welfare

What’s Wrong with Sales Tax Holidays?

Zachary BartschLeave a comment

Tax holidays are when some set of goods are tax-free for a period of time. These might be back-to-school supplies for a week or a weekend, or hurricane supplies for several months. These policies tend to be popular among non-economists.

There are practical reasons for anyone to decry tax holidays. Usually, there is a particular type of good that qualify for tax-free status. These are often selected politically rather than by an informed and reasoned way with tradeoffs in mind. Sometimes, there is a subpopulation that is intended to benefit. However, the entire population gets the tax holiday and those with the most resources, who often have higher incomes, are best able to adjust their consumption allocations and enjoy the biggest benefits. A tax holiday weekend is no good to a single-mom who can’t get off work during that time.

Getting more economic logic, these holidays also concentrate shopping on the tax-free days, causing traffic and long lines that eat away at people’s valuable time – even if they aren’t purchasing the tax-free items. Furthermore, retailers must comply with the law. This means ensuring that all items are taxed correctly, making neither mistakes in over-taxing or under-taxing. Given the variety of goods and services out there, this is a large cost for individual firms.

Finally, as economists know, there is a deadweight loss anytime that there is a tax. As a consequence, you might think that economists would love anytime that taxes are low. But, holding total tax revenue constant, a tax break on a tax holiday implies that there must be greater tax revenues on the other non-holidays. In particular, economists also know that losses in welfare increase quadratically with changes in tax rates. Therefore, higher tax rates on some days and lower rates on other days causes more welfare loss than if the tax rate had been uniform the entire time. In the current context, such welfare loss manifests as forgone beneficial transactions. These non-transactions are hard for non-economists to understand because we can’t see purchases that don’t happen, but would have happened in the absence of poor policy.

Let’s look at some graphs.

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RGDP Underestimates Welfare

Zachary BartschLeave a comment

Like many Principles of Macroeconomics courses, mine begins with an introduction to GDP. We motivate RGDP as a measure of economic activity and NGDP as an indicator of income or total expenditures. But how does more RGDP imply that we are better off, even materially? One entirely appropriate answer is that the quantities of output are greater. Given some population, greater output means more final goods and services per person. So, our real income increases.  But what else can we say?

First, after adjusting for price changes, we can say that GDP underestimates the value that people place on goods and services that are transacted in markets. Given that 1) demand slopes down and 2) transactions are consensual, it stands to reason that everyone pays no more than their maximum value for things. This implies that people’s willingness to pay for goods surpasses their actual expenditures. Therefore, RGDP is a lower bound to the economic benefits that people enjoy. Without knowing the marginal value that people place on all quantities less than those that they actually buy, we have no idea how much more value is actually provided in our economy.

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Growth of the Transfer State

Zachary Bartsch1 Comment

I’ve written about government spending before. But not all spending is the same. Building a bridge, buying a stapler, and taking from Peter to pay Paul are all different types of spending. I want to illustrate that last category. Anytime that the government gives money to someone without purchasing a good or service or making an interest payment, it’s called a ‘transfer’. People get excited about transfers. Social security is a transfer and so is unemployment insurance benefits. Those nice covid checks? Also transfers.

Here I’ll focus on Federal transfers, though the data on all transfers is very similar if you include states in the analysis. Let’s start with the raw numbers. Below is data on GDP, Federal spending, and federal transfers. Suffice it to say that they are bigger than they used to be. They’ve all been growing geometrically and they all exhibit bumps near recessions.

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