Lawrence Kotlikoff has responded to Laurence Vance’s criticism of the FairTax idea. So that it doesn’t get lost in the ever-longer thread here, here it is as a separate post. It seems to me that that his whole response underscores what a great job Vance did. Smoke and mirrors indeed!
Reviewing Laurence Vance’s Book Review
“There’s No Such Thing as a Fair Tax”
Dr. Laurence J. Kotlikoff
Professor of Economics, Boston University
In his Ludwig von Mises Institute December 13, 2005 review of The Fair Tax Book by Neal Boortz and Congressman John Linder, Laurence Vance identifies what he believes are 3 “lies” in the book and 17 “problems” surrounding the FairTax. Being a fan of both the FairTax and Congressman Linder as well as a student of consumption taxation, I offer here a point-by-point response.First, the alleged lies:
“Lie” #1 – “Taxes would be voluntary under the FairTax.”
Vance argues that everyone needs to buy goods and services and, therefore, everyone is, in fact, forced to pay the FairTax. This is obviously correct. But declaring that Boortz and Linder are “lying” on this point is wrong. The authors were simply saying that the public would have more discretion in the timing and amount they pay in taxes than under the current system. Today, income and payroll taxes are paid as soon as we earn money. Under the FairTax, no tax would be due until we spend what we earn.
Yes, calling the FairTax “totally voluntary,” as the authors do, is pushing literary license, but not beyond common practice. Indeed, the IRS touts the voluntary nature of our current tax system stating that “The U.S. income tax system is built on the idea of voluntary compliance. Compliance is voluntary when taxpayers declare all of their income. Taxpayers also voluntarily comply through obtaining forms and instructions, providing complete and correct information, and filing their income tax returns on time.”
No impartial reader of the book would come away thinking that the FairTax represents, in effect, the establishment of a voluntary charity for the government.
“Lie” #2 – “The FairTax rate would be 23 percent.”
Vance claims that the FairTax’s rate is really 30 percent. He’s both wrong and right at the same time. The tax-exclusive rate we’d pay at the store would, indeed, be 30 percent, but the rate that matters – the tax-inclusive rate – would be only 23 percent.
To see this, consider spending $1.00 under the FairTax on a good or service (e.g., a candy bar) whose price is 77 cents in the absence of the FairTax. In spending the $1.00, one pays 77 cents for the good or service and 23 cents (30 percent of 77 cents) in taxes. Hence, the $1.00, whether it represents a dollar of income or wealth, ends up delivering only 77 cents of consumption and, consequently, is being taxed at a 23 percent rate.
By analogy, the same can be said for the income tax. If wages of $1.00 were taxed at 23 percent, the taxpayer would have only 77 cents left to spend on consumption. Suppose we were to tax everyone’s wages at 30 percent, but also subsidize their wages at seven percent. Anyone looking at such a tax structure would say there is a 23 percent effective tax on wages.
In describing the FairTax rate as 23 percent, Boortz and Linder are quoting the rate in terms that are not only economically honest, but also permit ready and appropriate comparison with our prevailing income and payroll tax rates. Let’s assume taxable income of a sole-proprietor was $72,000, so that that taxpayer pays taxes of 28 percent plus 15.3 percent payroll taxes for a combined tax-inclusive rate of 43.3 percent. Unless Vance wants to refer to the 43.3 percent as actually a 77 percent rate, he really can’t compare that rate to the FairTax.
Vance owes the authors an apology on this one.
“Lie” #3 – “The FairTax would abolish the IRS.”
Vance reiterates what the FairTax legislation states, namely that a federal agency would be required to oversee and ultimately enforce the collection of the FairTax. If one were to call this agency the IRS, the IRS would not, in fact, be abolished. But here, again, the authors are engaging in reasonable literary license in suggesting that the FairTax would abolish the IRS.
