Bellerbys Economics - Mr Stephenson

Friday, February 15, 2008

Behavioural Licence

Traditionally, the way we deal with demerit goods - such as petrol, alcohol and tobacco is through taxation. Higher prices deter people from using that product and so social welfare increases.

But in many ways, taxation can be very ineffective -demand for merit goods is extremely inelastic - even when taxes are high - such as the nearly 70% tax on wine in the UK.

Why is this? The main reason is 'tax illusion' - the consumer doesn't really appreciate the level of tax on the product and simply assumes the price he pays is the 'correct price' for the product. There are other factors involved - the percentage of overall income represented by the purchase, the level of private benefit assumed by the user, whether the product is bundled with other products - eg a celebration - and so on.

A new idea suggested by the London School of Economics is that licensing may be a more effective solution. Take tobacco consumtion for example. If smokers had to buy a licence - let's say £50 before they were allowed to buy cigarettes from a shop, that might deter many from doing so. If a motorist had to pay a licence of £1000 before being allowed to buy pertrol, the use of public transport might suddenly increase. If the licence had to be purchased every year, there could be a fairly substantial dropping off in the use of merit goods.

There are drawbacks of course. In essence, this is a 'poll tax' that would hurt poorer people more than the rich, promoting inequality. It might lead to illegal stores selling contraband tobacco or petrol. It could lead to arbitrage with people travelling to France and Ireland to buy stocks for re-sale (or maybe people would just buy through e-bay, making the scheme difficult to enforce.

It's an interesting idea, however, and perhaps worthy of further public debate.

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