I say this with all the love in the world: economists have a special knack for taking certain economic ideas or concepts and finding the most counterintuitive or unclear ways of describing them. To anyone other than an economist, the phrase “public good” sounds like “good provided by the public sector.” Try to jump in and explain that, no, to be a public good, something needs to be both non-rival and non-excludable, and you’re likely to be met with glazed eyes.
This is one reason why I enjoy finding the ideas of economics clearly described or illustrated in works of fiction. When done well, it can help bring that “aha!” moment that makes an idea clear to someone in a way that charts, graphs, and technical verbiage simply can’t. But fiction isn’t the only avenue for that – we can find it in everyday life as well. One important idea in economics that is, in my opinion, terribly described is this:
“The legal incidence of a tax is not the same as its economic incidence.”
This is an important idea. And for those whose goal is improving the well-being of the poor by increasing taxes on the rich, understanding it is crucial. The fact that the law says the wealthy will be stuck with the bill for a tax does not mean the wealthy are the ones who will truly pay the cost.
To see why, let’s consider a service I’ve used many times – an online sales platform called Swappa. As an unabashed tech nerd, I’ve bought a ton of gadgets over the years. (Probably too many, but that’s a story for a separate post.) And when some new shiny toy has come out that I’ve decided I want, I would use Swappa to sell my current gadget to offset the cost of the new one. Swappa, of course, makes a fee with every sale it facilitates. But they also tell you, the seller, not to worry about that – the fee will be paid by the buyer, not the seller. They accomplish this by adding their fee to the posted price when you list an item. So if I put an item up for $500, they will actually list it at $525, and when it’s bought, the buyer pays $525, Swappa keeps $25, and I get $500.
That’s nice in theory, but in practice, it doesn’t work that way. I know the buyer will have to pay this extra fee, and the buyer doesn’t care one bit how much of it goes to me or Swappa. So I have to take that into account when I list an item. If I think something I’m listing will sell for $500, I don’t actually list it for $500, because I know the final price will come out too high for it to be bought. So instead, I list it at $475, Swappa adds its fee, and the price the buyer sees is now $500. According to Swappa, that $25 fee is paid by the buyer, but in reality, it’s paid by me, the seller. When put this way, it seems obvious.
Less obvious to many is how the same idea is at play with the taxes and other costs associated with all kinds of economic regulation. Saying “We’ll require employers to provide more benefits to their employees” just means “We’ll require employees to take lower pay from their employers to buy more benefits.” In his excellent book Catastrophic Care: Why Everything We Think We Know About Health Care Is Wrong, David Goldhill describes this from his point of view as an employer:
Many activists will, on the one hand, insist on laws to push for more health insurance coverage, longer paid parental leave, and/or a litany of other benefits, while on the other hand worry about stagnating wages. What they miss is the connection between the two. One might think the goal should be to find the “right” or “best” combination of wages and benefits, but there is no right, one-size-fits-all answer to this question. Nor is there any reason why one must be arbitrarily conjured up by policymakers. Different people will have different preferences about how their compensation is divided between cash and benefits. So why not let people have the option to choose the combination that works best for them?
Kevin Corcoran is a Marine Corps veteran and a consultant in healthcare economics and analytics and holds a Bachelor of Science in Economics from George Mason University.
READER COMMENTS
MarkW
Oct 5 2022 at 11:16am
According to Swappa, that $25 fee is paid by the buyer, but in reality, it’s paid by me, the seller. When put this way, it seems obvious.
But is that obvious? Buyers may be willing to pay more for a used phone on Swappa vs a lower-priced, but less convenient and secure alternative (say, Craigslist). In that case, part of the $25 is paid by the buyer, no?
David Seltzer
Oct 5 2022 at 12:11pm
Kevin, good stuff. Corporations don’t pay taxes either. Stockholders receive lower dividends, reduced capital appreciation and labor’s increase in wages are lower. The hidden DWL is less money to innovate. Consumers pay higher prices as costs are passed on. As for activists, many seem to live in a paradoxical world. From John Cochranes Grumpy Economist, Supply and inflation:
“The greater (lower) the degree of government involvement in the provision of a good or service the greater (lower) the price increases (decreases) over time, e.g., hospital and medical costs, college tuition, childcare with both large degrees of government funding/regulation and large price increases vs. software, electronics, toys, cars and clothing with both relatively less government funding/regulation and falling prices.”
vince
Oct 5 2022 at 4:59pm
It’s not so clear that corporations don’t pay taxes. The tax is a cost imposed on the business. The supply and demand curves dictate how much of it comes out of the corporation’s profit.
David Seltzer
Oct 5 2022 at 6:14pm
Vince, my sense, corporations don’t pay taxes. Individuals do. Looking at supply and demand functions, tax revenue wedged between consumer surplus and supplier surplus reduces both. A cost borne by individuals in an economy due to market inefficiency. Of course, I could be wrong.
vince
Oct 5 2022 at 8:57pm
Maybe I misunderstood your point. If you look at a corporation as a collection of shareholders, then sure, corporations don’t pay taxes.
nobody.really
Oct 5 2022 at 1:50pm
Kudos to Corcoran for making a fair and important point about the difficulty of identifying who bears the cost of a policy. That said, identifying these costs may be especially challenging in the context of health insurance.
1: Is it accurate that employees pay 100% of employer-provided health insurance? If 1) the employer has an interest in her employees remaining healthy and 2) there’s a positive relationship between employee health and employees having health insurance, then I’d expect the employer would find it in her self-interest to subsidize an employee’s choice to get insurance.