Whether or not the tax collection agency retains the initials I, R, and S, it would be completely different from the current enforcement apparatus. For starters, we’d no longer have more than 100,000 government bureaucrats enforcing 17,000 pages of federal tax law. Second, we’d no longer have to file individual income tax returns. Third, the IRS would no longer be in a position to know virtually every detail of our financial affairs. Fourth, tens of thousand of accountants, tax attorneys, and lobbyists would no longer spend their working lives trying to decipher, comply with, modify, and avoid tax laws and IRS regulations.
So the FairTax would abolish the IRS for all practical purposes. And, more importantly, the nation would save $250 billion plus in direct compliance costs and an even larger sum in efficiency costs from eliminating the current federal tax system. Yes, the FairTax would entail collection and efficiency costs, but much lower ones. State governments, most of whom are already collecting and administering their own state sales taxes, would be charge and compensated for collecting the FairTax.
“Problem” #1 – “The FairTax hides the amount of tax being paid.”
Vance claims that the FairTax hides the amount of sales tax being paid. Not so. The receipts one would receive in making purchases would clearly indicate the price of the commodity purchased as well as the amount of FairTax imposed on that commodity. In my $1.00 expenditure example, the receipt would say Snicker’s Bar 77 cents and Tax 23 cents.
In contrast to the FairTax, the current tax system makes it very hard to understand the extent to which we’re being taxed. The current tax system constitutes not one tax system, but four – the payroll tax, the federal personal income tax, the corporate income tax, and the estate and gift tax. The later three tax systems are extremely complex. Even the payroll tax is very hard for most workers to appreciate. How many workers, for example, understand that they are, in fact, paying the employer as well as employee portions of the 15.3 percent FICA tax?
The complexity of our tax system makes it extremely difficult for any of us to understand the full extent to which we are taxed on working and saving. The need, in the end, to guess what incentives we’re facing further distorts economic choices. The costs of these distortions are significant. Indeed, they may far exceed the roughly 2 percent of GDP direct costs of complying with the current tax system.
Thus, Vance has the issue of hidden taxes completely backwards. The FairTax is the most transparent of any tax system. The current tax system, in contrast, is specifically designed to and thrives on hiding its provisions.
“Problem” #2 – “The FairTax is progressive.”
Leaving aside the rebate, the public generally views sales taxes as regressive. They reach this conclusion by comparing sales tax payments with current income. Since someone with zero current income still has to buy food to eat, the ratio of that person’s sales tax payments to his current income is infinite. In contrast, the ratio of sales taxes paid to income in the case of someone with a $1 million in current income is much smaller. So the “poor” person with zero income is paying a much larger share of his current income than is the rich person in sales taxes.
The problem with this analysis is that people don’t pay for their consumption simply out of their current income. (If they did the person with zero current income would starve.) People also pay for their consumption out of their private wealth and out of the welfare benefits, Social Security benefits, unemployment benefits, and other government transfers provided by the government. Indeed, the “poor” person just mentioned might well be billionaire Warren Buffet. How so? Well Warren’s current annual income could be zero because he’s experienced capital losses on his investments during the current year. This wouldn’t prevent him from using his billions in assets to pay for steak dinners over the course of the year in his favorite Omaha restaurant.
Rather than consider progressivity on an annual basis, economists consider progressivity on a lifetime basis by comparing the present value of remaining lifetime tax payments to the present value of remaining lifetime resources. Remaining lifetime resources includes the present values of future labor earnings and government transfer payments as well as the amount of current net financial and tangible wealth.
From a lifetime perspective, a sales tax (with no rebate) is viewed as neither progressive nor regressive, but rather as proportional. The reason is that the present value of a household’s remaining lifetime spending must equal the present value of its remaining lifetime resources. If it didn’t, the household would be able to spend more over its lifetime than it earns.
Because spending equals resources on a present value basis, taxing spending is equivalent to taxing resources. And doing so at a proportional (fixed) rate means you are taxing resources as a proportional rate. This is what the FairTax does. But the FairTax adds in a rebate, making it not proportional, but progressive overall.
