FAA shutdown proves business taxes aren’t always passed on to consumers

With Congress unable to agree on a bill to extend operations of the Federal Aviation Administration, the agency has been partially shut down since last Friday. Numerous construction projects were halted, nearly 4,000 federal workers have been furloughed, and $200 million a week in aviation taxes are not being collected.

The situation is another unfortunate example of how gridlock in Washington is imperiling economic recovery. Yet it also serves as a useful natural experiment– one that contradicts an argument commonly used by opponents of taxes and government regulation.

Whenever a new regulation or tax on business is proposed, opponents are quick to argue that the costs will be passed on to consumers, especially when the industry in question is politically unpopular. The hope is that even though voters aren’t sympathetic to, for example, big banks, they will oppose new regulation to protect their own pocketbooks.

The abrupt end of aviation taxes put this idea to the test. Yet rather than passing the savings on to consumers, airlines are raising fares to capture the surplus as profit.

From a business standpoint, this makes sense. Prices of any good on the market are influenced by several things: the cost of producing that good (which includes taxes), competition with other producers of the same or similar goods, and consumers’ willingness to pay. Within these constraints, businesses try to price goods at a level that maximizes profits.

Sometimes pressures from competition and the limits of demand will force businesses to reduce prices when costs go down, but, as we are seeing with the airlines, they would much rather capture as profit whatever customers are willing to pay. Conversely, when costs go up due to new taxes or regulation, the market adjusts dynamically so that, as Matthew Yglesias put it, “what actually happens is a mix of higher prices, lower profit margins, and reduced consumption.”

Well-designed regulations are important to protect public health and safety, and taxes are necessary to fund the public services and infrastructure that we all depend on. They have costs as well, and we can debate the appropriate balance.

However, we should be skeptical of industry representatives who claim any new costs imposed on their business will be fully borne by consumers. After all, if the costs could be passed on with no impact on their profits, why would they invest so much in lobbying against it?