Transcript Taxes and equity

Taxes, Efficiency
and Equity
What is the impact of taxes?



On market equilibriums?
On efficiency?
On distribution? (i.e. who pays them?)
Economic Burden


The reduction in total economic surplus
that results from the adoption of a policy
Also known as ‘deadweight loss’
Review of economic surplus: the market for
potatoes
6
S
Consumer surplus
Economic surplus =
consumer surplus +
producers surplus
Price ($/pound)
5
4
3
Producer surplus
2
1
D
1
2
3
4
5
Quantity (millions of pounds/month)
The Effect of a Tax on the
Equilibrium Quantity and Price of Potatoes
Without a tax P = $3/lb
and Q = 3 million lbs/month
S + tax
S
6
Price ($/pound)
5
With a tax of $1/lb
• MC increases by $1/lb
• Supply shifts up by $1
• P = $3.50; Q = 2.5 million
• Consumers and producers share
the burden of the tax equally
• Producers receive $2.50/lb
• Consumers pay $3.50/lb
4
3.50
3
2.50
2
1
D
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
The Market for Potatoes Without Taxes
6
5
Price ($/pound)
S
Total economic
surplus = $9
million/month
How a tax collected for
a seller affects
economic surplus
4
3
2
1
D
1
2
3
4
5
Quantity (millions of pounds/month)
The Deadweight Loss Caused by a Tax
S + tax
S
6
Price ($/pound)
5
4
Deadweight loss
caused by tax
3.50
3
2.50
NOTE: An ad valorem
tax would rotate the
supply curve upwards
2
1
D
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
Taxes and Efficiency

How would you determine the impact of a
tax on efficiency?
Review of elasticity

Elasticity



What is the elasticity of demand for food?
What is the elasticity of supply for milk?




A measure of the extent to which quantity demanded and
quantity supplied respond to variations in price, income, and
other factors.
Short run vs. long run
What is the elasticity of demand for tropical
vacations?
For Exxon gasoline?
What is the elasticity of supply for land?
Elasticity of Demand and
the Deadweight Loss from a Tax
Deadweight loss
Deadweight loss
2.40
2.00
S+T
2.60
S
1.40
D1
Price ($/unit)
Price ($/unit)
S+T
S
2.00
1.60
D2
19 24
Quantity (units/day)
21 24
Quantity (units/day)
The greater the elasticity of demand, the
greater the deadweight loss from a tax
BUT…

The less elastic the demand, the greater
share of the tax paid by the consumer.
How effective are cigarette taxes at
reducing smoking?
 How effective are cigarette taxes for
earning revenue?
 What are the distributional implications of
taxes on necessities?

Differential taxes on inputs



E.g. tax on labor vs. tax on capital
Makes labor more expensive, capital is
used as substitute
What happens if we tax capital?

The problem of capital flight
Income tax and efficiency


Income taxes theoretically change our
consumption of work and leisure
Theoretically produce an excess burden
Taxes, Externalities and Efficiency


Externalities are a cost imposed on
society by producers
Efficiency requires that
producers/consumers pay the full cost
of production/consumption
Externalities in the Potato market:
pesticide applications
MC + MEC
6
S=
MC
Price ($/pound)
5
4
3
2
1
D
1
2
3
4
5
Quantity (pounds/acre/year)
Externalities in the Potato market:
pesticide applications
S+Tax
6
S=
MC
Price ($/pound)
5
4
3
2
1
D
1
2
3
4
5
Quantity (millions of pounds/month)
Double-dividend

Taxes on negative externalities are
efficient
Pollution
 Loss of ecosystem services from resource
depletion


Tax bads and use revenue to reduce
inefficient taxes on goods
Land Taxes and efficiency
What is the elasticity of supply for land?
How do property taxes currently
work?


Tax on combined value of buildings and
land.
What is the impact on economic
efficiency and distribution?
Demand for Land



What makes land valuable?
Price is determined by demand
What determines demand?
Basic needs
 Factor of production
 Speculation


Rent is major expenditure for poor
Supply and demand of buildings
P
S1
CS
p1
PS
D
q1
Q
TAX ON BUILDINGS - production cost
S2
P
S1
CS
p2
p1
Deadweight
loss
PS
tax
tax
D
q2
q1
Q
What happens to rent when the supply of buildings shifts?
TAX ON LAND - no production cost
S
P
“Buy land, they ain’t
making any more.”
-Will Rogers
P*
P1
tax
tax?
tax
D
Q*
Q1
Q
What’s the deadweight loss? What’s the impact on speculation?
Impact of shift in land tax

Reduces speculative demand



Increases supply of buildings on most
valuable land



Where is the most valuable land?
Rents fall
Reduces urban sprawl


Land prices fall
Capitalization theory
Bank of America Study
No deadweight loss
Subsidies



Same basic concept as a tax
Distort production incentives
Must be paid for, so a subsidy in one
place implies a tax in another
What do you think?

What are the efficiency implications of federal
subsidies for logging, mining, grazing and oil
extraction?




Requires higher taxes elsewhere, and increases
negative externalities
Are natural resources capital assets?
What would be the impact on output of a tax
on excess profits (i.e. profits above and
beyond a fair return to the factors of
production, also known as economic rent?)
Why aren’t taxes being shifted to economic
rent?
Taxes and equity


Who Pays a Tax?
Tax incidence

Statutory incidence
 Who

is legally responsible for paying?
Economic incidence
 Who
actually pays?
Tax on producers
S + tax
S
6
Price ($/pound)
5
4
Deadweight loss
caused by tax
3.50
3
2.50
2
1
D
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
A tax on consumers
S
6
Price ($/pound)
5
4
Deadweight loss
3.5
3
2.5
2
D
1
It makes no difference
if tax is placed on
producers or
consumers
D after tax
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
Taxes and equity

Who Pays a Tax?
The more inelastic the demand, the more
the consumer pays
 The more elastic the supply, the more the
consumer pays
 When supply is perfectly inelastic, the tax
falls entirely on the producer

Elasticity of Demand and
the Deadweight Loss from a Tax
Deadweight loss
Deadweight loss
2.40
2.00
S+T
2.60
S
1.40
D1
Price ($/unit)
Price ($/unit)
S+T
S
2.00
1.60
D2
19 24
Quantity (units/day)
21 24
Quantity (units/day)
The lower the elasticity of demand, the greater the share of a tax
paid by the consumer
What do you think?



Who pays the social security tax,
employees or employers?
If the demand for food is inelastic, why
is it not taxed in most states?
What would be the impact of a gasoline
tax on gasoline on equity?
Tax progressivity

What is progressivity?




Are sales taxes progressive?
Is the US income tax progressive?



Higher marginal taxes?
Paying for more than what you get?
"Society is responsible for a very significant
percentage of what I've earned," Warren Buffet
It takes a village to raise a millionaire
What can be said for and against progressive
taxes?
Taxes and stability


High taxes slow down economic growth
Stabilization policy
Lower taxes when economy is bad
 Increase taxes when economy is good