So Vance is right. The FairTax is progressive. But this is a plus, not a minus. Unlike Vance, the vast majority of Americans, including the vast majority of the rich, favor a progressive tax system.
“Problem” #3 – “The FairTax is an income redistribution scheme.”
Under the FairTax households with the same demographics will receive the same rebate. But as a share of remaining lifetime resources, the FairTax is progressive, as indicated above. But this is not a problem. Any tax system acceptable to the public must be progressive.
“Problem” #4 – “The FairTax creates new tax collectors.”
Totally incorrect. Today, everyone who files an income tax return, more than 200 million taxpayers, is a tax collector. The number of taxpayers will diminish by more than 90 percent. And they will be the same tax collectors as today. In one fell swoop, the FairTax reduces the number of taxpayers at the same time it vests everyone in the tax system, by making the price of government explicit. Here Vance argues that baby sitters and similar providers of personalized services would need to collect the FairTax and mail it into the government. This is true, but it’s no different under the current system. Anyone who is self employed is required to pay self-employment tax as well as federal income tax above a certain level of income.
Although the baby sitter will go from being a “taxpayer” to being a “tax collector,” nothing real will change. Apart from the change in words, the baby sitter is in the same position of having to mail a check to the government.
“Problem” #5 – “The FairTax creates new taxes.”
Wrong. Today, we tax returns on capital, we tax sales of capital assets, we tax labor earnings, we tax estates, and we tax gifts. All of these taxes are eliminated by the taxation of the final retail sale.
Yes, currently, there are no federal taxes directly levied on the purchase of most final goods and services. But at the same time the FairTax would institute these direct taxes, it would also eliminate direct taxation of the labor and capital income received by American taxpayers. Hence, the FairTax destroys old taxes at the same time it establishes new ones. Depending on how one quantifies labor supply and saving, the FairTax could be said to reduce, on balance, the number of taxes. In any case, counting up the number of distinct taxes seems like a silly and inherently arbitrary way to evaluate the FairTax. The important point is not the number of things being taxed, but the number of rates used to tax those things. Under the FairTax all goods and services will be taxed at one and only one rate – 23 percent.
“Problem” #6 – “The FairTax creates new taxpayers.”
I sure hope so. I hope the 40 percent or so of Americans who pay no income tax today have to pay the FairTax and see that they too are vested in our government. I hope that criminals who have illegally amassed wealth in the past will pay lots of sales taxes when they spend these holdings.
What about churches and other non-profits? Their tax treatment is as it is today. They’ll pay no taxes on their income, and charge no FairTax when those sales are substantially related to their exempt function. On the other hand, if they sell consumer goods or services, they’ll have to charge and remit the FairTax on these sales.
Plus, individuals will be able to donate to their church or favorite charity tax-free.
“Problem” #7 – “The FairTax makes it easier for the government to raise taxes.”
Quite the opposite. Politically, if there is only one tax rate that everyone needs to think about and keep track of, there will be lots of interest in that one rate as well as opposition to raising it. One key objection to the FairTax is that it is too visible, meaning that it exposes the true costs of the government. This is at the same time its major strength and weakness. Exposing the true cost of the government ensures downward pressure on the size of government. But doing so makes politicians who like to hide taxes wary. Moreover, as the public digs in its heels on raising the single rate, as I suspect it would, federal expenditures would have to be restrained to live within the 23 percent rate budget. I.e., the 23 percent FairTax rate has the potential of establishing a global budget for federal expenditures, something that should be wholeheartedly supported by Vance.
Vance suggests that the rate would have to rise over time to adjust for growth in the economy. This is (excuse the pun) off base in that the FairTax tax base will itself rise with growth in the economy. Hence, revenues will keep pace with overall economy-wide growth without requiring a rise in the tax rate.
