Transcript Taxation and Income Distribution

Chapter 12:
Taxation and
Income Distribution
Econ 330: Public Finance
Dr. Reyadh Faras
Dr. Reyadh Faras
1
Taxation and Income Distribution
Tax Incidence
 Statutory Incidence: who is legally responsible for
paying the tax.
 Economic Incidence: the change in the distribution of
private real income induced by a tax.
 Size Distribution of Income: how taxes affect the way
in which total income is distributed among people.
Dr. Reyadh Faras
2
Sources and Uses Should be Considered
 For example, a sales tax not only reduces demand but
also reduces incomes received by factors of production.
 Both producers and consumers are affected, but the
overall incidence depends on how both sources and
uses of income are affected.
 In practice, economists ignore effects on sources
(inputs) when considering a tax on a commodity and
ignore uses (consumers) when considering a tax on an
input.
Dr. Reyadh Faras
3
Incidence Depends on How Prices are Determined
 Determining who bears the burden of the tax depends
on how the tax changes prices.
 An important determinant is time; because price
changes take time.
 In most cases, responses are larger in the long run
than the short run, implying that the tax incidence may
differ according to time.
Dr. Reyadh Faras
4
Incidence Depends on the Disposition of Tax Revenues
 Balanced Budget Incidence: Computes the combined
effects of levying taxes and government spending
financed by those taxes.
 In general, the distributional effect of a tax depends
on how the government spends the money.
 Tax revenues are usually not assigned for particular
expenditures.
 Differential tax incidence: Examines how incidence
differs when one tax is replaced with another, holding
the government budget constant.
 Because DTI looks at changes in taxes, a hypothetical
reference tax system is used in comparison between
different taxes.
Dr. Reyadh Faras
5
Lump Sum Tax: A tax which does not depend upon
individual’s behavior.
Absolute Tax Incidence: Examines the effects of a tax
when there is no change in either; other taxes or
government expenditure.
Measuring Progressiveness of Taxes
Average Tax Rate: the ratio of tax liability to income.
Proportional: average tax rate is constant regardless of
income level.
Progressive: average tax rate increases with income.
Regressive: average tax rate falls with income.
Marginal Tax Rate: the change in taxes with respect to
a change in income.
Dr. Reyadh Faras
6
Tax liabilities under a hypothetical tax system
Income
$ 2,000
Tax Liability Average Tax
Rate
Marginal
Tax Rate
$ -200
3,000
0
5,000
400
10,000
1,400
30,000
5,400
7
First: the greater the increase in average tax rates as
income increases, the more progressive is the system.
Algebraically:
v = _________
Second: A tax system with higher elasticity of tax
revenues with respect to income is more progressive.
Algebraically:
v = _________
Dr. Reyadh Faras
8
Partial Equilibrium Models
They are models that look only at the market in which
the tax is imposed and ignore the ramifications in other
markets.
A. Unit Taxes on Commodities
A unit tax is a fixed amount per unit of a commodity
sold.
Dr. Reyadh Faras
9
Implications of the analysis of a unit tax
1. The incidence is independent of whether it is levied
on consumers or producers.
2. The incidence depends on the elasticities of supply
and demand.
Dr. Reyadh Faras
10
B. Ad Valorem Taxes
 An ad valorem tax is a tax with a rate given as a
proportion of the price.
 The analysis similar to that of the unit tax.
 The only difference is that the demand curve does
not shift by the same absolute amount for each
quantity, instead it shifts downward proportionally.
Dr. Reyadh Faras
11
C. Taxes on Factors
1. The Payroll Tax
 These are taxes imposed on workers as percentage of
their incomes.
 The incidence is determined by the difference
between what employers pay and what employees
receive.
Dr. Reyadh Faras
12
2) Capital Taxation
 These are taxes imposed on owners of capital.
D. Profits Taxes
 These are taxes imposed on firms profits.
 In a perfectly competitive market, firm’s output is
determined by the intersection of its marginal cost and
marginal revenues schedules.
 A proportional profit tax changes neither marginal
cost nor marginal revenue.
Dr. Reyadh Faras
13
 Therefore, no firm has the incentive to change
its output decision, which means that the price
remains constant; consumers are not worse off.
 The tax is completely absorbed by the firm.
 Profit taxes seem attractive because they distort
no economic decisions.
Dr. Reyadh Faras
14