Nationals as a whole are simply not important enough to the Coalition to warrant a gift of the family silver.
I think other gifts could have been given to secure NCNP support. This offering seems particularly costly to our nation’s environmental future.
The consensus on tax reform that is emerging (see e.g. AFR today, editorial, paywalled) is a continuation of the tax reform trends that have been around for at least two decades. The basic idea is to swap the tax mix around so that there are fewer adverse effects on working, saving, investing and taking risks. I summarise the main elements as 5 points. Continue reading Consensus on tax reform
DVD rental stores have been buffeted by competition and technological change in a way that is fascinating to students of business history. A fun thing to consider too because simple perceptions here drive justifiable economic knowledge and insight.
I once had 4 of DVD rental stores within 2 km of my home. Now there are none – the last closed a few weeks ago. I recall the original movie rental stores stores that rented out VHS and Betamax video cassettes and the eventual disappearance of the technologically superior Betamax cassettes. It was during this period that I bought a few Laser Disks with my favourite opera on them – it must have been 20 years ago. There were even a few specialised laser disk stores around Melbourne. The arrival of DVDs killed off video cassettes and laser disks and competition between the stores eroded profits until only a few surviver stores remained in accord with economic theories of monopolistic competition. Now online streaming, cheap legal DVDs under, I suspect, pressure from the illegal DVD trade, have finished off most of those. Both online streaming servives and online vendors of new DVDs have search facilities that are far superior too than those available in the physical rental stores. In the end, too, rental DVDs were often scratched so if you wanted to watch a complete unblemished version of a movie you bought it (the advent of illegal copying and competition have driven down the price of new DVDs close to their marginal production plus distribution cost) or downloaded it from a streaming service.
Few DVD rental stores remain these days and they have switched to specialised operations of the type described in this BBC report.
The DVD rental business is going the way of the CD music business and, to a less extent, book retailers. Book retailers probably have a brighter future because people do like to browse through boos in a store but, even here, I suspect many browse then buy online at cheaper prices. It is individually rational behaviour that in fact creates social costs.
I have been glancing through the 3-part report by Infrastructure Australia (a summary here) on Australia’s infrastructure needs over coming decades. I was mainly interested in the transport sector and proposals that looked – on casual reading of the press – like yet another case for user charges (congestion charging and heavy vehicle charging for road damage costs). As I started working on these issues more than 20 years ago I do get a little peeved by the almost annual attempt to revive such discussions somewhere which always get promptly forgotten.
On this occasion I can only say I am underwhelmed by the low economics intelligence of the Infrastructure Australia analysis. They still don’t understand the basics of user-charging. Nor for that matter did my friend Ian Harper in his recent reported proposals for competition reform.
Infrastructure Australia take as given Australia’s dismal future population trend forecasts (fair enough not their concern, but in my view the forecast rates of population growth via our migration program are unacceptably high) and then look for ways of dealing with the surge in congestion and heavy vehicle demands that will result. Their answer? Build more roads everywhere and find ways of funding such investments. Their answer? Road use charges that fund the roads.
That fundamentally misrepresents the intent of user charges. Unless these prices target congestion and road damage costs this won’t ensure efficiency. Indeed the issue is not primarily one of funding at all. All roads – new and old alike – that are subject to external costs should be priced to eliminate the external costs imposed on them (congestion and road damagers) so that all roads are utilised efficiently. Then if the roads make a profit expand their scale thereby making expansion decisions that reflect demands at the socially correct price.
Its the same old dumb-assed “engineer think” that has dominated Australian road infrastructure planning for decades. It is a shame that they cannot get the basic logic right.
The reforms on eligibility for the pension that Labor has opposed seem sensible to me, The current eligibility for a part pension (for a couple) is $1.15m in assets whereas under the proposed Coalition-cum-Green reform this is reduced to $823,000.
Suppose couples want to leave no bequests and that they own a house worth $650,000. Suppose also they retiree at age 65 and know they will live for 25 years to age 90.
The big factor determining their sustainable income is the rate of return on their assets and whether they can engineer a reverse mortgage on their house that yields this rate of return.
Suppose their assets earn a paltry 2% annually real return. Someone just on the old current eligibility limit (without a home) can spend $58,903 annually over the 25 years (or $92,102 if you include the reverse mortgage). With the lower eligibility requirement they can spend $42,154 annually (or $75,448 with the reverse mortgage).
More realistically suppose returns of 5% annually on the investments. Under the old limit they can (without a home) get income of $81,538 annually (or $127,715 with the reverse mortgage). Under the lower eligibility requirement they can get $58,393 annually (or $104,000 with the reverse mortgage).
I have used simple annuity formulae* to do these calculations. The basic idea is that you can draw down the value of assets and draw interest on residual asset values until they hit value zero at age 90. The Labor Party it seems to me in opposing the Coalition reforms is supporting people who don’t really need it. Of course everyone (including me) want its but it isn’t an imperative.
