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Brooks Wilson's Economics Blog: A Health-Coverage Tax and Its Burden

Friday, March 5, 2010

A Health-Coverage Tax and Its Burden

Ed Perkins, a travel writer for the Chicago Tribune, sniffs out a scam but I believe attributes it to the wrong party in "New charge on dinner tab is in bad taste."  Perkins believes that restaurateurs are scamming customers by adding a charge to their bill to cover the new tax on owners for the "Healthy San Francisco" health-coverage system.  I agree that someone is running a scam, but it is politicians who sold the tax as a new business tax that was somehow independent of prices consumers pay.  The restaurants are engaging in a political protest and economic education.  Perkins writes 
Nothing succeeds in the travel industry like a bad idea. The latest hidden mandatory add-on is a "health" charge added to restaurant bills. As far as I know, this scam cropped up first in San Francisco, but you can count on it to spread.

The rationale for this one is to cover the employers' mandatory contribution to the City's "Healthy San Francisco" health-coverage system. The charge actually is levied on employers, but at least some restaurants are adding a few dollars or percentage points to each customer's bill to cover this charge.
The economic impact of the tax is relatively straight forward involving three steps.  First, San Francisco restaurants become somewhat less competitive losing a little business to restaurants in surrounding communities. 

I will explain the second step with a graph.  The numbers are fictional but the direction of the movement of equilibrium prices and quantities are predicted by widely accepted economic theory.  As pictured in the above graph, the original equilibrium before the tax results in an equilibrium price of $22.50 dollars per meal with 32,500 meals per week consumed.  The city government imposed a tax of $5.00 per meal.  The restaurateurs added the tax to their cost structure which helped determine their supply of meals.  Supply shifted inward from S1 to S2.  The vertical distance between the two supply curves is the $5.00 tax.  The new equilibrium shown by the intersection of S2 and demand is at a price of $25.00 per meal with 27,500 meals per week consumed.  Consumers now pay $2.50 more per meal than they paid prior to the tax.  That is their burden of the new tax.  The restaurateurs receive $25.00 per meal but must subtract out the $5.00 tax.  Net the tax, they receive $20.00 per meal, $2.50 less than they received prior to the tax.  In my simple model, the burden of the tax is shared evenly between the restaurateurs and their consumers.

The long-run outcome shifts the burden to the tax entirely or almost entirely to the consumer.  This is because restaurants compete in something close to a perfectly competitive market.  As they adapt to new costs, including the tax, their supply curves becomes perfectly elastic, or something approximating a perfectly elastic.  Without the tax, the long-run equilibrium price was $22.50 per meal as determined by the intersection of demand and S1.  With the tax the new equilibrium is at $27.50 per meal as determined by the intersection of demand and S2.  The consumer pays $27.50 per meal and the restaurants receive $22.50, the price they received before the tax.  But the restaurateurs still have good reason to oppose the new tax.  Prior to the tax, they were selling 32,500 meals per week, after the tax, sales fall to 22,500. 

I did not pay attention to the political debate surrounding the implementation of the health-coverage tax, and I am assuming that politicians used an age old tactic of telling consumers that a tax will be paid for business and not them.  Maybe politicians are more honest in San Francisco.  If my assumption is incorrect, I apologize to these politicians.   

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