When "Incentives" are Inelastic

As I wrote about a while back, one of the things I sit around and do all day is price a couple thousand personal and business electronics items. One of the key factors in deciding how to price a product is its price elasticity. Briefly put, the price elasticity of a product is how responsive that product is to changes in price. A highly elastic product will see many more sales if the price goes down, and many fewer if the price goes up. An inelastic product will sell roughly the same number of products no matter how you price it (within a certain reasonable band -- it's always possible to find elasticity if you go far enough.)

It struck me recently that this is an interesting property when it comes to taxes that are supposed to provide people with an incentive to change their behavior.

So for instance, it's often suggested that the Federal Government put an additional tax on gasoline in order to incent people to drive less and/or buy more efficient cars. That in particular is an interesting suggestion, though, because although the price of gas has nearly doubled in the last 4-5 years, gas consumption has not changed notably. Some people have bought more efficient cars, some people have arranged to work from home or live close to work, but mostly people just shrug, grit their teeth, and pay. Gas prices have proved fairly inelastic over the last 4-5 years.

Why is kind of an interesting question. I suspect that a lot of it has to do with the methods of changing your gas consumption often being expensive. Selling your old car and buying a more efficient one is a major capital investment. Moving closer to work or finding a new job closer to your home is also, usually, a very costly (or at least troublesome) operation.

This would seem to suggest that adding a $0.50 or even $1.00/gal tax might well simply collect lots of government money without actually reducing gas consumption much. (A cynic might suggest that this is exactly what advocates are hoping for.)

Further, if the theory that capital investment is the main thing keeping people from reducing their gas consumption is correct, then the people who would actually reduce their consumption would be the value-conscious middle to upper class group -- while poorer citizens without the ability to move or buy a new car would simply buckle down and pay the higher prices. If that were correct, what was intended to be an incentive to reduce consumption would turn into a tax on people with low capital resources.

Two other interesting examples are cigarette taxes and state lotteries.

Smoking has decreased over the last twenty years -- though how much of that is the result of the taxes that now make up as much as 50% of the sticker price of cigarettes in some states is unclear. However, it's also pretty clear by this point that smoking is primarily become a working class phenominon. People who are still serious smokers at this point are pretty clearly price inelastic -- whether it's because they're too hooked, too stuborn, or simply too price-unresponsive to quit. So I think there's a legitimate question: goes raising the taxes further really stand much of a chance of decreasing smoking, or does it simply soak a generally low-income group for more money?

State lotteries are possibly the worst of all. The idea was that this was a voluntary tax: no one has to spend money on the lottery, but if you do most of your money will go to the government (generally public schools.) Yet really, lotteries primarily appeal to people who do not exect to ever see any large amount of money through the course of their normal lives. People with comfortable incomes, large annual bonuses, investment portfolios, and good prospects for advancement don't buy lottery tickets. People who can't imagine how they'd ever come into a large sum of money do. I would like to think it was not consciously planned this way, but the state lotteries as they stand now seem well calibrated to take spare money from people in a manner inversely proportional to their ability to afford it -- taking the most from those who have least hope of building capital resources any other way (and least knowledge of the statistics arrayed against them.)