In some of my coverage of the suspension of airline excise taxes I explained why no one should have been surprised that most airlines raised their fares to offset tax savings during the time that the FAA lacked re-authorization (and thus the authority to collect these taxes).
I tried to give a simple explanation of ‘tax incidence’ which some commenters found useful, but the majority of writing on the topic was filled with outrage that the airlines would pocket the money rather than passing on the savings to consumers.
I wasn’t outraged because I wasn’t surprised, and because this is exactly what the economics would have predicted would happen.
Matt Mitchell from the Mercatus Center put together a short video illustrating the economics, that when supply is inelastic, producers bear the primary burden of a tax.
Certainly in the short-run, supply of seats is inelastic (due to landing constraints, gate constraints, limited number of planes or at least time that it takes to pull more out of the desert, etc). Thus airlines were the ones paying the tax in the first place, with the tax removed they stopped doing so. And since consumers were already paying a price they were willing to pay at a certain supply of air travel, there’s no reason why we’d have expected price to fall.
In the end, Congress said that the tax was actually retroactive, so there are no tax refunds for folks who bought their tickets before taxing authority expired and who traveled during the time the FAA lacked re-authorization. The government gets that money, not the airlines as many suspected. But the airlines certainly did benefit from a week of ticket sales in which they weren’t paying the 7.5% excise tax (though of course they still pay income taxes, payroll taxes, etc).
After the 8-5-11 deal was announced for the reinstatement of the FAA tax, I noticed fares jumped all over the place. They were the same on Saturday, but then they rose by 15 percent on Monday, came down 5 percent on Tuesday, and are marginally more than before the tax expired.
@chitownflyer they were the same on saturday because the tax didn’t actually go back into effect until 12:01am Monday. When came online fares (actual, final price to consumers) immediately jumped by the amount of the tax. Then airlines adjusted fares, and remember this only happens at 3 distinct times each day,
“And since consumers were already paying a price they were willing to pay at a certain supply of air travel, there’s no reason why we’d have expected price to fall.”
This isn’t actually true. What matters here is not the price that consumers “were willing to pay”, but the fact that there is competition among the airlines. Here’s a simple example: airlines A and B fly the route XXX-YYY. Before the FAA fiasco they were receiving net revenue $100 per ticket and the consumers were paying $107.5 per ticket. At $100 A and B probably were probably making at least some profit (including from indirect sources), or else they would’ve quit. So when the taxes disappeared if A and B both upped prices to $107.5, they would split the total number of travellers in some proportion. But not if B undercut A to $105. Presumably then B would get a much higher proportion of the tickets being bought, so the lower revenue per ticket could be offset by the much higher number of tickets sold. So it may very well be profitable for B to undercut A, and similarly for A to undercut B. And this could bring back the price all the way to $100, at which point we know the airlines are still making some profits, as before.
* TL;DR: Airlines do not price seats naively. The simple supply and demand picture does not apply here. *
It is more surprising that the airlines were effectively able to collude to absorb the entire tax reduction. What’s not surprising is that there were such “undercutters” who publicly committed to pass the savings on to the consumers.
Supply is fixed in the short run and airlines were already filling their planes at a higher price. That’s why airlines weren’t lowering price. No collusion necessary.
The point I made wasn’t mainly about collusion. It was just that airlines aren’t price takers, or naive. They price strategically.
Which means the supply and demand pictures have no meaning here.
The rest (e.g. whether domestic US flights are full) is a matter of fact, so I can’t debate it..
@Emil Your claim that “the supply and demand pictures have no meaning here” simply has no basis in fact. Sorry!
Will this all happen again when the temporary extension expires on 9/16? I’ll bet Congress is quicker to action this time but it would seem this is headed for more congressional debate…