Politics, Taxation and Cigarettes

Here in New York, a $1.60 increase to the state tax on cigarettes has been passed. Everyone seems to have an opinion on this issue. Some say that this is a futile attempt by politicians to indicate that the deficit situation is under control. Others think that the reduction in demand will wipe out the increase in price, making the hike fiscally pointless. Few think it's a good idea. My plan here is to clear up a few things up about the tax.

First, for understanding, let's look at the forms a tax may take.

Specific - A tax based on the quantity purchased, independent of price. Imagine if peanuts were taxed at $.20 a pound, no matter their price.

Lump sum - A certain tax sum that is equally paid by those who qualify, ignoring behavior. A general lump sum tax of $100 forces all living taxpayers to pay 100$. Think of a road toll.

Ad valorem - Literally according to value is the most popular tax. This is a tax based on value. A sales tax that taxes 10% of an item's value is an ad valorem tax. More explanation here.

Now, the cigarette tax is per pack, so it's a specific tax. I believe an ad valorem tax is preferable to a specific tax in this industry.

Now let's look at the underlying issue. This year, New York's deficit seems to be at $9.2 billion - a historical high. As you likely know, states are required to keep a balanced budget. Profit(Loss) = Total Revenue - Total Cost. Costs are government programs and responsibilities, revenues are tax dollars. Thus, New York's choices include cutting programs and raising taxes.

The fact is that the state is already cutting as many programs as is reasonable. As seen in New York's Enacted Budget Financial Plan the state already planned to cut healthcare, eliminate rebates, remove cost of living increases, increase university tuition, close three prisons, reduce transit subsidies, freeze aid, and reduce funding for private education. In the future, there will be further cuts to healthcare, public education, higher education, public safety, energy, transportation, and other services. Despite these cuts, the state remains in deficit. There have been a few revenue increasing measures, taxes on small businesses rose significantly, the state began selling new license plates, they hiked income tax, increases in education tuition (as previously stated), increases in sin taxes and others.

We could continue cutting programs, but most would argue we also need to raise taxes. The question is difficult, What programs do we cut? What taxes do we raise? Taxes on cigarettes and alcohol have increased significantly in the last few years, and will likely rise in the future. The fact is that taxes on cigarettes and alcohol make sense, here's why:

Cigarettes and alcohol are stigmatized in society. Addicts and abusers are seen as societal problems. You can easily increase the sentence of a drunk driver or a pedophile because society dislikes them. The fact is that increasing taxes on cigarettes is more politically viable than increasing the sales tax or decreasing healthcare.

Cigarettes and alcohol also cause negative externalities. A person that consumes a vaccine reduces the chances that other people will get sick, a beekeeper helps pollinate surrounding farms - these are positive externalities. People apart from the initial transaction are being benefited. With cigarettes and alcohol, people are hurting their health and reducing their potential productivity. Friends and family grieve over someone's death. A death due to a drunken driver reduces the nation's productivity. Someone who is standing next to a smoker may become annoyed. These are all negative externalities. A person not party to the initial transaction is being harmed. By reducing the consumption of these goods, we expect a net increase in productivity and quality of life outside of the increase in the government's revenue. This however raises its own question - do increased prices really raise revenue?

For some goods, an increase in price causes a small decrease in quantity demanded. For other goods an equal increase will cause a greater decrease in quantity demanded. The corresponding change in quantity demanded due to an increase in price is called the elasticity of demand.

Example:

For salt, if there is a 1% increase in price, there is a <1% decrease in quantity demanded. This good is considered to have inelastic demand.

For pizza, if there is a 1% increase in price, there is a 1% decrease in quantity demanded. This good would be considered to have unitary elastic demand.

For Froot Loops, if there is a 1% increase in price, there is a >1% decrease in quantity demanded. This good is considered to have elastic demand.

So, if a good is elastic, an increase in price would cause a reduction in revenues as decrease in quantity demanded is outpaced by the increase in price. However, cigarettes tend to be addictive, and their demand tends to be inelastic. This implies that any increase in price will reduce quantity demanded by a smaller amount, increasing (in this case tax) revenues.

So, I believe the preferable form of the tax is ad valorem, as it would cause less economic damage. This tax has potential to increase production in the long run, while taxing most other products will decrease production. Government revenues will certainly increase. A sin tax is one of the most viable options when it comes to closing the budget.

