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Passing Costs on to Consumers

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"Passing Costs on to Consumers"

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Of the Obama administration’s search for a way to make banks pay for the cost of bailouts, Felix Salmon remarks “The NYT and Politico are talking about some kind of “fee”, but it’s hard to see how to stop that from being passed on to customers.”

When a business may find itself the subject of some proposed tax, it invariably claims that the tax is a bad idea because the cost will be passed on to consumers. The fact that the to-be-taxed businesses are making this claim should, however, give us reason to be skeptical. Take a look at the basic model of tax incidence, with the demand curve in blue and supply curves in red:

taxmodel

The cost of the tax is, indeed, passed on to customers. But customers then pass a share of the tax back on to producers by reducing the amount of the product they buy. For example, when the government raises cigarette taxes the companies don’t just take the hit, they raise prices. But this inspires some smokers to quit, makes other smokers more reluctant to share, makes it harder for teenagers to take the habit up, etc. Thus, cigarette company revenue is in fact impacted. In our case, if a fee raises the price of credit then some people will pay more for loans, but other people will become more reluctant to take loans out.

The exact location of the incidence has to do with the elasticity of demand for the product, which I think is going to be hard to estimate in the case of financial services. When elasticity is high, the incidence falls mostly on the producer, and when it’s low it falls mostly on the consumer. The real question isn’t whether or not the cost is in some sense “passed on” but what we think about the systemic impact of shifting people’s demand around. If you levy a tax on something arbitrary—basketball tickets—you get a big reduction in consumer welfare. If you tax an important production input—plastic—you get massive economic distortion. If you tax something unhealthy—cigarettes—you get healthier people. A lot of people say we should move to a less debt-based society and economy, in which case the impact seems good.

Perfect taxes are, however, hard to find. And the fundamental point is that we need to get some money. But an obvious time-consistency problem is looming. Bank lobbyists are mobilizing against any kind of fee. And in exchange for lavish financial support from banking interests, Republican members and “centrists” Democrats can be counted on to oppose any kind of fee. When challenged as to how they propose to fund resolution of insolvent systemically important financial institutions they’ll say that “no more bailouts” is the right answer. And when the next crisis comes, they won’t actually stand in the way of bailouts that are generally deemed economically necessary.

The ability of reactionary politics to simultaneously benefit from banker largess, steadfastly defending bankers interests on tax and regulatory issues, and also benefit from populist anti-banker sentiment is really remarkable. But I don’t expect it to end any time soon.

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