Transcript Chapter 11

Chapter 11
Taxation, Prices Efficiency, and
the Distribution of Income
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Lump-Sum Taxes
 A Lump-sum tax is a fixed tax that is owed
by everyone and is not subject to
something taxpayers can change.
 It is independent of income, consumption,
or wealth.
 An example is a Head Tax, which is
constant for everyone.
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Inefficiency in Taxation and the
Lump-Sum Tax
 Inefficiency in taxation results from the ability
to avoid taxes by avoiding a taxed activity.
 Because lump-sum taxes are unavoidable,
they serve as the benchmark by which other
taxes are measured.
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Price Distorting Taxes
 A price distorting tax is a tax that alters the
relative price of goods.
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Figure 11.1 A Price Distorting Tax Versus A LumpSum Tax
Expenditure on Other Goods
per Year (Dollars)
A
T
L
Y*
T
YT
Y1
E'
E
E''
U1
0
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U2
B'
L'
QT QL
Q1
Gasoline per Year (Gallons)
U3
B
Unit Taxes
 A unit tax adds to the price by a fixed
amount. Examples include the 32 cents
per pack of cigarettes and 24 cents per
gallon of gasoline in federal taxes.
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Tax Terms
 The Gross Price (PG) is the price paid
by consumers.
 The Net Price (PN) is the price received
by producers after the tax is paid.
 PN = PG – T
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Figure 11.2 Impact of A Unit Tax on Market Equilibrium
ST = MSC +$0.25
Price (Dollars)
S = MSC
Tax Revenue
1.15 = PG
1.00
0.90 = PN
C
Excess Burden
B
A
T = $0.25
DQ
0
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D = MSB
Q1Q*
Gasoline per Year (Gallons)
Excess Burden of a Unit Tax
DWL = 1/2TDQ
=1/2 ×T2 × (Q*/P*) × (ESED)/(ES – ED)
(A Step-by-step algebraic derivation is in the appendix to Chapter 11)
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Implication of the DWL
Calculation
 A doubling of the per unit tax
quadruples the Deadweight Loss.
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Figure 11.3 Excess Burden When Demand or Supply
is Perfectly Inelastic
A
Demand
Supply
after Tax
B
Supply
Price
Price
Supply
Demand
Net Price
after Tax
0
q
Quantity per Month
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0
q
Quantity per Month
Efficiency Loss Ratio of a Tax
 The Efficiency Loss Ratio is the
deadweight loss per dollar of revenue
raised DWL/R .
 Estimates of U.S. tax system place it
between 25 and 40 cents per dollar of
tax revenue raised.
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Incidence of a Tax
 The Legal Incidence is the burden of a tax
as determined by who is legally obligated to
pay the tax.
 The Economic Incidence is the burden of a
tax as determined by how much the parties
are affected in terms of paying higher
prices, or receiving lower prices.
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Shifting of Taxes
 Forward Shifting is the transfer of the
burden of the tax from the seller, who is
legally obligated to pay it, to the buyer.
 Backward Shifting is the transfer of the
burden of the tax from the buyer, who is
legally obligated to pay it, to the seller.
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Ad-Valorem Taxes
 Ad-Valorem Taxes add a fixed
percentage to the price of a good.
 The primary example is sales taxes.
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Incidence of an Ad-valorem tax
DWL = 1/2 TDQ
T = tPG
= 1/2 t2PG2(Q*/P*) × (ESED)/(ES – ED)
if t is very small, then this is
approximately
= 1/2 t2P*Q*(ESED)/(ES – ED)
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Using Excise Taxes on Alcohol
to Internalize Externalities
 Federal taxes on alcohol are per-unit
rather than ad-valorem.
 Externalities associated with alcohol are
estimated at $0.48 per ounce (of hard
liquor).
