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Principles of Tax Analysis

© Allen C. Goodman, 2014

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Lots of Different Taxes

Income/Business Consumption Wealth

Personal Income Sales Property

Corporate Income Use Estate

Value-Added Motor Fuel Inheritance

License Alcoholic Beverage Transfer

Hotel/Motel

Restaurant Meals

Telephone Call

Gambling

Most economistsDon’t like this one.

Why?

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Lots of Different Taxes

Income/Business Consumption Wealth

Personal Inc. Sales Property

Corporate Inc. Use (e.g. Roads) Estate

Value-Added Motor Fuel Inheritance

License Alcoholic Beverage Transfer

Hotel/Motel

Restaurant Meals

Telephone Call

Gambling

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Lots of Different Taxes

Income/Business Consumption Wealth

Personal Inc. Sales Property

Corporate Inc. Use (e.g. Roads) Estate

Value-Added Motor Fuel Inheritance

License Alcoholic Beverage Transfer

Hotel/Motel

Restaurant Meals

Telephone Call

GamblingWhy good?Why bad?

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Tax Incidence

• Who REALLY pays the tax

• If you buy something at the store, you give $ to the clerk, and the store pays $ to the gov’t, but who really pays?

• If you rent an apartment and property taxes in your city rise, what happens to the rent that you pay? Who really pays?

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Tax Incidence and Burden

• Progressive Tax– Tax Burden/income ↑

as income ↑

• Proportional Tax– Tax Burden/income

is constant as income ↑

• Regressive Tax– Tax Burden/income ↓

as income ↑Income

Tax

These are real slopes,but it’s hard to see them.

Following slides willbe similar but not to scale.

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Progressive Tax

• Progressive Tax– Tax Burden/income ↑

as income ↑– Slope of ray = T/Y– Mgl Tax Rate =

ΔT/ΔY

• Example – Gas Guzzler Tax

• Federal Income TaxIncome

Tax

T

Y

Y1 Y2 Y3

Ave.TaxRate

Mgl.TaxRate

T

ΔT

ΔY

Average Marginal

Ave Ray to origin

Mgl slopeNot to Scale

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Proportional Tax

• Proportional Tax– Tax Burden/income

constant as income ↑– Slope of ray = T/Y– Mgl Tax Rate =

ΔT/ΔY

• Example – Medicare Tax

Income

Tax

Y1 Y2 Y3

T

Y

ΔT

ΔY

Average Marginal

Ave Ray to origin

Mgl slopeNot to Scale

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Regressive Tax

• Regressive Tax– Tax Burden/income ↓

as income ↑– Slope of ray = T/Y– Mgl Tax Rate =

ΔT/ΔY

• Example – FICA tax for Social Security

Income

Tax

Y1Y2 Y3

Mgl.TaxRate

T

Y

ΔT

ΔY

Average Marginal

Ave Ray to origin

Mgl slopeNot to Scale

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FICA, Medicare Taxes - 2014

0

1000

2000

3000

4000

5000

6000

7000

8000

0 20000 40000 60000 80000 100000 120000 140000 160000

Income

Tax

es FICA Tax

Medicare Tax

FICA and Medicare FICA isRegressive

Medicare isProportional

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General Rules for Taxes

• Only way (legally) to avoid taxes is to change behavior.

• The more that one agent can avoid the tax, – the less is collected– the more someone else pays

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Taxes and Efficiency

• Excise Tax– Tax on a particular

good.– Look at a unit (as

oppose to percentage) tax.

• Partial eq’m analysis looks at a single market.

$

Q

D S

Q0

P0

EfficientQuantity! WHY?

EfficientQuantity! WHY?

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Taxes and Efficiency

• Excise Tax– Tax on a particular good.– Look at a unit (as oppose to

percentage) tax.• $1 Tax Collected on

DEMANDERS

$

Q

D S

Q0

P0

$1

Why is this treated as a downward shift?

Suppose you buy gasoline at $3.00 per gallon.

Your state imposes a $1.00/gallon tax.

You keep your receipts and pay tax.

You demand gas based on $2.00 per gallon, because you know you’ll have to pay an additional $1.00. Your demand curve shifts DOWN by $1.00.

3.0

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Total Revenue

Taxes and Efficiency

• Excise Tax– Tax on a particular

good.– Look at a unit (as

oppose to percentage) tax.

• $1 Tax Collected on DEMANDERS

$

Q

D S

Q0

P0

Who Pays?

P1

Q1

D'

$1

3.0

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Taxes and Efficiency

• Excise Tax– Tax on a particular

good.– Look at a unit (as

oppose to percentage) tax.

• $1 Tax Collected on DEMANDERS

$

Q

D S

Q0

P0

What’s DW$

P1

Q1

Prod.

Con.DW

$1

3.0

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Total RevenueProd.

Suppose the $1 is on Suppliers?

$

Q

D S

Q0

P0

• Excise Tax– Tax on a particular

good.– Look at a unit (as

opposed to percentage) tax.

