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Benefit-cost analysis: government compensation vs. consumer tax model

  • Andrew Schmitz EMAIL logo , Dwayne J. Haynes and Troy G. Schmitz
Published/Copyright: October 28, 2013
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Journal of Benefit-Cost Analysis
From the journal Journal of Benefit-Cost Analysis Volume 4 Issue 3

Abstract

We provide a theoretical and empirical comparison of two historic production quota buyouts: the 2002 US Peanut Quota Buyout and the 2004 US Tobacco Quota Buyout. Producer compensation under the US Peanut Quota Buyout came from the treasury while the US Tobacco Buyout was paid for by a consumer tax (i.e., tobacco tax). Given these two buyouts, an important question arises: How does the method of compensation affect distribution and efficiency? Producers, consumers, and society favor a treasury buyout (TB) for several reasons. Producers are compensated considerably more under a TB, consumers are not burdened with the charge of funding the buyout, and society does not face additional efficiency losses due to the buyout.

Keywords: compensation; consumer tax; government buyout; quota values
Corresponding author: Andrew Schmitz, University of Florida – Food and Resource Economics, 1130A McCarty Hall, Gainesville, Florida 32611, USA, e-mail:
  1. 1

    The “consumer tax” in our model is a tax on cigarette manufacturers and therefore the impact of this tax on end consumers depends on the extent to which manufacturers pass the tax on to consumers.

  2. 2

    Data obtained through correspondence with Dr. E. L. Dohlman (peanut specialist, USDA/ERS). Professor Stan Fletcher (University of Georgia, highly regarded specialist who works on the economics of US peanut production and marketing) estimated the value of the quota to be in the neighborhood of $0.10 per pound.

  3. 3

    For the purpose of this article, “quota holders” and “producers” will be collectively referred to as “producers.”

  4. 4

    Schmitz and Schmitz (2011) show the true value of the quota exactly equals the gain to producers when the quota is implemented, plus the gain to producers when the quota is removed. However, this is not the case under a consumer tax buyout (Schmitz, Schmitz, & Haynes, 2012).

  5. 5

    Given a CTB, Period I refers to the period of compensation before competitive equilibrium is restored and Period II refers to the period when competitive equilibrium is restored (Schmitz et al., 2012). It is important to note that Period I may be comprised of one or more years, depending on the length and type of buyout. Additionally, the results presented in the following empirical section are net yearly estimates.

  6. 6

    As Schmitz and Schmitz (2010) did not account for the possibility of inflated quotas in their analysis of the US Peanut Quota Buyout, the assumption in this article’s analysis is that the true quota value was used as the basis for the buyout.

  7. 7

    This production value accounts for the change in stock size over the 5-year period.

  8. 8

    We present a true quota value of $0.30/lb. as an extreme case to show the possible effects of bidding up quota values through lobbying and other forms of rent-seeking behavior. The average true quota value (of Burley and Flue-cured tobacco) during the time of the buyout was likely around $0.53/lb.

  9. 9

    See Appendix for results under varying elasticities.

  10. 10

    These are yearly estimates for each period. Given the CTB, Period I is comprised of 10 years and Period II is comprised of only 1 year.

  11. 11

    This refers to net producer loss during the period immediately after the buyout (competitive equilibrium restored).

  12. 12

    These are also yearly estimates; however, given the TB case, competitive equilibrium is restored immediately upon removal of the quota, as opposed to in the last year of compensation as in the CTB case.

Appendix

This section shows the economic effect of varying the supply and demand elasticities in the above models. The first case uses a slightly more elastic demand curve (ED=–1.6 as opposed to ED=–1.1). This seemingly minor change has several implications on the economic results of both implementing and removing the tobacco quota. While the value of the quota does not change, producers, consumers, and society are affected differently by its implementation. More specifically, this increase in demand elasticity translated into a 41% lower net producer gain, 36% lower consumer loss, and 25% higher deadweight loss (Table A1).

Table A1

Economic gains and losses under quota implementation (ED=–1.6 and ES=0.87).

ComponentArea1999–2003 Average (US million dollars)
True value of quotap1p2ca251.8
Net producer gain[(p1p0da)–(dcb)]51.2
Consumer loss(p1p0ba)61.1
Deadweight loss(acb)10.0

Given a TB, the more elastic the demand, the higher the net producer gains and the lower the consumer gains from removing the quota [in both the true quota value and inflated quota value cases (Table A2)]. However, given a CTB, the more elastic the demand, the lower the Period I producer gain and the lower the Period I consumer loss from removing the quota (in the inflated case, as there is no net producer gain in the true quota value case). After competitive equilibrium is restored (Period II), the producer loss and the consumer gain are both lower under the more elastic demand (Table A3).