The major point he also misses is that the FairTax is global tax reform. When the U.S. is the only industrialized country in the world with a zero rate of tax on savings and investment and productive enterprise, other nations will have to follow suit or lose their citizens’ investments to the U.S.
“Problem” #8 – “The FairTax makes it easier for state governments to raise taxes.”
The states may adopt the FairTax’s broader sales tax base, but would likely cut their rates in so doing. What Vance ignores is the competition across states in attracting business and workers. This competition explains why state tax rates are relative low and are likely to remain low.
“Problem” #9 – “The FairTax has unknown and potentially huge Transition costs.”
Saying so doesn’t make it so. There is no reason to expect significant transaction costs. The inventory transition valuation issue raised by Vance can readily be sorted out.
“Problem” #10 – “The FairTax makes exceptions while claiming to have none.”
Totally incorrect. Unlike today, where the tax code is used as an effective second appropriation committee, the FairTax taxes every form of consumption expenditure that can readily be taxed without exception. The FairTax exempts educational expenditures, but educational expenditures are viewed by economists as a form of human capital investment, not a form of consumption.
“Problem” #11 – “The FairTax has a great potential for fraud.”
This is the major concern about the FairTax raised by economists and tax practitioners, but it is not based on rigorous analysis. There is every reason to believe the FairTax would reduce noncompliance from its current $300 billion level.
First, much of the $300 billion stems not from fraud, or the intentional violation of a known legal duty, but rather from mistake. The FairTax eliminates virtually all potential for innocent mistakes, and it makes it much more difficult to claim that noncompliance arises from mistakes; i.e., the simplicity of the FairTax removes the plausible deniability of fraud.
Second, the vast majority of sales of consumer goods and services and all of the sales of expensive consume goods and services is done in retail stores, whose sales tax payments could readily be monitored. As for the other transactions, we’d have the entire IRS or, whatever you’d want to call it, available to enforce this single tax. By setting very high penalties and using ad campaigns to indicate that cheating on the sales tax hurts everyone, collecting the FairTax should be straightforward.
Third, the FairTax reduces the effects of all known factors on fraud. The three factors that economists have shown to affect compliance are marginal rates, likelihood of being caught, and penalties. The FairTax enhances all three:
1) The FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax’s reduction in average tax rates on the working age population reflects the broadening of the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. Consider, as an example, a single household earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 16.2 percent under the FairTax.”
2) The likelihood of being caught increases dramatically when the collection points decrease from 140 million to 20 or so million.
3) The FairTax imposes significant penalties on those who would commit tax fraud.
“Problem” #12 – “The FairTax will turn thousands of Americans into criminals for not collecting the tax.”
Thousands, if not millions, of Americans now cheat on their income taxes. And we have more than 150 tax penalties, several of which are criminal today. But we do perform audits and fine people for not paying. The same would occur under the FairTax. People who cheat would get caught and pay penalties. However, the FairTax has several provisions enhancing taxpayer rights.
“Problem” #13 – “The FairTax does not repeal the 16th Amendment.”
The FairTax cannot repeal the 16th Amendment, which has to be done in a separate piece of legislation. So, Vance’s point is that we must live with the income tax? Not so. The FairTax does repeal Subchapters A and C of the 1986 Internal Revenue Code that implement the income tax. Vance’s concern here is that the income tax will be restored and that we’ll end up with both the income tax and the FairTax. But if the popularity of the FairTax will, I believe, preclude that from ever happening.
“Problem” #14 – “The FairTax doesn’t repeal federal excise taxes.”
True. But not a problem. We want to retain some flexibility to tax goods, like cigarettes, the consumption of which can impose significant costs on society at-large, at higher rates. These taxes serve a different purpose than general revenues. They are in effect taxes on externalities.
“Problem” #15 – “The FairTax doesn’t lower taxes.”
