Transcript Chapter 6 Taxes Powerpoint

Chapter 6
Taxation & Government Intervention
Adjust for Undesired Market
Results

A progressive tax is one whose rates
increase as a person's income
increases.


Canadian income tax is an example.
A regressive tax is one whose effect
decreases as income rises.

Canadian sales tax is an example.
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Results

A proportional tax is one whose rates
are constant at all income levels,
regardless of the taxpayer's total annual
income.
Adjust for Undesired Market
Results

Demerit goods and activities are those
considered to be bad for a person,
although one may like them.

Addictive drugs are a demerit good; using
addictive drugs is a demerit activity.
Adjust for Undesired Market
Results

Merit goods and activities are things
believed to be good for a person, although
one may not engage in them.

Motorcycle helmets are a merit good; using
helmets while driving a motorcycle is a merit
activity.
Market Failures and Government
Failures

Market failures are reasons for
government intervention.

Market failures are situations where the
market does not lead to a desired result.
Market Failures and Government
Failures

Government intervention, however, need
not improve the outcome.

Government failures are situations
where the government intervenes and
makes the situation worse.
Costs of Taxation

The costs of taxation include:
The direct cost of the revenue paid to
government
 The loss of consumer and producer surplus
caused by the tax
 The administrative costs of collecting the
tax.

Costs of Taxation

The welfare loss triangle – a geometric
representation of the welfare loss in
terms of misallocated resources caused
by a deviation from a supply-demand
equilibrium.
Costs of Taxation
Consumer
surplus
Price
S1
S0
A
P1
P0
P1–t
B
D
tax
C
E
Deadweight
loss
F
Producer
surplus
Q1
Demand
Q0
Quantity
Benefit Principle

The benefit principle states that the
individuals who receive the benefit of the
good or service should pay the cost
(opportunity cost) of the resources used
to produce the good.

Examples are gasoline taxes and airport
taxes, both paid by travelers.
Ability-to-Pay Principle

The ability-to-pay principle –individuals
who are most able to bear the burden of
the tax should pay the tax.

The best example of this is a progressive
tax, such as the Canadian income tax.
Applying the Principles of
Taxation
Burden Depends on Relative
Elasticity

The person who physically pays the tax
is not necessarily the person who bears
the burden of the tax.

The burden of the tax depends on
relative elasticity.

The burden of the tax is rarely shared
equally since elasticities are rarely equal.
Who Bears the Burden of a Tax?
Demand is inelastic.
Price of luxury boats
S1
$70,000
Consumer pays
60,000
50,000
Supplier pays
40,000
30,000
20,000
10,000
200
400
tax
S0
Demand
590
600 Quantity of luxury boats
Who Bears the Burden of a Tax?
Inelastic Demand and Incentives
to Restrict Supply

When demand is inelastic, producers
have incentives to lobby the government
to restrict supply.

Farming is a good example.

Advances in productivity increase supply
but they result in lower prices.
Long-Run Problems of Price
Controls

In the long run, supply and demand tend
to be much more elastic than in the short
run.

Therefore, price controls will cause large
shortages or surpluses in the long run.
Long-Run and Short-Run Effects
of Price Controls
Price
Short run
supply
P1
P2
P0
Long run
supply
Price ceiling
D1
D0
Q0 Q1
Q2
Q3
Shortage
Quantity