Tax it out of existence

I was thinking about scotch the other day. My brother recently got married and during the reception my brother came by our table and mentioned to my father and my uncle that the open bar was offering a single malt scotch. My father and uncle seemed to be very much into this beverage, given the rapidity with which they made their way to the bar. If two of my kindred are heading in a direction quickly, as a middle child, I find it hard not to follow. I'm not much of a drinker, enjoying the occasional beer, but I decided in the sprit of the event I would imbibe this spirit along side my father and uncle. That's what the scotch ads tell me to do, in any regard. The bartender immediately handed them a glass with scotch poured over top ice cubes. “Scotch on the rocks” might be the term. My father and uncle were aghast and they requested their scotch with only a bit of water. Since I had no experience with scotch, this scotch-on-the-rocks offering couldn't have offended me so I volunteered to take that glass and not let it go to waste.

I guess scotch is an acquired taste because it tasted to me like my bike chain. I imagine the taste could grow on you, as beer and kimchi have grown on me over the yahrens. I'll give scotch another try, I suppose. I did promise to let Brett (your friendly Long Run Blog poobah) buy me a scotch when I see him at TAM 8. Actually, come to think of it I didn't make that promise directly to Brett yet and this may be the first he's heard of it. Oh well, it's on the table. Can't un-ring a bell.

A couple weeks after the wedding I got onto wikipedia to research this scotch ritual thingy I had witnessed at the wedding. Why were they excited about a single malt scotch? Two scoops of different ice cream is better than one scoop, so why wouldn't two or more malts be better? Why were they so horrified at scotch on the rocks? Why did they only take it with some water? Why a big suit? Where do the odd movements come from? Why a movie?

In my research, I noticed most scotches (scotchen?) are aged for no less than 12 years. That's a pretty long time to wait for a drink. And a pretty long time for an investment to pay off. It occurred to me this was an interesting barrier to entry. It might be terribly hard to start your own scotch plant if you go to investors and tell them they'll have to wait 12 years before you start selling a drop.

A barrier to entry, as I'm sure most readers of this blog know, is something that prevents potential rivals from starting their own company, selling a similar product, and snatching market share. My scotch research got me thinking about other products with a high barrier to entry.

I used to work for a Canadian tax software company. We were used by all the Big Six accounting firms (I think there are less now) for personal and corporate tax preparation. A couple of our competitors got us hauled up before the Candian courts for monopolistic behavior. It seemed obvious that one tax software company that had such a lock on the major public accounting firms was probably keeping their market using unfair trade practices. The truth is our company was one of the first companies to create a tax software program back in the 1980s. It's reasonably easy to create a program that will handle basic taxes but the really tricky stuff needs some pretty smart chartered accountants. It costs a lot to hire them. Since we were the first on the market, we could slowly add new forms and new calcs to do the tricky stuff, stuff maybe only a few hundred Canadians really needed. The chartered accountants who worked for us all year around needed something to do during the summer, after all. (Well, technically tax season ended before hockey playoffs so they could wile away late spring wagering on hockey.) So the barrier was if you wanted to release a tax software package de novo that did all the hard tricky stuff, the stuff the major accounting firms really needed, it would be pretty costly. For example, the really tricky stuff we might have done in 1992 dollars and at 1992 salary levels. A new company would have to pay accountants in 2009 dollars and at 2009 salary levels.

A classic barrier to entry they teach you in Economics 101 is the one used by the cigarette industry. In Canada, for example, there are only about three major tobacco retailers: Imperial Tobacco, Rothmans, and RJR – Macdonald. But you almost never hear these companies by name (except when they're being sued). You do, however, know all their brands. Each company markets 8-12 different brands. Smokers tend to be brand loyal. New smokers tend to (cancer) stick with the first brand they get hooked on. A certain percentage of smokers become dissatisfied and switch to another brand. If each tobacco company only had one brand and you started your own, you could capture a decent enough number of new smokers and brand switchers just by being on the shelf. However, if you're one out of 18 different brands you're not going to get many smokers randomly and you have to work very very hard to over come the established brand images.

Thinking about cigarettes then reminded me of how much tax we pay on cigarettes (as well as booze) in Canada. It was customary in Canada to simply raise the tax on smokes or a two-four of beer anytime the government needed additional funds.

This seemed to work well until smokers noticed just south of the border cigarettes were quite a bit cheaper. Now few Canadians -- even smokers -- are willing to lay aside fears of the mass violent and merciless handgun thrill kill slaughter that awaits them the minute they cross the border into Vermont. But many were happy to let entrepreneurial sorts slip across the cold dark surface of Lake Ontario, load a speedboat full of cigarettes, and then slip back into Canada under the cover of darkness. Many were then happy to purchase these considerably cheaper cigarettes at a price that was considerably higher than the US price but amazingly lower than the Canadian price.

[caption id="attachment_1177" align="aligncenter" width="200" caption="Canadians think all Americans look exactly like this"][/caption]

Other people noticed this was a lucrative business and started making their own trips across the lake at night. Sometimes these new comers and the veteran smugglers would get into friendly disagreements about who could sell their smuggled smokes at what street corner or outside of what school yard. To settle matters, they would pull out guns and start shooting each other in a mass violent and merciless handgun thrill kill slaughtering way.

Some other entrepreneurs realized they could cut out the middle man (by "middle man" I mean trips across a cold lake in December) and simply steal cigarettes on the Canadian side of the border from the friendly 7-11 guy.

The Canadian government admitted, grudgingly, that you couldn't indefinitely keep raising tax on smokes. In concert with provincial governments, the federal government lowered tax on cigarettes.

Now there is a notion in the “war on drugs” that says you should legalize drugs. I'm all for that. I don't do drugs, contrary to appearances, and I've never taken drugs in my life (illegal ones, I mean, like mary jane, roofies, poppers, speed, sandra bullock, etc.). But I think people are always going to find a way to fork up their brain and it's their right to fork themselves up, so, quit with the laws already. Some in the USA believe you should legalize drugs and then “tax it out of existence”. And in a very long winded way I'd like to suggest that experiment has been done in Canada already with the cigarette vice. Many drugs are pretty easy to grow or make at home. If you tax a vice too high, that's nearly the same as making it illegal. You make it nearly as lucrative for crime to get back into the business.

-- Karl Mamer