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Sunday, January 17, 2016

The Luxury Tax: A Folly of The Consumption Tax

Introduction

Many politicians and lay persons believe the urban myth that Economics is a quantitative science, and that static analysis works with the interaction of human beings.  Politicians believe this when creating tax policy to generate revenues for the Government. These politicians sell the citizens that “taxing the rich” will increase revenue, or the implementation of a consumption/sales tax can simply be passed on to the consumer. All of these points are remarkably false.  All the costs of a consumption tax go back to the business owner, as it impacts the original factors of production: Labor, land and capital.   A glorious example of how this is proven to be true can be found in the famous Luxury Tax of 1990.

The Promise of the Luxury Tax of 1990

This tax was one part of a larger bill named: “The Revenue Reconciliation Act of 1990”.  This bill was created to generate over $140 Billion over a five year period. (Woof, 1991). For this analysis, we will simply focus on the maritime industry and the impact the firms in this market segment due to the implementation of this law. Specific to the maritime industry, any boat sales exceeding $100,000, there was a consumption (excise) tax levied.  The assumption was that consumers of yachts would absorb the increase price, as the other assumption was that the tax would be simply be passed on to consumers, and the Government would receive their projected revenues. However, this was not the case.

The Economic Impact of the Luxury Tax of 1990

The results of the implementation were not surprising for those who understand economics. First of all, the division of labor was impacted.  George Will remarks on the job losses due to this bill: “According to a study done for the Joint Economic Committee, the tax destroyed 330 jobs in jewelry manufacturing, 1,470 in the aircraft industry and 7,600 in the boating industry.” (Will, 1999)  In the State of Florida, the luxury tax impacted the layoff of approximately 13,000 workers. (Pin, 2011) This shows how the consumption tax impacts the division of labor, as it is one of the original factors of production.  Next, the businesses took a huge hit due to this tax. The Wall Street Journal notes here the following: “Yacht retailers reported a 77% drop in sales..” (Wall Street Journal, 2003)  Since sales drops, this reduces the amount of capital that business owners can purchase, borrow and pay back. The end result with this example:  Capital is impacted. What about land? How is this impacted? One can deduce that if sales are impacted, revenues are not able to keep up with the expenses.  Many of the boat manufacturers shut down their plants, and/or filed for bankruptcy protection from their creditors. (Salpukas, 1992) This would impact the land, since the boating manufacturing plants were closed down.

Economics is about Subjective Value

Many think Economics is about stats, graphs, charts and the like. While these items play a vital role in the historical analysis of human behavior, it does not tell the entire story.  Our individual preferences, as humans, are highly subjective. This sort of subjectivity cannot be accurately quantified, nor is the analysis static.  This is the fundamental reason why these sorts of Central Planning projects always fail.  It assumes that humans do not seek alternative choices when the costs to obtain a good change or rise.  Rising prices act as a harbinger for consumers, so they can alter their ordinal goods/services preference ranking. If someone prefers eggs over toast, yet the price of eggs rises exponentially, this does not mean the consumer will continue to purchase eggs. The consumer’s resources are scarce as well, even if they are “rich”. They have other items they prefer, and may choose to plow resources into those items when the price of eggs, using our example, rises too high. This is the notion of elasticity of demand.  Each individual actor has a different preference ranking, and that ranking changes constantly. It is impossible for any human to “plan” out or predict what those rankings will be for millions of individuals.

Other Economic implications from the Luxury Tax of 1990

The Luxury tax bill of 1990 was passed into law in the hopes to generate more tax revenue for the U.S. Government. However, the tax revenues fell short.  After the first year of its roll out, the tax revenues, due to this tax, was about a few tenth of a million dollars. (Pin, 2011) This is not shocking since many of the firms went bankrupt, shut its operations down, or lost revenues.  Ironically, since there were layoffs due to this tax law, the number of unemployment claims rose during this time period.  The explicit cost to the U.S. Government thanks to the job losses from this law was approximately $24.2 million in unemployment benefits. (Will, 1999)  This shows a double whammy for the U.S. Government: There was a short fall in tax revenues, and the Government had increased cost thanks to paying out unemployment insurance to displaced or unemployed workers.
It should also be noted that during this time period, the United States was suffering from a recession. This also impacted the luxury item industry. However, the “solution” would not be raising taxes on these items during this time period. The proper “solution” would be lowering the taxes to encourage growth and economy expansion.  Raising taxes during this time period simply strengthens the argument on how taxes impact business owners.

Conclusion

The economic impacts of the luxury tax of 1990 are quite clear. This version of a consumption tax demonstrates the ill effects of a consumption tax.  Politicians will sell the citizens on the notion of a consumption tax is “better than” an income tax. Just recall the Luxury Tax of 1990 any time the notion of a consumption tax is raised.  The results will be similar, yet it will spread through the entire economy quicker, since it will impact all good/services sold.   It also will not be passed forward to the consumer, but the economic cost will be pushed backwards to the business owner. Regardless if it is a sales tax on specific items, or all items, the tax will impact those original factors of production: Land, Labor and Capital.


Works Cited

Pin, L. (2011, March 10). U.S. Luxury Tax-A Total Failure. Watching America.
Salpukas, A. (1992, Febuary 7). Falling Tax Would Lift All Yachts. New York Times.
Wall Street Journal. (2003, January 3). Good Riddance to The Luxury Tax. Wall Street Journal.
Will, G. (1999, October 28). Tax Break for the Yachting Class. Washington Post.
Woof, S. M. (1991). A Corporate Perspective on the Revenue Reconcilliation Act of 1990. Journal of Corporate Accounting and Finance.


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