The Government Version of Price Discrimination

Local governments often dig themselves into a deep hole. Tax rates need to be high enough to cover overall spending, some of which is impossible to cut. Pensions and other long term liabilities are often a big piece of that. A city can't simply decide not to pay pensions, because those are contractual obligations. The problem is that tax rates that are high enough to pay for spending are so high they deter new businesses from entering. So local governments often offer special tax breaks and other incentives to specific businesses to entice them. They couldn't simply offer everyone the same deal, because they'd go broke. (Broke-er?) But it's still a winning move to give a specific new business a lower tax rate. It's a good idea for such a city to charge different tax rates to different businesses, depending on their willingness to incorporate elsewhere.

It struck me that this looks a lot like the common practice of "price discrimination," which is economists' horrible term for charging different prices for the same product or service based on the buyer's willingness to pay. It's a perfectly defensible practice, even though people get morally indignant about the possibility that they might not get the absolute lowest possible price. Actually, even people paying the high price benefit (generally) from price discrimination. The price discriminating company can attract more customers by offering different prices to different customers, which allows them to spread fixed costs across a larger portfolio of customers. That allows overall prices to be lower than otherwise. Price discrimination is common when there are high fixed costs. It might cost you, say, $10 on average to serve all of your customers, naively dividing total expenses by total customers. But in many cases the marginal cost of servicing one additional customer is lower than the average cost. Maybe you're a restaurant with excess capacity near the end of the lunch hour, and you'll have to throw out a bunch of prepared items if they don't get sold. You might be willing to offer some kind of discount on the fly. Or maybe you're a doctor serving both wealth and indigent populations, and you know your less wealthy patients will simply do without medicine if you don't offer them a low price. It can be much more subtle than these examples.

I should be clear here. I don't think local governments are engaging in clever, well-planned strategies to maximize their revenues. I think they're locked in place by fiscal profligacy, because previous generations of politicians made irresponsible promises to their constituents. Still, there's a superficial resemblance here, so I thought I'd remark on it.