Wrong. The FairTax dramatically lowers marginal rates and completely eliminates the double taxation on returns to savings and investment. And over time, the FairTax will stimulate growth and permit much lower rates of taxation than would otherwise be the case.
“Problem” #16 – “The FairTax doesn’t address the root problem that the government has no fundamental right and should have no power to tax us.”
The government has the rights we the people have given it through the Constitution. This, again, is a Vance problem, not an American problem, but he should read the Tenth Amendment of the United States Constitution, which is part of the Bill of Rights. It states: The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people. If Vance wants to strike that Amendment, he has a long way to go.
Problem # 17 – “The FairTax makes welfare universal through the prebate.”
Wrong. The FairTax simply declines to tax Americans before they have met their own sustenance in life. Nobody is taxed on the necessities of life under the plan. And nobody is required to pay for the cost of the government until they have met their own needs. I don’t consider that welfare.
Dr. Laurence J. Kotlikoff
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Don said: “My claim is that the company has a broader set of options than you have expressed.
In particular, it is under no obligation to make or let the market clear if it is not to its advantage to do so. It can set the price that it is willing to sell for, but it cannot force consumers to buy anything at that price if they don’t want to.”
So what’s the alternative? To ignore your variable cost? To let you inventory stay on your shelves, while you suffer total loss, instead of partial cost? You just say to your creditors and people who submit you month-to-month bills: “oh, what the heck – it’s just a sunk cost so it doesn’t matter, please forgive me”. Well, it matters to them, and it would matter to you if you are actual producer rather than hypothetical one. You made all your decision based on those variable costs of production. So like it or not, you would not be able to ignore market prices and you would have to follow them – even if it means that the “Fair Tax” confiscated most or all of your income.
Don also said:
“The best price for the company to set, even though uncertain, is the one that causes the last unit sold to result in a marginal revenue to the company that exceeds its marginal cost, with the particular marginal cost being the one that is appropriate for the situation at hand.”
Of course it is. Except, no one knows what price that is until market selection favors those firms who are closer to that point. Firms would never produce an output, for which they would run into losses (considering standard error of their demand forecast, at forecasted MR=MC they would always enter into a large area where costs exceed revenue – and no one wants to produce that kind of output). So they deliberately stay away from MR=MC point that is only a forecast with a significant standard error.
That’s why are referred to revenue “maximizing” as trying to play it safe (trying, because we live in an uncertain world).
In short: If you ignore market prices and you don’t clear – you decide to suffer total loss on every good unsold, instead of taking what you can take for a market price. Your variable cost cannot be observed as sunk in output/pricing decisions, even if it happens in past and you already paid it off, because by selling quantity of those goods you actually reduce your potential cost – and that’s why we don’t call that cost “fixed” (many of us would need that money back, and that’s why we go into production of these items ). Your best estimates of future cost curves are your present ones. If you ignore it, and you total revenue drops below your average variable cost, you can forget about next output decision (you won’t have money to finance it) and you can shut-down.
Sasha,
Merry Christmas or equivalent.
You shouldn’t be disagreeing with me because I am supporting your claim of catastrophic results if previously expended production costs cannot be recovered.
Everything that I have said is an attempt to give the best or least bad result given that reality.
So what’s the alternative? To ignore your variable cost? To let you inventory stay on your shelves, while you suffer total loss, instead of partial cost?
If you intend to stay in business and your product is not perishable, then what you keep on the shelf will reduce the amount of inventory build that you need to do for next month, so it’s not a total loss by any means. Again, the goal is to make the best of what may be a bad situation.
If you ignore market prices and you don’t clear – you decide to suffer total loss on every good unsold, instead of taking what you can take for a market price.
The assumption is that everything that you bring to market will sell at the same unit price. If you bring too much to market, the last units you supply will not only sell at lower prices themselves, but they will force lower prices on all of the previous units supplied. This is why there is a unit price and quantity that produces a maximum revenue for a given market demand schedule, whether it’s observable or not.
