Postage stamps effectively tax millions of Americans each day. People are often unaware of the kind of taxes hidden in stamps. The economic landscape looks very different when one can see these taxes, which economists refer to as taxation through regulation or cross-subsidization.
The U.S. Postal Service (USPS) is an independent agency of the Federal government and receives modest funding annually from Congress. But this is not the tax hidden in the price of stamps. The tax involves charging the same $0.49 first class postage for letters sent across town or across country.
In a market, competition ensures that prices reflect costs. If mail were delivered by a competitive market, the lower cost of cross-town letters would yield a lower price. Let’s say that the market prices of cross-town and cross-country postage would be $0.30 and $0.70. Then the USPS charging $0.49 for all letters is economically equivalent to taxing cross-town letters and subsidizing long-distance letters.
Professor Richard Posner of the University of Chicago first spelled out how prices can be used to tax one group of consumers to subsidize another. Cross-subsidization requires government control over prices, either directly, as with the USPS, or indirectly via regulation, as with insurance and banking, or trucking, railroads and airlines until the late 1970s.
Cross-subsidization must overcome two challenges. First, the high prices cannot get undercut. The USPS could not continue to charge $0.49 for cross-town mail delivery if rivals could undercut the USPS’s price, steal customers away, and still make a profit due to the low cost. The USPS’s monopoly on first class mail delivery protects the high price against competition. In trucking and airline regulation, government regulators decided which carriers could serve each route.
Second, consumers must purchase the over-priced service. The availability of competitively priced alternatives threatens cross-subsidization. The Interstate Commerce Commission, for example, started regulating railroads, but had to extend this regulation when trucks began hauling over-priced freight. Government can also require purchase of over-priced products, as with auto insurance, and health insurance under the Affordable Care Act.
For politicians, cross-subsidization is wonderful. Consumers are often totally unaware of the taxes hidden in prices. And politicians can deny that they are taxing or subsidizing anyone, since no money goes through the public treasury. Artificially high prices allow the regulated firm to make up losses incurred serving some customers at less than cost. Thus regulated firms do not need government funds and may not oppose the system.
Postage stamps also illustrate the most common form of cross-subsidization, namely having low cost customers subsidize high cost of service customers. Equalizing prices for different customers, as with first class mail, often seems fair to people. Low cost customers may not realize that they are paying too much, and high cost customers can be reminded of their good deal.
Insurance regulation frequently cross-subsidizes high cost customers. The Affordable Care Act makes healthy young people buy over-priced coverage to lower premiums for persons with preexisting medical conditions. Property insurance in hurricane-prone states typically subsidizes high risk coastal properties. Coastal properties do pay higher premiums, but the rates are lower than justified based on the likelihood of loss.
Defined benefit public employee pension plans also typically involve cross-subsidization. Here short-term employees subsidize employees who eventually retire through the system. Unfavorable rules for refunds of contributions for employees who leave before retiring help pay for generous benefits for retirees. Short-term employees would be better off under portable defined contribution plans. Benefitting lifelong state residents and employees at the expense of short-term state residents proves to be a popular policy for politicians.
Tax day is approaching, and this annual ritual of filing a return raises awareness of and helps generate political pressure against raising income taxes. By contrast, government manipulation of prices effectively and secretly taxes some and subsidizes others. But if you look carefully, you can see the taxes hidden in postage stamps and other prices.
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Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.