Schwarzenegger's 'fun tax' folly

» Discuss Article    (9 Comments)

Highly addictive "sin" products such as alcohol and tobacco have very low price elasticities (less than 1.0, with 0 being baseline). If the taxes on these "inelastic" products are raised, there is very little falloff in demand -- consumers just "gotta have" these goods. The net result is an increase in tax revenues, which is precisely why government officials typically favor sin taxes.

Highly discretionary products such as amusement park visits and sporting events, though, have very high price elasticities (much greater than 1.0). If taxes on these products are raised, there is a proportionally larger falloff in demand. In such cases, the paradoxical result is a drop in tax receipts.

So how might these economic principles apply to the governor's proposed fun tax?

Consider the likely effects on a resort such as Disneyland. According to a Disney fact sheet, the resort directly employs 20,000 people, indirectly employs an additional 41,800 people in the surrounding area, and accounts for almost one-third of the $7.3-billion tourism industry in Orange County.

Disneyland is also a prodigious tax-revenue generator. It contributes more than half of Anaheim's total annual tax revenues of almost $200 million. Disney visitors spend an additional $1 billion annually at nearby hotels, restaurants and retail stores, which generates another $81 million through various excise taxes, fees, licenses and sales tax.

Now here's the crucial point that has eluded the governor's tax analysts. All of these jobs, economic activity and tax revenues begin with ticket sales at Disneyland. If Schwarzenegger succeeds in slapping a large new ticket tax on this economic "seed corn," there will be a lot fewer Disneyland visitors precisely because resort demand is highly price elastic.

So what might be the possible effect of reduced Disneyland ticket sales on total tax revenues and jobs? Several calculations can help us think this through.

Disneyland hosts roughly 15 million visitors a year at an average daily ticket price of about $60. A new 6.5% fun tax on tickets would therefore yield $58.5 million in new direct revenues. However, that's before you take into account the reduction in demand from higher ticket prices.

If one very conservatively assumes a demand price elasticity of 1.0, whereby any percentage increase in price is met with an equal percentage drop in demand, a 6.5% increase in ticket prices would result in a reduction in ticket demand equal to about 1 million fewer visitors to Disneyland. So right off the bat, there would be about a $4-million reduction in tax revenues collected from the fun tax.

Now, let's also take into account the loss of significant indirect tax revenues from fewer occupied hotel beds, fewer restaurant meals, fewer souvenirs sold and so on. Consider, for example, just the loss in bed tax revenues. In Anaheim, tourists pony up 15% for the bed tax on an average daily hotel rate of $150. If the loss of 1 million visitors to Disneyland results in 250,000 fewer hotel rooms occupied for the year, that's another $5.6 million in forgone revenue.

More broadly, the Anaheim/ Orange County Visitor and Convention Bureau reports that visitors spend several hundred dollars a day above their hotel room and ticket expenses. Apply state and local tax rates to these expenditures, and you come up with millions more in the minus category.

This is still only half the story. Let's also consider how a loss in visitors to Disneyland would affect local employment. If just 1,000 of the more than 60,000 jobs generated by Disneyland were cut, and these "fun-tax casualties" collected unemployment compensation, state budget costs would rise by millions more.

In addition -- and this is what would likely finally push the government's fun tax into the revenue red -- the unemployed people would spend far less and in turn create even more unemployment, thereby generating far less in sales and income taxes.

But bottom line: Even if my very conservative scenario is off, and the fun tax ekes out a small gain in revenues, any benefit to the state budget will be more than offset by the recessionary damage done to the California economy.

That's why we don't need a fun tax, but rather a governor who handles this crisis a little bit more like Adam Smith and a lot less like Goofy.

Peter Navarro is a professor at the Paul Merage School of Business at UC Irvine, a CNBC contributor and the author of "The Coming China Wars."