It may be that we have a difference in assumptions. When you talk about ignoring a market price, my claim would that there is no market price until I decide how much to supply at what price. What already exists and is beyond my control is a market demand schedule of quantity demanded vs price. Given that, I try to do the best I can knowing that my perception of the market demand schedule is uncertain.
The only way that I see that a market price could exist before I decide how much of my post-production inventory to supply at what price is to be working from the basis of some variant of a perfect competition model. All reported prices are merely historical in character and don’t necessarily reflect current supply and demand conditions.
Regards, Don
Suppose people faced with a 23/30% consumption tax cut their consumption and increase their savings? If they do this, won’t the tax rate have to be increased in order to make the total collections revenue neutral? If the tax rates are raised, that could cause people to cut their consumption even further.
If people reacted to it in the opposite way and cut their savings and increased their consumption, then government revenues would be greater than expected and the rate would have to be cut to leave it revenue neutral. Cutting the rate would then encourage people to consume even more and save even less and raise total taxes once again.
I don’t see how anybody can be sure how people would react to be sure that it in fact was revenue neutral.
Don,
Merry Christmas to you and everyone who celbrates today.
You said: “If you intend to stay in business and your product is not perishable, then what you keep on the shelf will reduce the amount of inventory build that you need to do for next month, so it’s not a total loss by any means. Again, the goal is to make the best of what may be a bad situation.”
So, you’re talking about products that can’t be spoiled, products that will not be obsolete before next stage of production or have a high obsolesence cost.
But regardless of your future adjustments in cost curves (that will come with past experience, as Rothbard explained), you will have to follow a prevailing market price in order to clear that product and not to suffer a total loss in unsold units.
Don also said: “The assumption is that everything that you bring to market will sell at the same unit price. If you bring too much to market, the last units you supply will not only sell at lower prices themselves, but they will force lower prices on all of the previous units supplied. This is why there is a unit price and quantity that produces a maximum revenue for a given market demand schedule, whether it’s observable or not.”
Do you assume here that an individual producer’s supply greatly determines total market supply – and that producers can adjust prices based on their own individual stock of merchandise (with no close substitutes)? Unfortunately, consumers don’t care about your own forecasting errors and they create a market price in interactions with all sellers within a market. If you produce some output greater than optimal (or what consumers determine based on their deman and total market supply of all sellers), you will simply have to follow that market price or suffer a loss.
Don: ” When you talk about ignoring a market price, my claim would that there is no market price until I decide how much to supply at what price. What already exists and is beyond my control is a market demand schedule of quantity demanded vs price.”
What will also exist is total market supply, in which you only have a fractional contribution and little or no control. Based on that, you will have clearing price that might drive you out of business or make you richer (based on your output).
Don: “The only way that I see that a market price could exist before I decide how much of my post-production inventory to supply at what price is to be working from the basis of some variant of a perfect competition model.”
The only way that I see your assumption can exist is a perfect monopoly model. What I described explains how you must behave when you own supply does not control market demand and supply (real world).
Sasha,
The only way that I see your assumption can exist is a perfect monopoly model. What I described explains how you must behave when you own supply does not control market demand and supply (real world).
From the Hoppe chapter on Rothbard that you referenced earlier–
MURRAY N. ROTHBARD:
ECONOMICS, SCIENCE, AND LIBERTY
By Hans-Hermann Hoppe
© 1999 The Ludwig von Mises Institute
From 15 Great Austrian Economists
Edited by Randall G. Holcombe, pp. 223-241
Moreover, Rothbard refuted every alternative theory as nonsense, nonoperational, or
false. It is nonsense, for instance, to define a monopolist as someone who has control
over his price (a “price-searcher”). Every businessman has perfect control over his price
(and no control at all over the quantity bought at that price by consumers). Hence, under
this definition, no one exists who is not a monopolist. Likewise, is it nonsense to define a
monopolist as “the only seller of any given good,” for in an objective sense, every seller
of every product is always the only seller of his own unique product (brand). Thus,
everyone is a monopolist with a one-hundred-percent market share of one’s own product.
