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Case study of Espresso Tax

Seattle is currently considering a 10-cent tax on espresso drinks to pay for pre-school and day-care programs. The legislation’s sponsor, Rep. Burbank, argues that people who spend $3-5 on exotic espresso based coffee drinks can afford – and will be “happy to pay” - an extra dime for kids.  But coffee shop owners have been fighting the tax.  Jeff Babcock, owner of Zoka Coffee, staged a rally in protest this month. He says “It’s not a luxury item as far as the culture here.  It’s a cold, wet, damp environment. Coffee’s big, and everyone loves their lattes.”  Zoka says most of his customers are liberal, and tend to support government spending, but that they oppose the Espresso tax. “They just think it’s a crazy tax,” he says.

The Seattle ballot measure (Prop 77) would not tax regular drip coffee, only espresso drinks. Proponents of the tax say it will raise “at least $6.5 million a year,” while a more conservative City Council estimate says annual revenue will likely top out at $3.5 million.

Use these facts in considering the following questions:
- The population of Seattle is 572,000
- Only half the people in Seattle drink any espresso drinks.  Among those who do, the average person drinks 230 espresso drinks per year.
- The average espresso drink costs $4.00
- Competition among coffee shops is so intense that the price of $4/drink covers only the cost of rent, labor, materials, and normal return on capital. As a result, no coffee shop is willing to sell espresso drinks unless they realize at least $4 in revenue / drink.  As a result, the tax will have the net effect of increasing the price of espresso drinks to $4.10.

Questions:

1. If the City Council’s revenue projection is accurate, what, to the nearest hundredth, is the value of the own price elasticity of demand for espresso drinks?  Show your work.

2. Assuming the Council’s $3.5 million revenue estimate is accurate; estimate the deadweight loss that would result from the imposition of the tax.  Show your work.

3. What is the ratio of the deadweight loss to the amount of revenue raised by the tax?

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