Table A2

Tobacco buyout (treasury funds) results: true quota value vs. inflated quota value (ED=–1.6 and ES=0.87).

True quota valueInflated quota value
ComponentAreaUS million dollarsComponentAreaUS million dollars
Government cost(p1p2ca)251.8Government cost(p3p2cf)839.4
Net producer gain(p0p2cb)200.6Net producer gain[(p0p2cb)+(p3p1af)]788.2
Consumer gain(p1p0ba)61.1Consumer gain(p1p0ba)61.1
Efficiency gain(acb)9.8Efficiency gain(acb)9.8
Table A3

Tobacco buyout (consumer funds) results: true quota value vs. inflated quota value (ED=–1.6 and ES=0.87).

True quota valueInflated quota value
ComponentAreaUS million dollarsComponentAreaUS million dollars
Tax value(p1p2ca)251.8Tax value683.4
Producer gain Period IN/A0Producer gain[(lp1jo)–(jnca)] 131.0
Producer loss Period II[–(p1p0da)+(dcb)]–51.2Producer loss Period II[–(lp0go)+(gnb)]–193.2
Consumer loss Period I(p1p0ba)–61.1Consumer loss Period I(lp1ao)–278.6
Consumer gain Period II(p1p0ba)61.1Consumer gain Period II(lp0bo)344.7

The second case uses a slightly more elastic supply curve (ES=0.98 as opposed to ES=0.7). Once again, the value of the quota does not change, but the impact on producers, consumers, and society does. In fact, the more elastic the supply curve, the higher the net producer gain, consumer loss, and deadweight loss from implementing the quota (these results as seen in Table A4 were higher than both the original case and the increased demand price elasticity case).

Table A4

Economic gains and losses under a tobacco quota implementation (ED=–1.1 and ES=0.98).

ComponentArea1999–2003 Average (US million dollars)
True value of quotap1p2ca251.8
Net producer gain[(p1p0da)–(dcb)]111.3
Consumer loss(p1p0ba)122.9
Deadweight loss(acb)12.0

Given a TB, the net producer gain was lower under this scenario of a more elastic supply curve while the consumer gains were higher (Table A5). Given a CTB, the more elastic the supply curve, the higher the net producer gain and the higher the consumer loss from removing the quota. After competitive equilibrium is restored, both the net producer loss and consumer gains were significantly higher than with the original elasticities (Table A6).

Table A5

Treasury buyout results: true quota value vs. inflated quota value.

True quota valueInflated quota value
ComponentAreaUS million dollarsComponentAreaUS million dollars
Government cost(p1p2ca)251.8Government cost(p3p2cf)839.4
Net producer gain(p0p2cb)140.5Net producer gain[(p0p2cb)+(p3p1af)]728.1
Consumer gain(p1p0ba)122.9Consumer gain(p1p0ba)122.9
Efficiency gain(acb)12.0Efficiency gain(acb)12.0
Table A6

Consumer tax buyout results: true quota value vs. inflated quota value.

True quota valueInflated quota value
ComponentAreaUS million dollarsComponentAreaUS million dollars
Tax value(p1p2ca)251.8Tax value(Imno)700.0
Producer gain Period IN/A0Producer gain Period I[(lp1jo)–(jnca)]229.1
Producer loss Period II[–(p1p0da)+(dcb)]−111.3Producer loss Period II[–(lp0go)+(gnb)]−341.5
Consumer loss Period I(p1p0ba)−122.9Consumer loss Period I(lp1ao)−322.2
Consumer gain Period II(p1p0ba) 122.9Consumer gain Period II(lp0bo)451.4

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Published Online: 2013-10-28
Published in Print: 2013-12-01

©2013 by Walter de Gruyter Berlin Boston

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https://doi.org/10.1515/jbca-2013-0010
Keywords for this article
compensation; consumer tax; government buyout; quota values

Articles in the same Issue

  1. Masthead
  2. Masthead
  4. A cost-benefit analysis of Tulsa’s IDA program
  5. Congressional modification of benefit-cost analysis as a vehicle for particularized benefits and a limitation on agency discretion: the case of the federal contract tower program
  6. Benefit-cost analysis of accelerated replacement of Hong Kong’s pre-Euro IV buses
  7. Accounting for systematic risk in benefit-cost analysis: a practical approach
  8. Benefit-cost analysis: government compensation vs. consumer tax model
  9. Comments
  10. The most appropriate discount rate
  11. The choice of the social discount rate and the opportunity cost of public funds
  12. Erratum
  13. Scitovsky reversals in benefit-cost analysis with normal goods
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