Tuesday, February 16, 2010

Virginia's immaculate reductions

Washington Post editorial "Virginia's immaculate reductions" (February 17th, 2010) criticizes Virginia Governor Robert McDonnell for his failure to shrink the state's budget. McDonnell halted the selling of the state's liquor stores to private owners. The Post conjectures the reason is because of the money the stores bring in each year in revenue.

The governor said he would raise hundreds of millions of dollars to build roads by selling off state-run liquor stores. But at his urging, a bill in the legislature to do just that was killed last week. The probable reason? Profits from such liquor stores go directly into the state's coffers, to the tune of about $100 million a year.

This reasoning does not make sense to Corrections. If one holds a bond whose coupons yield $100 per year every year for ten years, then one is able to sell that bond for its net present value. There is little difference between cashing it out and holding it (if there were, then individuals would buy or sell it until no arbitrage was possible.

Similarly, the sale of the state's liquor stores should represent the net present value of the business's worth. Let us ignore any potential for increased efficiency when individual businesses take over, as it only helps Corrections's point. A possible objection to our statement might be "but what if the state is charging as a monopolist but in selling its businesses individually it creates a competitive industry that no longer has the monopolistic rents it previously did?" However, it is within the state's capacity to tax liquor stores until the deadweight loss, consumer surplus, and state revenue is exactly the same. This is depicted graphically below (click to enlarge). A government monopoly (left) can be the same as a taxed industry (right).

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