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Figure 11.4 Impact of an Ad Valorem Tax on Labor
Wages (Dollars)
Excess S
Burden
WG = 5.20
5.00
E
E'
WN = 4.16
Tax Revenue
D = Gross Wage
Net Wage = WG (I – t)
0
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Q1 Q*
Labor Hours per Year
Independence of Legal and
Economic Incidence
 It does not matter whether the buyer or
seller is legally liable for a tax.
 The economic incidence of the tax is
determined by supply and demand
elasticities, the amount of the tax, and
the original equilibrium price and
quantity.
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Figure 11.5 Incidence of a Tax Collected From Buyers
S = MSC
C
Price (Dollars)
PG + T =1.15
1.00
PG = 0.90
A
B
D = MSB
D' = MSB – T
0
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Q1Q*
Price per Year (Gallons)
Figure 11.6 The More Inelastic the Demand, the Greater the
Portion of a Tax Borne by Buyers
Price (Dollars)
S = MC + $0.25
C
1.20
1.15
1.00
.95
.90
S = MC
E
B
A
DQ’
D’
DQ’
0
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D
Q1 Q2 Q*
Gasoline per Year (Gallons)
Price (Cents)
Figure 11.7 Impact of a Tax on a Good with a Perfectly
Elastic Supply
E'
60
MC + T = S'
E
50
MC = S'
D
0
Q1
Q*
Housing per Month Square Feet
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Figure 11.8 Tax Incidence When Market Supply is
Perfectly Inelastic
Wages (Dollars)
S
E
W*G
tw*G
WN= W*G (1– t )
F
D=W
WN= WG (1– t)
0
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Q*
Labor Hours per Year
Shifting Under Imperfect
Competition
 Monopolists can shift less of a given tax
forward to consumers than can
competitive industry.
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Figure 11.9 Shifting Under Monopoly
Price
MC + T
PMT DPM
PM
P*T
DP*
P*
MC
D
DQM
DQ*
MR
QMT QM Q*T Q*
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Output per Year
General Equilibrium Analysis and
Shifting
 When one good is taxed and another good is
not taxed, the impact of the tax is not
confined to the taxed good.
 Because a tax on one good lowers the profit
that can be made to firms producing it, they
may shift their productive resources to the
other good so as to maximize their after-tax
rate-of-return in both markets.
 This has the effect of equalizing the after-tax
rate-of-return.
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Figure 11.10 Multimarket Analysis of Excess Burden
Price
A
B
E2
E1
PF(1 + t)
PF
A
DQF
S'
S
E2
PC(1 + t)
S'
E1
PC
B
DC
DQC
DF
QF2 QF1
0
QC2
QC1
Clothing per Year
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S
Figure 11.11 Multimarket Analysis Incidence
A
B
S' = MC + T
S
S
S'
Price
E2
PG
P*
PN
E1
P
P'F
E1
E2
D
0
Q' Q*
Clothing per Year
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D
0
QF Q'F
Food per Year
Government Taxes and Expenditures
and the Distribution of Income
 The Tax Incidence is who bears the burden of
a tax.
 The Expenditure Incidence is who receives
the benefits of a government program.
 The Budget Incidence is the net analysis of a
program’s tax and expenditure incidence.
 The Differential Tax Incidence is the change
in the tax incidence that results from
substituting one equal yield tax for another.
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The Lorenz Curve
 The Lorenz Curve maps the cumulative
percentage of households against their
cumulative percentage of income.
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Figure 11.12 A Lorenz Curve
Percentage of Real Income
100
E
Line of Equal Distribution
75
y
60
50
25
20
10
5
3
0
Area A
Area B
x
10 25
50
75
Percentage of Households
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D
100
The Gini Coefficient
 The Gini Coefficient is the ratio of the
area between the Lorenz curve and the
perfect equality line (Area A in the
previous slide) to the area under the
perfect equality line (Areas A and B).
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Effective Tax Rates for All
Federal Taxes, 1998
Income Category
(in quintiles)
Effective Tax
Rate (percent)
Lowest
4.5
Second
13.3
Third
18.9
Fourth
22.1
Highest
28.7
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