Taxing the rich: Un a-ha! the moment

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 contradictory or obscure ways to describe them. To anyone other than an economist, the phrase “public good” sounds like “a 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-rivalrous and non-excludable, and you may be met with glazed eyes.

This is one of the reasons why I enjoy finding economic concepts clearly stated or illustrated in works of fiction. When done well, it’s the “Aha!” Can help bring moments that clarify an idea to someone in a way that charts, graphs and technical jargon simply cannot. But fiction is not the only means of this – we can find it in everyday life too. An important concept in economics that I think is horribly described:

“The legal incidence of a tax is not the same as its economic incidence.”

This is an important concept. And for those whose goal is to improve the poor by raising taxes on the rich, this is crucial to understand. Just because the law says the rich will be stuck with the tax bill doesn’t mean the rich are the ones who will actually pay the price.

To see why, let’s consider a service I’ve used many times – an online sales platform called Swappa. As a die-hard techie, 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 comes out that I decide I want, I’ll use Swappa to sell my current gadget to offset the cost of the new one. Swappa, of course, charges a fee with each sale to facilitate this. But they also tell you the seller, don’t worry about it – 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’ll actually list it at $525, and when it’s bought, the buyer pays $525, Swappa puts $25, and I get $500.

This is nice in theory, but in practice, it doesn’t work that way. I know the buyer has to pay this extra fee, and the buyer has no idea how much of it goes to me or Swappa. So I have to take 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 be too high to buy. So instead, I list it at $475, add Swappa’s fee, and the price the buyer sees is now $500. According to Swappa, the $25 fee is paid by the buyer, but in reality, it is paid by me, the seller. When done this way, it seems obvious.

Less obvious to many is how the same concept can play out with taxes and other costs associated with all forms of economic regulation. Saying “we need employers to provide more benefits to their workers” means “we need to take less pay from their employers to buy more benefits for our workers.” In his excellent book Catastrophic care: Why what we think we know about health care is wrongDavid Goldhill describes it from his perspective as an employer:

from [newly hired employee] Becky is single without dependents, my company will pay $5,679 this year for her health insurance; He will pay $2,112. Or so he thinks. In reality, Becky is paying all $7,791 of her insurance premiums…to understand this seeming paradox, put yourself in the shoes of my company when we originally decided whether to create that job for Becky. We weigh two factors: the value of Becky’s work to our company and the cost to us of hiring Becky. Notice the problem is “cost to us,” not wages or salaries, because an employee always costs an employer more than his wages…whether he knows it or not, his compensation is carrying the burden of our $5,679 contribution to his insurance premium.

Many activists, on the one hand, would push for legislation to push for more health insurance coverage, longer paid parental leave, and/or other benefits, while worrying about stagnant wages, on the other. What they miss is the connection between the two. One might think that the goal should be to find the “right” or “best” combination of wages and benefits, but there is no correct, one-size-fits-all answer to this question. Nor is there any reason to be arbitrarily misled 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.

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