Tax Discussion Definitions: Elasticity

In order to have a better understanding of all the nuances of discussing tax policy, I’m going to spend some time talking about terms that policy wonks and lawmakers throw around a lot. This entry will focus on the concept of elasticity; if you’re an economist this might be old news but a refresher never hurts right?

So what is elasticity?  Basically, elasticity is a measure of responsiveness. It tells how much one thing changes when you change something else that affects it.  Best analogy is a rubber band; it’s elastic when it stretches in response to you pulling it.  In economics, there is elastic demand—this happens when a consumer buys less of something when the price increases and more of something when the price drops.  There’s also inelastic demand, which occurs when a consumer buys about the same amount if the price goes up or down. Dr. Samuel Baker from the University of South Carolina created an interactive tool that provides more examples of this concept. The first example he provides is about a bleeding unconscious man that’s brought to an emergency room.  This would be considered inelastic since he’ll get treatment regardless of the price.

So what does this have to do with tax policy?  Lawmakers always have to consider how much of a burden they’re imposing when raising taxes and know who actually ends up paying for a tax that might be aimed a different group (example: buyer vs. seller).  This concept is know as tax incidence

If a tax is raised too much, use of the taxed service or product could decrease below the expected level of tax revenue a government is aiming to collect.  Also, politicians need to be aware of how the public will react to certain taxes.  For example, food is pretty inelastic since we need it to survive. If groceries were taxed in Washington, consumption might decrease some but the tax will be paid due to the necessity of eating. This would be a burden on families, especially those with lower incomes (Link to Catherine’s food brief). 

Also, policymakers use the concept of elasticity to reduce certain behaviors. The best example of this is tobacco (link to Catherine’s tobacco brief).  It’s commonly known that the long-term effects of smoking and chewing tobacco physically harm and kill people.  This makes tobacco an easy target in terms of raising taxes. To change consumption behavior, lawmakers raise the tax to try and make smoking too expensive for consumers.  When this happens,  revenue from the tax declines and it’s easy for the Legislature to argue in favor of the declining revenue of tobacco sales because the decreased use offsets future healthcare costs.  As Catherine mentioned, the State recently closed a loophole for consumers when they raised the fee for roll-your-own cigarettes.

That’s elasticity in a nutshell!  Without using mathematical models to describe pricing points and such, just know that elasticity is how you react to certain things like cost and how flexible you are when market variables change.  This is a relationship that government needs to understand well if it wants to implement tax policies that are a) fair to the majority of citizens, and b) politically possible.   We’ll add more definitions like this one to give you a clearer perspective of underlying issues that come up when folks talk about taxes.