Transcript Slides1

Power Point Slides to Accompany:
Public Finance
by John E. Anderson
Chapter 12
Equity Aspects of
Taxes and
Expenditures
Introduction

In this chapter we are concerned about
who bears the burden of taxation.

That requires knowledge of who really
bears the burden,

Not just knowing what the law says about
who is required to pay.
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The Incidence of Taxes

Tax incidence is about who the burden of
taxation falls upon.

When a tax is applied to goods
consumers purchase, for example, one
might think that they bear the burden of
the tax.

But the tax raises the price of the good,
and reduces the quantity consumers wish
to buy.
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The Incidence of Taxes,
[continued]

Consequently, the producer is affected by
the tax as well.

Similarly, if the tax is applied to the
producer, there are economic
consequences for both producers and
consumers.

We consider each of these possibilities,
examining the precise burdens in each
case.
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The Concept of Incidence

Economic incidence

Economic vs. statutory incidence
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Figure 12.1: Effect of a Unit Tax on Demand
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Partial Equilibrium Tax Incidence
First, we consider the issue of tax
incidence in a single market.
 In this case, we examine how the tax
affects equilibrium price and quantity in
one market.
 Since other markets are not considered,
we call this type of analysis partial
equilibrium analysis.

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Figure 12.2: Incidence of a Unit Tax Applied to Consumers
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Figure 12.3: The Effect of a Unit Tax on Supply
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Figure 12.4: Incidence of a Unit Tax Applied to Producers
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Incidence of an Ad Valorem Tax

If the tax is applied to the value of the
good, the size of the tax rises with the
price.

Hence, we must model the tax as
increasing with price.
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Figure 12.5: Effect of an Ad Valorem Tax on Supply
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Figure 12.6: Incidence of an Ad Valorem Tax Applied to Producers
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What Determines Producer’s
and Consumer’s Incidence?

Most fundamentally, the incidence of a
tax is determined by two factors:

Price elasticity of demand, and the.

Price elasticity of supply.

It is the relative size of these two
elasticities that determine the tax burden.
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Figure 12.7: The Incidence of a Unit Tax Depends on the
Elasticity of Demand
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Figure 12.8: The Incidence of a Unit Tax Depends on the
Elasticity of Supply
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Tax Incidence Effects in
Multiple Markets

So far, we have only considered the
effect of a tax in a single market.

Now, we turn to consideration of a tax
applied in one market that has effects in
other markets as well.
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Figure 12.9: Tax Effects on Related Goods
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Figure 12.10: General Equilibrium Incidence of a
Taxation of Capital in the Corporate Sector
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Equity Concepts

Horizontal equity: treat equals equally

Vertical equity: treat unequals unequally

Defining equals is a problem: Do we use
income, wealth, or consumption?
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Equity Concepts,



[continued]
Conflicts can arise between horizontal and vertical
equity.
Suppose that we grant a property tax exemption for the
first $100,000 of property value for agricultural land
owners.
We might consider that change an improvement in the
vertical equity of the property tax, making the tax more
progressive, but it also worsens the horizontal equity of
the property tax when we consider property owners in
the residential, commercial, and industrial classes of
property.
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Figure 12.11: Effect of the Tax and Expenditure System
on the Income Distribution
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Source: Paul L. Menchik, 1991, The Distribution of Federal Expenditures, National Tax Journal 44:269-276
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