Thursday, December 01, 2005

Lower GST

Cherniak has a post today on why lowering the GST will win the Tories points but is bad policy. He even concedes that this policy move might give the Tories the first half of the election. Unfortunately this is followed by a flawed argument about why retailers will raise prices to fill the entire gap created by the tax cut. Here is my comment to him on why I disagree:

1. Seriously, this is first year economics. A good is currently being sold for $100 with 15% tax for a total of $115. Theoretically say that the retailer is paying total costs of $80 to sell this and therefore makes $20 profit. Sales taxes are decreased to 13% and all other things remain the same. There is now a gap between what was previously being paid and what you think prices will increase to of about $1.85. This gap will be SHARED by consumers and retailers. If one retailer chooses to take all of it his competitors will take advantage of him by taking less. This is obviously possible because the retailers were will to operate at the $20 profit level and therefore will be willing to compete with each to the point where the market clears. No good, save maybe cocaine is totally inelastic. If dealers are charging tax they will be able to adjust prices accordingly.

2. Even if we are sent through some sort of economic vortex and what you theorise happens that will still mean more profits for retailers. Which means either more dividends for shareholders or increased investment. Both good things for the economy, I'd say.

3. The reason that you shouldn't save this for an economic rainy day is that that's when the government needs more money. Don't you see how that would make your argument circular? You did after all, start by saying that this tax was introduced during a recession.

4. Speaking of which I'll take up that challenge if you'll define "worst". Longest? Highest unemployment? Aggregate GDP shrinkage? Frankly I'd pick the third measure.

Point 3 counters his statement that this cut should be saved for an economic rainy day. Point 4 deals with his claim that the early 90s had the worst recession in Canadian history since the Depression. I haven't looked at the unemployment data yet but I know that 82 was worse for GDP growth and 45-46 was just as long.

Some commenters on his site have stated the psychological barrier of prices that end in .99 as a reason why retailers won't increase prices by 2% (actually it's more like 1.85%). I'm not sure about this. Walmart markets their prices as being fairer because they don't do the .99 thing so there would no problem for them and Walmart is unfortunately where most people who would be helped most by this cut shop. Also, if retailers want to increase prices without seeming like they are they can just offer fewer sales or reduce prices less steeply when goods do go on sale. But, again, basic economic theory states that retailers will only take part of this cut. The proportion taken will depend on the elasticity of the demand for the good and the level of competitiveness in the particular market.

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