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Thursday, May 14, 2009

What is the 'buyer price'?

Andrew Leigh has a nice article about the wisdom of assuming taxpayers are perfectly informed. He summarizes some recent studies that show many taxpayers are not, in fact, very well informed about how the tax code works and Leigh points out that this has important implications for anyone talking about tax policy. I was particularly struck by this passage:
For this experiment, [the authors] exploited the fact that product prices in the US do not include sales taxes. Working with a grocery store, they posted tax-inclusive prices on a series of randomly selected products, and watched to see how it affected consumer behaviour. When surveyed, consumers typically knew that tax would be applied at the checkout – yet posting a tax-inclusive price on the shelf still reduced demand by 8 percent.
Like hundreds of econ professors across the country, I emphasize to my students that statutory incidence (who the government collects the tax from) has no bearing on economic incidence (who really pays the tax in the form of changed prices), but to be honest, it's never entirely sat right with me. I know that the sticker price of a gallon of gasoline includes a bunch of taxes, while the sticker price of a gallon of milk doesn't, but like the consumers in that survey, I (and, I have to assume, most of my students) tend to think more about the sticker price, not the register price, when making relative buying decisions. Of course, I cannot begin to imagine the headache that would ensue if I tried to model economic incidence as a function of statutory incidence.

[speaking of semantics and economic jargon, if one of my students had written that quote, I would have corrected them that they really mean 'quantity demanded' in that last sentence but that's a topic for another day]