Fiscal Sustainability

Today there is a common contradiction among American citizens - everyone is worried about the Government Deficit, but no one is willing to cut spending. Bernanke gives a brief, insightful speech on the topic. Nothing he says is very radical, but he sums up the current situation very well.

http://www.federalreserve.gov/newsevents/speech/bernanke20100427a.htm

My interpretation:

"The current deficit height is due to low tax revenues and high government spending. In the near future, the size of the deficit will narrow but we are on an unsustainable path. Problems include rising healthcare costs, largely due to an aging population. [Editor's note: The long term trend of increasing healthcare costs are largely due to increased innovation in medicine, although an aging population is also a factor].

The solution is that long term spending must be in line with revenues by cutting spending and increasing taxation. Current tax code is not efficient, equitable, nor transparent. The issue is structural and tax reform is necessary. If we fail to act, high interest rates will reduce America's potential output and it will hamper America's ability to respond effectively to crisis.

Reduced investor confidence can itself cause many other problems for the nation."


Few may argue with his advice from an economic standpoint, but I believe that politically the statement was very bipartisan. Further evidence that an independent FRB is valuable for America's economic stability.

I hope to see reform in the future to provide more sustainable spending, but forgive me if I'm skeptical.

Hearts and Roses

I apologize for my rather lengthy hiatus. I have returned to discuss man's most dreaded day of the year--Valentine's Day. Many argue that Valentine's Day is a holiday conjured up by evil corporations to do the most evil thing any company can do--make money. I don't disagree, but I fail to see how this makes Valentine's Day any different from other holidays. Looking beyond the malevolent profit-seeking monoliths known as Hershey's, DeBeers and (worst of all) Hallmark; one can see that there are some interesting economic phenomena associated with the holiday. Unfortunately, as a college student, I have not the time nor the resources to do a thorough study. Fortunately, the fellows at Billshrink have done it for me (with quite a pleasing presentation, might I add)

For those who don't like reading (why are you here?) these are my favorite statistics mentioned:
40% of valentine cards purchased are by parents for children. (2004)
Per capita, Americans ate 24.7 lbs of candy in 2004
There were $13.5bn in chocolate shipments, with only $5.5bn in shipments of non-chocolate candy (2004)
61% of all men would like flowers on Valentine's Day, 40% receive them (2004)

Of course, with such wild claims the first thing to look for is citations, which include the U.S. Census Bureau, Floramax, and :cringe: Wikipedia.

I hope all couples enjoy the holiday in any manner that suits them. For those attention hungry singles out there, enjoy Singles Awareness Day and keep in mind you're not alone.

My Best

TIME's Man of the Year

The Chairman of the Federal Reserve, Ben Bernanke, was recently named TIME's man of the year.

Notable quote:
TIME Managing Editor Richard Stengel called the Federal Reserve “the most powerful, least understood government force shaping our lives”
[link]

He spearheaded multiple new monetary facilities that focused on specific components of the economy in order to stabilize some markets without hurting others. Keeping a clear head through economic havoc, he never let politics influence his true goal of economic stability. Largely due to his hard work, we have seen unemployment turn around during this recovery. Indeed a terrific chairman. Love him or hate him, he certainly has incredible power and incredible influence. Great choice on the part of TIME. Congratulations Chairman.

Good News, Everyone!

Most expected to see 130,000-140,000 jobs lost in November. The net change in non-farm payrolls for November was a miniscule decrease of 11,000. This is in contrast to a perceived 190,000 jobs lost in October and 463,000 lost in June. These gains were mostly from temporary services, a strong indicator that we are indeed in a recovery and that full time jobs will soon follow. Not only that, but the September numbers were revised down (219,000 to 139,000) and October numbers were revised (190,000 down to 111,000), showing that a total of 159,000 jobs believed lost were not.

Better yet, for the first time in many months we saw unemployment decrease from 10.2% in October to 10% in November. Moody's Economy expected unemployment to peak at 10.7% in mid-2010, so this is terrific news.

Average weekly hours also increased by .6.

The bleak side of the newly released information was that hourly wages only increased .1% last month, showing a shy 2.2% raise in the past year.

