Chapter 12 Taxation and Income Distribution

Who actually pays a tax b. Legal Incidence – who is legally responsible for paying a tax c. Economic Incidence – who actually pays the tax d. Example – tax of $1 is placed on $10 item how is income distribution affected i. Price stays at $10 – income of seller reduced ii. Prices rises to $11 – income of buyers reduced iii. Price rises to $10. 30 – buyers pay $. 30 and sellers pay $. 70 e. To the extent taxes affect quantity sold and produced, tax affects income of suppliers of inputs for the product. i. Example: tax on gasoline reduces gasoline consumption it reduces income of gasoline tanker truck owners and drivers. ii. May reduce the income of furnace manufactures by reducing the price of heating fuel. III. Tax Incidence Perspectives a. People pay taxes not corporations b. How to group people for purposes of tax incidence i. Often think of producers and consumers 1. But consumers are also producers and producers are also consumers 2. 0 of households own stock directly, others own stock indirectly ii. By income Rich, Middle Class, Poor 1. How do you define these categories? c. Tax affect both suppliers of inputs and consumers of a product. i. In practice tend to ignore one side and do analysis on the other 1. Tax in commodity ignore impacts on inputs 2. Tax on inputs, ignore impact on consumers d. Incidence depends on how prices are determined i. How taxes change pr ices determine who pays the taxes ii. Amount of time is important – more time more adjustment to taxes e. Tax incidence depends on how tax revenues are spend . Progressiveness of tax system i. Policy says tax system should be progressive. ii. Higher income pay a higher percentage of taxes 1. Usually measured as increase in average tax rate taxes/income 2. Exemptions, deductions and marginal rate structure affect average tax rate iii. 2 measures 1. Percentage change in tax rate divided by percentage change in income 2. Percentage change in taxes divided by the percentage change in income 3. Measures can produce different results IV. Partial Equilibrium Models of Tax Incidence a. Analyzes impact of tax on the market in which tax was imposed b. Ignore impact of market change on other markets i. Appropriate if tax is small ii. Appropriate if market is small iii. Otherwise need general equilibrium analysis c. Tax incidence of a unit tax – tax per unit of the good i. Legal incidence on buyers – figure 12. 2 1. Tax reduces the demand curve for the product from the supplier’s point of view since at each price the consumer buys less of the product. [pic] ii. Legal incidence on seller – figure 12. 3 1. Tax reduces the supply curve for the product from the consumer’s point of view since at each price the suppliers supply less of the product pic] iii. Economic incidence is independent of legal incidence 1. Arrive at same Price, Quantity, and tax split regardless of whether tax is on producer or supplier. a. Sales tax example iv. Tax incidence depends on relative elasticities of demand and supply v. Example Qd = 1,000 – 5P and Qs = 4P – 80 Tax $45 per unit [pic] [pic] d. Tax incidence of an ad valorem tax – tax per unit of the good i. A percentage tax rather than a unit tax ii. Sales tax as compared to gasoline tax iii. More difficult to calculate but shifts demand as shown in figure 12. V. Payroll Tax Controversy a. Legal incidence 7. 5% paid by employer and 7. 5% paid by employee b. Statutory distinction between employer and employee is irrelevant c. Economic split depends on elasticity of supply of labor d. Logical that the labor supply is fairly inelastic i. Household provides certain amount of labor regardless of wage ii. May not be true in long run VI. Tax on Capital a. Increasingly capital perfectly mobile b. Moved to where return is highest after adjusting for risk c. Rate of return on capital same everywhere in world d. No single country can make suppliers of capital bear any portion of a tax on capital VII. Taxes in markets with monopoly power a. Impact of taxes same as in competitive markets b. Consumers and monopolist share tax depending on the elasticity of demand c. Figure 12. 10 VIII. Taxes in oligopoly markets a. Impact of taxes difficult to determine b. Price increase resulting from reduction in output resulting from the tax may make a company more profitable IX. Tax on profits a. Tax on normal profits reduce investment because profit is return on capital and risk b. Tax on economic profits born entirely by company with change in behavior c. Seemly ideal tax but not very operational X. Tax Incidence and Capitalization a. Tax increase on real estate is capitalized into PV of property b. Borne entirely owners at time tax is levied c. May be reimbursed if public expenditures increase property values XI. General Equilibrium Models a. Read first paragraph P 271 b. Generally not operational [pic] ———————– Po Pg Pn Q0 Q1 Supply ConsumerDemand Supplier Perceived Demand Tax paid by Consumers Tax paid by Suppliers Deadweight Loss from Tax Consumer Losses and Producers losses Po Pg Pn Q0 Q1 Supply Demand Consumer Perceived Supply Tax paid by Consumers Tax paid by Suppliers Deadweight Loss Consumer Losses and Producer losses Deadweight Loss Consumer Losses and Producer losses Tax paid by Suppliers Tax paid by Consumers Consumer Perceived Supply Demand Supply 300 400 95 140 120 Deadweight Loss from Tax Consumer Losses and Producers losses Tax paid by Suppliers Tax paid by Consumers Supplier Perceived Demand ConsumerDemand Supply 300 400 95 20 200 120 140 Chapter 12 Taxation and Income Distribution Who actually pays a tax b. Legal Incidence – who is legally responsible for paying a tax c. Economic Incidence – who actually pays the tax d. Example – tax of $1 is placed on $10 item how is income distribution affected i. Price stays at $10 – income of seller reduced ii. Prices rises to $11 – income of buyers reduced iii. Price rises to $10. 