Yet, this circumstance does not affect in the slightest that each entrepreneur must
compete at all times with every other entrepreneur for consumer spending, regardless
how unique or different one’s goods may be. On the other hand, in a subjective sense, no
seller of anything can ever be established definitely as a monopolist. According to this
interpretation, the term “given good” means “a good as defined by consumers.” Thus, the
determination of whether or not the seller of something is its only seller, or of how large
his market-share is, depends on the consumers’ definition of what this good is; that is, on
their classification of particular physical objects into various groups of homogeneous
goods. Not only can such classifications continually change, but different consumers can
classify the same physical objects differently. Hence, in this sense the term monopolist
becomes practically useless and non-operational, and all attempts to measure a product’s
market share must be considered futile.
The analysis of a single seller good can be implicitly extended to any good by simply encapsulating the difference in the market demand including competition that the seller faces. As you note, it will be uncertain in any case.
Regards, Don
Suppose people faced with a 23/30% consumption tax cut their consumption and increase their savings?
=================================================
People will not face consumption tax. They will face market prices formed by supply and demand, and any tax will only affect future supply (because producers will have to absorb a sales tax).
People’s savings depend on their time preference (if they prefer their consumption now or later). Since we don’t have knowledge of future tax rate and its effect on market supply (and prices), we don’t know that future consumption will be less expensive. Therefore, any short-term change in savings would not be attributable to the “Fair Tax”.
PS
With many people laid-off and entrepreneurs going out of business (as a result of a brutal 23% total revenue tax), one might only suggest that savings would eventually go down, along with aggregate supply and demand (stagnation). People with meagre income would spend most or all of their money just to sustain their basic needs. For them, savings would entail a very high cost (higher time preference).
Don, you misunderstood Rothbard.
A single seller does not control market supply. The author actually tried to suggest that everyone is a monopolist and that a notion of “single seller controling a market supply (including substitute” – is just a nonsense.
- Single seller does not control market supply or market prices
- Trying to analyze market price formation using a single seller model is unrealistic.
Hoppe: “Hence, in this sense the term monopolist
becomes practically useless and non-operational, and all attempts to measure a product’s
market share must be considered futile.”
Sasha,
Let’s say you sell a store brand 37″ plasma TV.
No one else sells the same thing, but there is certainly no shortage of close substitutes.
For your product, you can set any price you want, and build as many or as few as you want, but you cannot force consumers to buy even one if they don’t want to.
The demand for your specific TV is a subset of a larger, more general demand, that might be all TVs between 36 and 42 inches in size, for example.
The price that you set and the quantity that you supply are set by you in an attempt to leave youself in the best possible financial position. This is a highly uncertain process, but the process takes as its inputs the projected state of demand vs price for your specific TV and your projected marginal cost, broadly defined.
The above is true if you are a sole seller, but it is also true when competitive substitutes exist. The only difference is that the demand/price schedule for your specific TV may highly depend on the demand/price schedule and supply of all other 36 to 42 inch TVs.
Regards, Don
Don, your example is not realistic.
There are always competitors, especially for something like “store brand” anything. Market price will form in a process in which you contribute only a fraction and you have almost no direct control. Profit always attracts competition, even if we all have some kind of patent or niche.
Read Rothbard and Hoppe more carefully:
“the term monopolist becomes practically useless and non-operational, and all attempts to measure a product’s market share must be considered futile”
Therefore, you have no way of knowing how much of your own supply contribute to overall market supply. Therefore, clearing price will appear, whether it is convenient for you, or not.
PS
All of you guys in this blog are trying to come up with a world in which no one ever would go out of business. It’s kind of funny.
