Unintended Tax Consequences

by Elaine Schwartz    •    Aug 6, 2011    •    612 Views

Protesting a proposed luxury tax for pet grooming, Chicago’s Soggy Paws canine clients wore signs saying “…please don’t tax my haircut.” The politicians who were hoping for more revenue might have been disappointed.

Some history…

The Omnibus Reconciliation Budget Act of 1990 included a luxury tax on yachts, aircraft, and more expensive furs, jewelry, and autos. It was supposed to be a relatively painless way to add $31 million to federal revenue.

But it did not work out that way. With higher prices depressing quantity demanded, the government actually lost money. Job cuts in each of the impacted industries meant elevated federal spending for unemployment benefits. Diminished sales decreased government revenue. The net result? A loss of $7.6 million rather than a $31 million gain.

Current proposals to eliminate tax breaks on corporate jets sound remarkably similar to past luxury taxes. Yes, the affluent who can afford it will pay more. But also, a domestic industry employing close to 120,000 will be adversely affected.

The Economic Lesson

It is all about supply and demand. When a tax increases price, it shifts the supply curve to the left. Correspondingly, because supply crosses the demand curve at a higher price, a lower quantity is demanded.

An Economic Question: What are the pros and cons of higher taxes for the most affluent in a society?

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