2: Due to “adverse selection,” group health policies are cheaper per capita than individual policies. Thus, employers experience economies of scale in providing health insurance.
3: I believe employers get tax advantages for providing health insurance. Again, this would suggest that employers may experience economies of scale.
4: Why would employers get a tax break? Society may feel a duty to provide a social safety net, perhaps including health insurance. (See, for example, F.A. Hayek.) And many people who have studied the issue–including Nixon’s people, Romney’s people, and Obama’s people–have concluded that the best combination of political viability and economic efficiency comes from encouraging/perpetuating employment-based health insurance for 80% of households, and having government swoop in to address the needs for everyone else.
If you really want to measure the cost of current US healthcare policies, you might want to compare those costs not to a libertarian ideal, but to the cost of the more likely alternative: the type of health care systems found in the rest of the developed world.
Thomas Lee Hutcheson
Oct 8 2022 at 7:01pm
Good observations.
Still, it’s hard to see how our current system of subsidizing health insurance by subsidizing employers to purchase it on behalf of employees is the best we can do. Adverse selection (which I’m not sure is a big problem, anyway) can be handled with and ACA like system of subsidizing the person to buy from an insurer which uses community ratings. Employer “provided” health insurance forces the employer to spend a larger percent of the workers compensation on low income employees. This means either lower wages or, if the minimum wage applies to less employment of low wage workers.
vince
Oct 5 2022 at 4:55pm
Fringe benefits started in WW2 as a way to circumvent wage controls. Now they’re tax loopholes that should be closed. Generally, the company gets a deduction and the employee gets tax-free income. Pay the employee cash that is taxable, and let him spend it how he wants.
Why should employers even be in the healthcare business? It bloats administrative compliance costs that are unrelated to the objective of the business, which is providing goods and services to the customers. Let each person buy the individual policy that he wants. Level the playing field.
Monte
Oct 5 2022 at 7:07pm
Is there any other way to describe economics (see Scott Sumner’s Why is economics is so counterintuitive)? Bryan Caplan, however, would have us believe just the opposite (Basic Economics is Intuitive). How perplexing! Maybe it is all in the way economics is explained. Milton Friedman was certainly capable of demystifying economics in terms the general public could understand, although I suspect even he found it challenging to discuss the merits of comparative advantage, the most counterintuitive idea in the social sciences, with his audience.
All that aside, Kevin is right. The whole notion of taxing the rich amounts to nothing more than progressives stirring up envy and resentment within their base. I think Lawrence B. Lindsay, former National Economic Council director, was right when he suggested that the government, particularly when it increases this tax above a revenue-maximizing rate, is “giving up revenue simply to punish the rich” in order to garnish votes based on the illusion of a noble gesture.
vince
Oct 5 2022 at 9:09pm
“The whole notion of taxing the rich amounts to nothing more than progressives stirring up envy and resentment within their base. ”
The cliche complaint is that the rich don’t pay their fair share. Maybe, but those complainers never clarify what that fair share is. My guess–fair to them means they pay too much and those with higher incomes pay too little. The fact that they don’t define fair share tells me it’s demagoguery.
Does anyone find it amusing that Bernie Saunders used to complain about the millionaires and billionaires … until he became a millionaire. Now he only rants about billionaires.
Monte
Oct 5 2022 at 9:57pm
Good points!
robc
Oct 6 2022 at 9:50am
They may be cherry-picking results, but when I have seen “people on the streets” interviews, the fair share is usually much lower than the rich are already paying.
Matthias
Oct 5 2022 at 10:29pm
You are right about tax incidence in the long run.
However in the short run wages have nominal rigidity, and thus in the short run increasing or decreasing mandated employer-provided benefits does change the total compensation that workers get.
And for better or worse, the short run is what much of politics revolves around.
Walter Boggs
Oct 6 2022 at 8:18pm
I grow weary of reading that every other (something something) country has figured out healthcare. If that were true, they would all have the same system, but in fact they have quite a variety of approaches.
I grow weary of reading that healthcare in Country A costs less than healthcare in Country B. Everything depends on how you measure “cost”, and comparisons across countries are very hard to make.
I grow weary of being told that “healthcare is different, so what we know about markets doesn’t apply”. Markets exist whether we want to call them that or not, so we’re best off dealing with them as such.
As you can see, I am tired and I need to lie down.
Thomas Lee Hutcheson
Oct 7 2022 at 7:44am
Good post. The most extreme consequence of this idiocy is when the Supreme Court allowed Hobby to exercise an “religious liberty” right to chose what was not covered (contraception) by their employees’ health insurance purchased as part of the employee’s compensation.
Thomas Lee Hutcheson
Oct 7 2022 at 5:37pm
If employer “provided” health insurance is a hugely important example of the uncertainty of incidence (although economists are not very uncertain about it) another is a controversy over allowing restaurants to pay a less than minimum wage with the employee getting the tips with a guarantee that the employee will get at least the minimum wage. As far as I can tell both the market in restaurant meals and restaurant labor are perfectly competitive in DC so it shouldn’t make any difference. Apparently the restaurant industry thinks that the change will be acted on by consumers as an increase in meal prices and quantity demanded will fall although the meal + tip price of the meal is still determined by the customer. Employees seem to think that tips will not fall enough to offset the higher price of meals and that incomes of those still working will increase. It all comes down to how “rational” costumers are.
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