So to give you a final answer:
No, you cannot become an instant monopolist and single seller in your market by artificially narrowing a definition of market in which you compete (Rothbard showed how this kind definition of monopoly is absurd). Your broader market will exist, whether you admit it or not.
If you decide to define the market in which you compete so narrowly and you boldly claim that a separate market exists only for your 37″ store brand plasma TV – and if in some weird reality you become a sole supplier of such product and no one else can enter your mini-market – you only created yourself a nightmare. It can only make you feel better before sales figures start to show.
By making your market definition so narrow, you virtually made it impossible to estimate future demand for your planned output. Why? Because one of the determinants of demand are prices of substitutes and complements (and substitute product could be anything – more broadly you define them, you increase chances that you are correct, since people substitute luxury items with those products that don’t even seem to be close substitutes…).
So if you decide to have more precision in determining your market supply by declaring yourself a sole supplier – you made your demand almost impossible to estimate, because you increased the number of substitute products’ prices to investigate… So you would actually mess up your demand forecast without a good reason. Why do I say that?
Well, even if you only sell your store-brand products for which you have a patent (what a “realistic” scenario for the US economy), you would still not be able to affect prices greatly by manipulating your own output. That’s due to prices of close substitutes, which you decided not to account for in your supply analysis. Whether or not you want to accept other sellers as a part of your market, their supply and prices will form a prevailing market price and demand conditions, over which you have no control.
But like I said, your example is not realistic representation of the US sellers – and it is irrelevant for this topic.
Sasha,
Rothbard is clearly saying that the word ‘monopoly’ has no possible consistent and useful meaning. However, he is not placing any limitation on the possible range and refinement of the degrees and gradations of competition that may exist. The only exception is that a totally unique product with no possible substitutes will still face competition from every spending alternative that an individual may have.
What I attempted to describe was a model in which the demand for your specific product combines with your marginal costs to determine the price and quantity which give you the best result. Having a model by itself places no limits on the results. The existent of nearly perfect substitute competition will strongly affect the demand schedule that your specific product faces
and, thereby, the proper price. If you posit a situation in which setting a price as little as a penny above a competitive substitute results in no demand whatever, so be it. The model doesn’t care and should be capable of producing that result.
In all cases, for all degrees of competition, the reality is extremely uncertain. As a result, the model may or may not be useful in directly setting a price. However, even if it can’t be so used, it may still be useful in suggesting how changes in pricing and quantity may affect results.
Regards, Don
Don,
That model is unrealistic and it is actually implying something that Rothbard refuted. On the top of that, it may actually confuse people into believing that formation of market prices depends on total market demand – and a single firm’s inventory. And that’s far from reality and useless for understanding full effects of the “Fair Tax” when it is applied on market prices, which firms have to follow if they don’t to get suffer loss of unsold goods.
If one strictly interprets Say’s law, he/she will reach an interesting conclusion about the real extent of any supply curve. But that’s future Radeta’s law and will not go into that this time.
Considering the scenario of the ‘cold turkey’ transisition of the Fair Tax, I see two conditions. First, The transition has some taxes eliminated ( personal and corporate taxes for example). The tax reductions would be more or less dependent upon the existing corporate tax rate. This must mean that unprofitable compaies would have no reduction, as they pay no income tax. In general, this procedure favors companies with tax rates above the mean and harms companies with tax rates below the mean. I do not consider this condition neutral.
Second, personal income and payroll taxes are eliminated on day one and the new ‘Fair Tax’ in now added to balance things out. What about employees that have (somewhat) inflexible pay rates, such as unions. It could take years to reduce the pay rates. Would this not be an increase in real wage and would this not increase unemployment. This would also favor some companies at the expense of others. I see the possibility of great imbalances as production facilities are shifting in the direction of companies these tax shuffles favor.
Why would this not cause one big recession with high employment as the economy shifts things around to compensate for these ‘neutral’ events.
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