• $1 Tax Collected on SUPPLIERS

Who Pays?

Cons.

EXACTLY the same result.

EXACTLY the same result.

DW

P1

Q1

3.0

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If result is same …

• Why do we usually collect sales taxes from the sellers?

• Do we ever try to collect it from the buyers?

• What happens when we do?

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Sales Tax on the Internet• Margo is passionate about rare orchids but can't find

them in Indiana, so she orders her supplies online from an orchid supplier with headquarters in Vermont. The supplier has all of its facilities in Vermont and collects payment in Vermont. Margo does not have to pay Indiana sales tax (or Vermont sales tax) on her orchids.

• A few months later, the supplier opens a warehouse in Indiana to handle its online orders for the entire country. Margo continues to order her orchids from the headquarters in Vermont but she must now pay Indiana sales tax. Her ride on the tax-free train is over.

• Many states have reevaluated their attitude towards collecting use taxes. For example, New York state has added a line to income tax returns requiring all residents to calculate how much they should pay on Internet, mail order, or out-of-state purchases.

http://www.nolo.com/legal-encyclopedia/article-29919.html http://articles.latimes.com/2009/dec/24/business/la-fi-hiltzik24-2009dec24?pg=3

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Marketplace Fairness Act of 2013 • The Marketplace Fairness Act grants states the authority to compel

online and catalog retailers ("remote sellers"), no matter where they are located, to collect sales tax at the time of a transaction - exactly like local retailers are already required to do. However, there is a caveat: States are only granted this authority after they have simplified their sales tax laws.

• The Marketplace Fairness Act requires that states must simplify their sales tax laws in order to ease those concerns and make multistate sales tax collection easy. Specifically, states seeking collection authority have two options for simplifying their sales tax laws.

• Option 1: A state can join the twenty-four states that have already voluntarily adopted the simplification measures of the Streamlined Sales and Use Tax Agreement (SSUTA), which has been developed over the last eleven years by forty-four states and more than eighty-five businesses with the goal of making sales tax collection easy. Any state which is in compliance with the SSUTA and has achieved Full Member status as a SSUTA implementing state will have collection authority on the first day of the calendar quarter that is at least 90 days after enactment.

http://www.marketplacefairness.org/what-is-the-marketplace-fairness-act/

Has passed Senate, but notyet passed House.

Something like that will pass.

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http://www.streamlinedsalestax.org/uploads/images/state%20map%202014_1_1.jpg

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MFP of 2013 – 2 • Option 2: Alternatively, states can meet essentially five

simplification mandates listed in the bill. States that choose this option must agree to:– Notify retailers in advance of any rate changes within the state– Designate a single state organization to handle sales tax

registrations, filings, and audits– Establish a uniform sales tax base for use throughout the state– Use destination sourcing to determine sales tax rates for out-

of-state purchases (a purchase made by a consumer in California from a retailer in Ohio is taxed at the California rate, and the sales tax collected is remitted to California to fund projects and services there)

– Provide free software for managing sales tax compliance, and hold retailers harmless for any errors that result from relying on state-provided systems and data.

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Important Concepts!

• DW loss relates to the change in quantity. Remember, we saw that efficiency related to quantity. The more behavioral change that a tax makes, the more DW loss.

• Incidence relates to elasticity of demand and supply. Remember elasticity addresses whether quantity changes a little or lot. If you can change your behavior a lot, and avoid the tax, its incidence on you is small.

• If you can’t change your behavior and avoid it, its incidence is a lot! Does it matter how we collect the tax?

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Total (yellow)

Another Gas Tax Example

• Suppose that Southfield puts a $1/gallon tax on gas.

• Let’s look at demand and supply.

• Why did I draw demand and supply like I did.

$

Quantity

D

S

Who Pays?

Q0

$1

P0

P1

Q1

Price ↑ a little;Quantity ↓ a lotMost is paid by

producers.

S'

Consumer

by producer

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TaxCollected

Another Gas Tax Example

• Suppose that the US puts a $1/gallon tax on gas.

• Let’s look at demand and supply.

• Why did I draw demand and supply like I did.

$

Quantity

D

S

Who Pays?

Q0

$1

P0

P1

Q1

Price ↑ a lot;Quantity ↓ a littleMost is paid by

consumers.

S'

WHY?

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Excess Burden of Excise Taxes – Gen’l Eq’m

• Previously, we looked only at a single market. Even if a tax doesn’t change quantity in a given market it may change behavior in other markets. U0

U1

U2

• We can’t measure U1 – U2, but we CAN, in principle, measure the cost in $ of this excess burden.

Gasoline

Other Goods

Excess Burden

EB is like DW Loss

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Even if Q doesn’t change! – Gen’l Eq’m

• Previously, we looked only at a single market. Even if a tax doesn’t change quantity in a given market (again, suppose it’s gasoline) it may change behavior in other markets. U0

U1

U2

• Again we can’t measure U1 – U2, but we CAN, in principle, measure the cost in $ of this excess burden, even though the amount of gas did not change.

Gasoline

Other Goods