30 – buyers pay $. 30 and sellers pay $. 70 e. To the extent taxes affect quantity sold and produced, tax affects income of suppliers of inputs for the product. i. Example: tax on gasoline reduces gasoline consumption it reduces income of gasoline tanker truck owners and drivers. ii. May reduce the income of furnace manufactures by reducing the price of heating fuel. III. Tax Incidence Perspectives a. People pay taxes not corporations b. How to group people for purposes of tax incidence i. Often think of producers and consumers 1. But consumers are also producers and producers are also consumers 2. 0 of households own stock directly, others own stock indirectly ii. By income Rich, Middle Class, Poor 1. How do you define these categories? c. Tax affect both suppliers of inputs and consumers of a product. i. In practice tend to ignore one side and do analysis on the other 1. Tax in commodity ignore impacts on inputs 2. Tax on inputs, ignore impact on consumers d. Incidence depends on how prices are determined i. How taxes change pr ices determine who pays the taxes ii. Amount of time is important – more time more adjustment to taxes e. Tax incidence depends on how tax revenues are spend . Progressiveness of tax system i. Policy says tax system should be progressive. ii. Higher income pay a higher percentage of taxes 1. Usually measured as increase in average tax rate taxes/income 2. Exemptions, deductions and marginal rate structure affect average tax rate iii. 2 measures 1. Percentage change in tax rate divided by percentage change in income 2. Percentage change in taxes divided by the percentage change in income 3. Measures can produce different results IV. Partial Equilibrium Models of Tax Incidence a. Analyzes impact of tax on the market in which tax was imposed b. Ignore impact of market change on other markets i. Appropriate if tax is small ii. Appropriate if market is small iii. Otherwise need general equilibrium analysis c. Tax incidence of a unit tax – tax per unit of the good i. Legal incidence on buyers – figure 12. 2 1. Tax reduces the demand curve for the product from the supplier’s point of view since at each price the consumer buys less of the product. [pic] ii. Legal incidence on seller – figure 12. 3 1. Tax reduces the supply curve for the product from the consumer’s point of view since at each price the suppliers supply less of the product pic] iii. Economic incidence is independent of legal incidence 1. Arrive at same Price, Quantity, and tax split regardless of whether tax is on producer or supplier. a. Sales tax example iv. Tax incidence depends on relative elasticities of demand and supply v. Example Qd = 1,000 – 5P and Qs = 4P – 80 Tax $45 per unit [pic] [pic] d. Tax incidence of an ad valorem tax – tax per unit of the good i. A percentage tax rather than a unit tax ii. Sales tax as compared to gasoline tax iii. More difficult to calculate but shifts demand as shown in figure 12. V. Payroll Tax Controversy a. Legal incidence 7. 5% paid by employer and 7. 5% paid by employee b. Statutory distinction between employer and employee is irrelevant c. Economic split depends on elasticity of supply of labor d. Logical that the labor supply is fairly inelastic i. Household provides certain amount of labor regardless of wage ii. May not be true in long run VI. Tax on Capital a. Increasingly capital perfectly mobile b. Moved to where return is highest after adjusting for risk c. Rate of return on capital same everywhere in world d. No single country can make suppliers of capital bear any portion of a tax on capital VII. Taxes in markets with monopoly power a. Impact of taxes same as in competitive markets b. Consumers and monopolist share tax depending on the elasticity of demand c. Figure 12. 10 VIII. Taxes in oligopoly markets a. Impact of taxes difficult to determine b. Price increase resulting from reduction in output resulting from the tax may make a company more profitable IX. Tax on profits a. Tax on normal profits reduce investment because profit is return on capital and risk b. Tax on economic profits born entirely by company with change in behavior c. Seemly ideal tax but not very operational X. Tax Incidence and Capitalization a. Tax increase on real estate is capitalized into PV of property b. Borne entirely owners at time tax is levied c. May be reimbursed if public expenditures increase property values XI. General Equilibrium Models a. Read first paragraph P 271 b. Generally not operational [pic] ———————– Po Pg Pn Q0 Q1 Supply ConsumerDemand Supplier Perceived Demand Tax paid by Consumers Tax paid by Suppliers Deadweight Loss from Tax Consumer Losses and Producers losses Po Pg Pn Q0 Q1 Supply Demand Consumer Perceived Supply Tax paid by Consumers Tax paid by Suppliers Deadweight Loss Consumer Losses and Producer losses Deadweight Loss Consumer Losses and Producer losses Tax paid by Suppliers Tax paid by Consumers Consumer Perceived Supply Demand Supply 300 400 95 140 120 Deadweight Loss from Tax Consumer Losses and Producers losses Tax paid by Suppliers Tax paid by Consumers Supplier Perceived Demand ConsumerDemand Supply 300 400 95 20 200 120 140