Cash for Clunkers, Price Gouging, and Tax Policy

August 21, 2009

The Daily Kos has a post accusing car dealers of taking advantage of the cash for clunkers program and gouging consumers:

I returned this last week to go ahead and close a deal on a Prius and learned that they had none in stock due to demand from the Cash For Clunkers program (Good news. Glad to hear the program is working and sending people to the dealer). But when I asked pricing, I was told that due to increased demand, dealers were adding on $1,500 to $3,500 to MSRP (Bad news! Dealer is converting program dollars to profits).

Faced with an increase in demand, dealers increase prices to avoid a shortage. It’s standard supply and demand taught in any intro econ course.

We often see these types of issues in tax policy due to the fact that our tax code is routinely used as a tool to encourage and discourage various behaviors. The government can subsidize and industry or activity, but it can’t mandate who benefits. Some examples: the mortgage interest deduction allows home owners to deduct their mortgage interest paid, but evidence and theory suggest that the subsidy leads to higher home prices and benefits sellers, high income buyers, and Realtors. State sales tax holidays eliminate the sales tax on certain goods for short periods of time, but evidence suggests that retailers could take advantage of the sales tax holiday frenzy by increasing prices before and during the sales tax holiday thereby capturing some of the benefit meant for consumers. Education subsidies flow at least partially to educational institutions in the form of increased tuition, reducing the benefit for students.

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