Friday, February 11, 2011

Short Term Instability vs. Long Term Externailties

Theory suggests that the most economically efficient and least disruptive way to raise revenue is to tax those items where there is a low level of elasticity, specifically, necessities like food and clothing as opposed to luxuries like jewelry and limousines. While it may provide more stability in the short run, over the long run, the effects of externalities may prove such a policy to be misguided.

The problem lies in the price of eating healthy. Even in the status quo, healthy foods are comparatively expensive. The New York Times reported in December 2007 that the price of “unhealthy” food was $1.76 per 1000 calories, whereas the price of “healthy” food was $18.16 per 1000 calories.

A nutritious diet for any given person means that they will, over the long run, keep in better health, thereby increasing their personal and the economy’s productivity. This means higher tax revenue for governments, increased productivity for their employer, higher wages for the person, and lower health care costs to society vis-à-vis Medicare and/or Medicaid.

If a tax were to be placed on food, we would end up creating a long-term health problem due to substitution effects: as the price of healthy food increases, this would cause a number of people who would otherwise consume healthy foods to instead choose unhealthy food, as healthy food would no longer be economically viable for them. The positive long-run externalities that would have otherwise been captured by individuals and society would therefore be lost.

Taxing necessities such as food may be advisable in the short run to avoid disruption to the market, but, over the long run, their effects on consumer choices may prove such taxes to be unadvisable.

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