Unemployment is still high, and it will be an arduous climb back to full production, but at the least there are plenty of strong indicators that show we are heading in the right direction.

(Information courtesy of Dismal Scientist, always a good resource)

Inflationary Fears

During the Great Recession (many now believe we are experiencing a recovery), the Federal Reserve increased the money supply substantially in order to increase liquidity in credit markets (called "credit easing" as opposed to "quantitative easing"). Some people fear future inflation, and it is difficult to say when the Fed should reduce the money supply. I decided that a comment concerning inflation is central to future discussions, so I wanted to touch on it first.

Quick definition of terms
Inflation is a rise in the overall level of prices in a country, hyperinflation can be seen as out-of-control inflation (often 100%+), and deflation is a reduction in general prices. M0 is a measure of the monetary base. M0 is not a measure of money that is being used for consumption or investment. It is simply a measure of coins, paper money, and bank reserves. There are many measures of the money supply that can be seen here. When the Fed "prints money" it increases M0.

Is inflation bad?
Inflation can be bad, and it can be good. When people think of inflation, they often think of their money being reduced in value. If the money in your bank account stays relatively constant, while prices rise, then you can buy less goods. During hyperinflation (seen in postwar Germany, Zimbabwe and others), the value of money is reduced so fast that money needs to be spent as soon as possible in order to retain its worth. This makes lending almost impossible and can lead to the collapse of economic markets. However, this also highlights a benefit of inflation. Inflation stimulates consumption. In an inflationary environment, holding onto money will reduce its value over time. In America, consumption is two-thirds or more of GDP, so strong consumption is central to economic growth. The higher the economic growth rate, the higher you want your inflation to be. In America healthy inflation is seen as 2-3%, while in developing countries the healthy rate may be much higher

But deflation makes my money worth more! What's wrong with that?
Deflation does sound good to a consumer, and that's the bad part. If holding onto your money becomes a good investment, then people are less likely to spend it. This stifles consumption. With a reduction in consumption, firms are forced to lay off workers, increasing unemployment and reducing production (GDP). This is known as a recession. This scares consumers, so they are even less likely to spend their money. This reduction in consumption again forces companies to lay off even more workers in order to cut costs, and the cycle is repeated. This is known as a "Deflationary Spiral", which some believe characterized the Great Depression.

So What?
Deflationary Spirals are very bad for economies and they are very difficult to get out of. Because of this, the Federal Reserve avoids deflation at all costs, which brings us back to the current market. During this recession, the Fed increased the money supply by a substantial amount, creating fears of future inflation. However this money is simply floating around. Inflation is characterized by more money chasing the same number of goods. If there is more money in the market (read: increase in M0) but not an increase in consumption or investment, then it has no effect on inflation. This can be seen in recent numbers for CPI (an inflation index). From April to October % annual change was under 0%, with .3% growth during October compared to a year ago. It is for this reason that the Fed was, and continues to be wary of deflation. The increase in the money supply has not been accompanied by an equal rise in economic growth, and the Fed will likely leave the liquidity in the market until healthy economic growth is seen.

In the 80s we experienced a "Double Dip Recession" or a W shaped recession. This means that there was a short post-recession period of growth before we dropped back into another recession. Many believe that this recession occurred because the Fed increased interest rates too soon in order to stave off over-inflation. Learning from the past, the Fed has continued to keep interest rates low and M0 high. They will likely wait until they see signs of strong growth before enacting contractionary policy, and when they do so such policy is likely to be introduced cautiously. Until we see true inflation in CPI and PCE numbers, I personally believe it would be foolish to tighten the economic belt. The Fed can act swiftly if need be, so be patient, keep a clear head, and pay attention to the numbers.

Nice To Meet You,

My name is Nicholas Taverna. I am currently a senior Economics major attending the State University of New York at Geneseo.

This blog is an attempt to underline interesting statements, share my amateur economic views and perhaps stimulate a conversation concerning economics. I will point to interesting articles I find, as well as pose questions and share opinion. I have no intention for this to trail off into rants or politician-bashing, but I invite any and all to comment. My ultimate goal is to widen my own view of economics and to catalogue any important findings. I may occasionally share something off-topic or personal but intend to keep that sort of thing to a minimum.