Diamonds are Forever - Elasticity

I'm posting a 14-part series of mini-essays on diamonds (but really about the economic point of view). Here's part 4.

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Elasticity 

You might think that cash-strapped governments could easily balance their budgets by taxing expensive items like diamonds. If you’re a progressive, you might even see an added benefit of soaking the rich, while avoiding taxes on the poor. Diamonds seemingly present themselves as an attractive source of funds to squeeze. 

Yet, this notion is flawed. 

In 1991, the Bush administration implemented a luxury tax on items like yachts and jewelry with the explicit aim of reducing the federal deficit. The tax lasted only two years before the Clinton administration repealed what had been an utter failure from the perspective of those implementing the tax.

The rich have innumerable options for spending their money. It’s easy for them to “escape” from taxed items. When the luxury tax increased the price of yachts and jewelry, the rich fled these assets and put their money elsewhere (real estate, stocks, etc…). The demand for yachts/diamonds is highly elastic—sensitive to price changes—as opposed to (say) the demand for cigarettes. 

The demand for the taxed luxury items was so elastic that the tax worsened the government’s budgetary position. In fact, the drop-off in yacht sales was so steep that the industry contracted severely and many ship-building construction workers lost their jobs. The government paid out more in unemployment benefits than it collected in taxes. 

The deficit grew larger.