Thoma and Taxes

This post is a response to Mark Thoma’s article in the Financial Times yesterday, found here.

In his article, Thoma suggests that a Pigovian tax should be imposed on the financial industry to correct for the negative externality it generates (the negative externality being too much risk).

Two questions come to mind after reading Thoma’s article.

Will this tax decrease the amount of risk in the financial industry? My gut reaction is that a tax will not change the fact that many people in the financial sector are risk-takers. Taxing the bad behavior of Wall Street will not change the composition of its workers, who will continue to take speculative risks. In fact, if the tax is too high—and it would be if banks had to pay $6-$14 trillion as Thoma suggests—volatility of financial markets could increase if firms fight fire with fire and increase their risks given the higher taxes. Historical evidence (pdf) suggests that high financial transaction taxes is associated with higher risk taking and increased volatility.

Will this tax help the people it is intended to help? Given higher taxes, financial firms might increase their rates or the fees they charge to their customers. Long-term investments (such as buying a house) usually have a high price elasticity of demand, so imposing a tax on financial firms could lead to poor outcomes for the people Thoma claims the tax should help: those in the middle-class who were hurt in the Great Recession.

small percent changes in mortgages lead to large percent changes in number of houses bought (demand elastic)
Demand for houses is elastic

The fact that people tend to wait until the “market is right” to buy a house implies that a small percentage increase in price of mortgages will lead to a large percentage decrease in the amount of homes purchased. This might be a bad thing if a place thinks people ought to buy homes instead of rent them.

I agree with Thoma that mitigating risk in the financial sector is important and that Wall Street should be held more accountable for what happened in the lead-up to the financial crisis, but an FTT is probably not the best way to achieve this goal.

Apple’s Music Factory

Last week, Apple released their new music app, aptly named Apple Music.

The iTunes music store opened in 2003 and has sold more than 25 billion songs since then. iTunes changed the way that music was sold in 2003, but in 2015 it is mostly playing catch-up. The new Apple Music is similar to existing music streaming services such as Spotify, and its radio service iTunes released in 2013 is identical to Pandora.

It seems that there’s always a doomsayer who warns of a coming tech bubble return the economy to reality. These doomsayers claim that Snapchat is overvalued, Instagram is not worth a billion dollars, Twitter can’t make a profit, etc. Streaming services such as Pandora and Spotify rely solely on subscriptions and advertisements for revenue. iTunes also requires a subscription ($10 for a single license and $15 for a family license) and its radio service similarly plays ads.

Apple Music is different than these other music streaming services in one key respect: it has a way to generate profits. Apple makes money through selling phone and macs, and it seems that this new service is a marketing strategy to lure more people over from the Android and MS Windows market. The revenues Apple earns from its music subscription service are only needed to cover the costs of the streaming services, such as paying the artists and record labels. Other services, such as Pandora and Spotify, must find ways to generate profit without selling hardware, which is fairly difficult.

Apple’s move to subscription-based music is interesting to me for a couple reasons.

The first reason is that iTunes has maneuvered around its main problem to this point: charging a (relatively high) amount of money for files people can receive (steal) online for free. I feel guilty whenever I pirate music illegally, but I don’t like dishing out ten bucks for an album when I want to build my music collection. iTunes operates within the monopolist model–it charges much higher for its music than the marginal cost of distributing it, and by doing so, many people might purchase its music cannot afford to do so. Young people often wisen up to this fact and resort to stealing music online. Artists ought to be compensated for their work, and iTunes causes a significant amount of dead-weight loss right now through its sorta monopoly on digital music. Will pirating go out of fashion? Probably not, but Apple Music will probably lower the number of illegal downloads.

The second reason I find Apple Music interesting is that direction music is moving seems to be the opposite from videogames, another industry with very low marginal costs to distribute its goods. Both music and videogames have moved fully into the digital marketplace. However, the most popular videogames right now (League of Legends, DOTA 2, and Hearthstone) are all free-to-play, and make money from selling characters or cosmetic items that impatient players can buy with real-money instead of the in-game currency. Blizzard, the developer of Hearthstone, recently released “character portraits” for Hearthstone, which means that it is charging $10 for a purely cosmetic detail (players protested pretty loudly at this announcement). I am very confused why people can justify buying a character portrait for $10 but balk at the idea of buying a Kanye album for the same price. The free-to-play model seems to have taken over the videogame industry, while music is moving towards a subscription model. I wonder if this trend will continue.

Anyway, Apple Music is really cool. If you haven’t updated your iPhone to the latest OS I would recommend doing so and signing up for the free 3 month trial. If you’re looking for new music, check out Vince Staples’ new album: Summertime ’06. It’s a really good album.