The Joy of Tax

Nobel Laureate Milton Friedman once compared governments to a teenager with their father’s credit card. As long as there is money to be spent, they will spend it. Unfortunately, the recent economic slowdown is starting to hit states’ budgets. And since individual states, unlike the federal government, cannot simply print money to make up the difference, they have to find other sources of funds.

Everyone knows that politicians don’t get elected by calling for tax increases or for cuts in spending on popular programs. So the only avenue left for state politicians in tough economic times is to find a group that the public doesn’t like (or for whom they feel no sympathy) and drudge up a moral case for taxing them. Massachusetts lawmakers, for example, have discussed taxing the Harvard University endowment. The endowment, estimated at roughly $34 billion, currently grows tax-free due to Harvard’s status as a non-profit institution. The argument, says Representative Paul Kujawski, is simple: “It's mind boggling that one entity not paying taxes has $34 billion…When people can't afford to live, how do you justify not taxing them?” Whether or not you agree with the tax, the message from Massachusetts law-makers is quite clear: times are tough, and we need tax those who have the money.

Law-makers in California are trying something similar, going after an equally well-endowed group: the porno industry. According to Representative Charles Calderon, the 25% tax on both the production and consumption of pornography will generate $665 million in tax revenue from the $4 billion per year industry. However, unlike their east-coast compatriots, the California politicians sponsoring this bill are not invoking a “rich should pay their fair share” argument; rather, they are drawing inspiration from 20^th century British economist Arthur Cecil Pigou. Pigou is best known for the “Pigouvian tax”, which is a tax designed to correct the negative by-products (externalities) of market activities. An externality is an outcome of a market activity that affects a third party not involved in the transaction. Positive externalities are things like education, which provides indirect benefits to society beyond the direct effects on the person attending school. Negative externalities are things like pollution. The emissions from the car I drive, for example, impose costs on others that I don’t pay for. As a result, there is a tendency for people to under-consume goods with positive externalities (since they don’t get the full social benefit) and over-consume goods with negative externalities (since they don’t pay the full social cost). Pigou and others have argued that the role of government is to tax goods with negative externalities (to put the individual cost in line with the social cost) and subsidize goods with positive externalities (to put the individual benefit in line with the social benefit).

Pigouvian taxes have enjoyed a bit of resurgence recently. Gregory Mankiw, Harvard professor and former head of the President’s Council of Economic Advisors, has even gone so far as to create the “Pigou Club”, which includes many notable economists, policy wonks and pundits. The Pigovian tax most often cited by Mankiw is a carbon tax. According to Mankiw, a carbon tax would be the best way to get people to use less fossil fuel, and that the cost could be offset by decreases in the payroll tax. This is an idea that most economists think will work.

So how is a tax on porn a Pigouvian tax? Representative Calderon claims that the tax will help address the “secondary effects” of the porno industry, including the spread of sexually transmitted diseases and crime associated with adult venues. However a more careful look at the evidence suggests that Calderon’s assertions about the porn industry are, well, overblown.

As far as the first claim goes, while STDs do count as a social ill and public health problem, a porn tax seems like a strange way to solve it. Making porn more expensive (and just in California) will not make porn stars more likely to use protection. If anything, the tax will raise the cost of production as well as sales, encouraging studios to film more exotic and risky behaviors. And for anyone who thinks that porn encourages unsafe sex among its viewers, perhaps funding more comprehensive sex education would be a better place to start.

More interesting is the claim about crime at adult venues. While Representative Calderon (true to form as a politician) offers no empirical evidence to back up this statement, researchers have looked into this issue and found mixed evidence. A study commissioned by the city of Los Angeles (cited in the link above) found adult venues to be associated with higher rates of prostitution, robbery, assault and theft in surrounding communities. However, a study conducted by researchers at Duke University, looking at areas with adult venues with comparable control areas without them, found no evidence of “secondary effects” associated with these businesses. Further, Dr. Daniel Linz of the University of California, Santa Barbara and Dr. Bryant Paul of Indiana University, have published several papers dismissing the “secondary effects” theory, and have questioned the methodologies of studies used by law-makers to push bans and zoning restrictions. Interestingly, while they have found evidence of increased crime associated with venues that serve alcohol, they actually found this effect to be higher at establishments that did not feature adult entertainment.

If we accept, however, the dubious notion that adult venues cause more crime in the surrounding areas, this implies that a Pigouvian tax should be levied on all venues for which such a relationship holds. According to recent research from the University of Denver, this includes sporting events. The study, which looks at criminal offense data from the host communities of college football games, suggests that games days induce, “sharp increases in assaults, vandalism, arrests for disorderly conduct, and arrests for alcohol-related offenses.” The authors further note that, “…upsets are associated with the largest increases in the number of expected offenses.” So not only should sports teams (and fans) pay a tax for going to a ball game, but teams that lose a lot should pay even more. This is bad news for Los Angeles Dodgers, San Diego Padres, and San Francisco Giants, all of which currently have losing records.

So why treat sports differently from porn when there is actually more substantial evidence of the former increasing crime? It is politically difficult (if not impossible) to attack a beloved institution in a state with 5 MLB teams, 3 NFL teams, 3 NHL teams, and 4 NBA teams (one of which is currently in the Finals), not to mention all the major college and high school teams littered throughout Pacific Coast.

But what about the most practical question: will the tax work? Daniel Hamermesh doesn’t think so. This tax would affect both the demand and supply sides of the market. If the demand for adult entertainment is inelastic (as Hamermesh suggests), then the tax wont affect consumption but will generate tax revenue. The supply side, however, is a different story. Businesses tend to move to the most favorable climates, when possible. A tax on Hollywood (completely infeasible politically), might not lead to the flight of studios to other states because there are a lot of fixed costs associated with the movie industry: large sets, studios, networks of writers and actors and other service staff. The adult entertainment industry, by contrast, is much more mobile. All you really need to make a movie is two busty blonds, a hotel room, a camera and a slew of battery operated devices. The likely effect of a tax will be the exodus of the porn industry from Southern California to Western Nevada, taking 40,000 jobs with it. This could only exacerbate the current budget woes.

Real Pigouvian taxes can and do work. However, cash-strapped legislatures have a strong incentive to use Pigouvian arguments to justify taxing a politically unpopular group, particularly ones with high silicone to body fat ratios. So beware of politicians bearing Pigouvian taxes; you might just get screwed in the end.