With a bit more effort I could allow for bequests and longevity risk but these will change these calculations in a straightforward way. Bequests anyway are irrelevant in a situation where you are trying to compute eligibility for basic pension entitlements. Notice too how critically the value of the family home enters these calculations. Excluding the family home from these asset tests does not seem defensible if the opportunity to purchase reverse mortgages is available.
(*) It is a while since I have done financial mathematics but the equation I used is that the sustainable income X * annuity formula given interest rates r and time horizon n, namely a(r,n), must equal the initially value of the capital asset V so X =V/a(r,n). I think that’s right.
Ireland has followed Australia in introducing plain packaging of cigarettes. David Prentice and I gave an interview on the Australian experience and its implications for such countries in The World Customs Organisation News, February 2015, Vol 76, pages 62-64. This type of work David and I did on plain packaging won’t get prestigious academic awards but in terms of practical policy and promoting the public good I rank it among my best.
I am interested that the two dominant ideas in tax economic theory over the last 40 years seem to diminish or downplay the case for redistributive taxes.
First, there are the strong arguments on income taxes from James Mirrlees (1971), and a plethora of followers, which places a premium on relatively flat income tax schedules with a hefty lump-sum income transfer to all. This is effectively a negative income tax of the type promoted by Milton Friedman in 1962. There is specific concern in this literature with the disincentive effects of high marginal tax rates on high income earners. I exaggerate a bit here – some of the Mirrlees followers do argue for a U-shaped marginal tax schedule (high marginal tax rates at both low and high incomes) – but I think the main thrust of this literature is consistent with the original ideas of Mirrlees.
Second, the literature on optimal excise taxes (when there is also an income tax instrument available) generally favours uniform VAT-style excises over differentiated excises of the type favoured by Frank Ramsey in 1927. There is almost no support for the idea of levying high taxes on luxury goods at least when an effective income tax is available. The early work here was by Anthony Atkinson and Joseph Stiglitz (1976) but it has recently been generalised and extended by Louis Kaplow (2008). Since a uniform VAT style tax on consumption goods is essentially equivalent to having no excises at all and substituting for this a proportional income tax this literature parallels the optimal income tax literature in its fairly anti-redistribution implications.
Almost none of the authors of this type of theoretical work come from the “right” of politics – they are mostly somewhat left-wing in orientation. Indeed Joseph Stiglitz has written books such as “The Price of Inequality” that criticise strongly the growing inequality particularly in the US. It seems there is a theoretical Stiglitz and one who is a political advocate and that he keeps these hats quite separate. Much the same comment too could be made about Anthony Atkinson who criticises growing inequality and, in particular, the failure to address issues of poverty.
It is never clear how much impact theoretical work in economics impacts on practical policy-making but the dominant trend throughout the OECD in recent years is to implement the type of agenda suggested by this theoretical work: See e.g. Mankiw et al (2009). Most OECD governments have moved towards flatter income tax schedules and away from differentiated excises towards VAT or GST style taxes. The same is definitely the case in contemporary Australian tax debates which seek , by-in-large, to push further the income tax flattening and GST promoting tax policies developed in recent decades.
One argument is that society needs to live with a low income class who don’t work but who receive large transfers from the wealthy who pay high average but low marginal tax rates. To me that is a bleak vision although it is one that is explicit in the original Mirrlees work. According to this view average tax rates can be quite high if marginal rates are high on low income earners – perhaps through the conjunction of means-tested transfers from government and the tax system. Then much income can be accessed from high income earners who do not suffer substantial disincentive effects in terms of reducing labour supply effort because marginal tax rates on them can be low. This is then used to effect transfers to the poor who, even should they choose not to work because of the high effective marginal tax rates, do not impose large efficiency costs on the economy because they are relatively unproductive in their work roles anyway. This assumes that involvement in work has no intrinsic value or social role and that a worker is equally keen living off social security benefits than working for similar incomes – a view that is plausibly false.
It might just be that the focus of economists is on efficiency issues since efficiency gains can be justified by weak value judgements such as the Pareto Principle. Income distribution issues are less the concern of economic theorists. Or it might be thought that achieving egalitarian income distributions is an unnecessary tax policy objective if everyone gains when the wealthy are less constrained to still further increase their wealth – “the rising tide raises all boats” argument of John F. Kennedy. That can be question by evidence showing persistent poverty problems. It is sometimes further argued that democracies, such as the US, have become captive to wealthy vested interests and this interests are driving tax policy. Finally, apart from lump-sum transfers to all that mean low rates of tax at low incomes it could be that other policies are being seen as the primary means of addressing poverty. One that is often mentioned is the minimum wage law. Of course too such laws are widely criticised on efficiency grounds as causing unemployment.