Low hanging fruit and the inequality question By Scott Sumner

Increasing economic inequality has become one of the trendy issues in economics, mostly for the wrong reasons. I’ve pointed out that inequality pundits tend to rely on income data, which doesn’t measure what they assume it measures—economic inequality.

This discussion has led to lots of proposals that would do more harm than good, such as higher minimum wage rates and increased taxation of capital income.

None of this surprises me at all. But here’s what does surprise me. There are lots of policy changes that:

1. Are highly desirable even apart from any impact on inequality

2. Would also substantially reduce economic inequality

3. And yet receive little or no discussion, even from the people most concerned about inequality.

In the past I’ve focused on two of those policy changes, legalizing drugs and dramatically lowering the tax rate on cigarettes. If you want to take an international perspective, then greatly increased immigration would be a third policy option.

Today I’ll focus on another policy shift that would reduce inequality—sharply cutting the tax on lottery tickets, which now absorbs roughly 40% of all money gambled in state lotteries. Here are some points worth considering:

This floored me: Americans in the 43 states where lotteries are legal spent $70 billion on lotto games in 2014. Seventy billion? I thought. No, that’s impossible. That’s more than $230 for every man, woman, and child in those states–or $300 for each adult. But it’s true: According to the North American Association of State and Provincial Lotteries, lotteries took in $70.1 billion in sales in the 2014 fiscal year. That’s more than Americans in all 50 states spent on sports tickets, books, video games, movie tickets, and recorded music sales. . . . Lotteries set aside about 40 percent of their ticket sales as state revenue that often goes to schools. Then, winners of more than $600 are subject to 45 percent windfall taxes on their good fortune. “The house” is winning, even when it’s losing. But it’s the poor who are really losing. The poorest third of households buy half of all lotto tickets, according to a Duke University study in the 1980s, in part because lotteries are advertised most aggressively in poorer neighborhoods.

The phrase “in part” made me chuckle. It would be roughly like the claim that “far more men than women go deer hunting, in part because deer hunting rifles are advertised more aggressively in Field and Stream than Cosmopolitan. But let’s put that aside, and focus on the economic issues.

Economists use the term ‘inferior good’ to refer to anything that is disproportionately purchased by the poor, such as cigarettes and lottery tickets. ‘Luxury goods’ are goods that are disproportionately purchased by the rich (even relative to income), such as large yachts and Ferraris.

Now let’s consider two hypotheses. One theory is that the recent interest in inequality reflects a sincere desire to help the sort of people who spend lots of money on cigarettes and lottery tickets. The other hypothesis is that it’s just a smokescreen, and the real agenda is to enact higher tax rates, with the money going to increased spending on high speed rail, fixing JFK airport, and “education.” (I use scare quotes because the evidence suggests that, at the margin, increased spending helps teachers unions more than students.) How could we tell which hypothesis is true?

One approach would be to look at what we tax. The high taxes on cigarettes are sometimes justified on externality grounds, but economists who have studied the issue say the tax is far too high based on “second hand smoke” externalities. And I can’t even imagine an externality argument against a market that basically sells hope to people—lottery tickets. The War of Drugs has chosen to focus most heavily on the supply side of the market, which just so happens to be disproportionately made up of poor and minorities, relative to the demand side of the drug market.

We did have a tax on luxury goods, which seems like a really good idea if you are worried about inequality. But then the tax was repealed. And the reason it was repealed is especially interesting—it was successful:

But it wasn’t long before even these die-hard class warriors noticed they’d badly missed their mark. The taxes took in $97 million less in their first year than had been projected — for the simple reason that people were buying a lot fewer of these goods. Boat building, a key industry in Messrs. Mitchell and Kennedy’s home states of Maine and Massachusetts, was particularly hard hit. Yacht retailers reported a 77% drop in sales that year, while boat builders estimated layoffs at 25,000. With bipartisan support, all but the car tax was repealed in 1993, and in 1996 Congress voted to phase that out too. January 1 was disappearance day.

So the tax was a huge success, which reduced the only kind of inequality that matters, consumption inequality. But apparently some progressives who supported the tax had hoped that it could raise lots of revenue for the government without actually depressing the living standards of America’s rich. That would occur, of course, only if the rich maintained their living standards by donating less money to charity and investing less money in new capital formation. Instead, the rich actually did reduce their living standards, and America was on the road to greater economic equality. Senator Kennedy, et al, reacted in shock and horror and had the bill repealed. Meanwhile Massachusetts is among the leaders in taxing the poor via the lottery and cigarettes.

And I haven’t even mentioned the environmental externalities of 400-foot yachts and private jets, which are probably many times worse than second hand smoke.

Some misguided people want to help the poor by banning state lotteries. But that would make things even worse. Buyers would have to rely on the black market, or drive all the way to New Hampshire or Rhode Island to buy their tickets. The solution is simple, cut the state’s take from 40% to 10%, and make up the lost revenue through higher sales and property taxes, where the burden is shared more fairly across all of society. And bring back the luxury tax on yachts and private jets.

PS. I do realize that my proposal to tax luxury goods will generate a lot of opposition. I’m actually not sure if any luxury tax is desirable. It’s difficult to enforce. Rather I’m trying to provoke a different way of thinking about inequality. It’s consumption inequality that matters. If you are not reducing the output of the yacht and private jet industry, then you are doing precisely NOTHING to reduce economic inequality. As long as we tax inferior goods at absurdly high rates, and have bi-partisan support for repeal of high tax rates on luxury goods, then we are not really having a national debate about inequality.

I’m not sure what the debate is actually about. Some people may have a hidden agenda. Some people may have pure motives, and simply be confused. But I see no one in either party going after those low hanging fruit. That makes me think that whatever is done to address inequality will either have a hidden agenda (high speed rail, education, etc.), or be mostly ineffective due to economic illiteracy.

PPS. Some people advocate high lottery and cigarette taxes by claiming they are “voluntary.” Put aside the rather strange use of the term ‘voluntary.’ Even if it were true, it would be an argument against taxing these goods. Any fair tax should apply to everyone, not merely to the subset of people who choose to buy a particular good—especially if they are disproportionately poor.