lecture 12: tax incidencelfbrooks/leahweb/teaching/pppa6085/...november 17, 2015 adminrfhpgtax...

Admin RFH PG Tax Types 3 Rules Extensions GE Tax

Lecture 12: Tax Incidence

November 17, 2015


Overview

Course Administration

Ripped From Headlines

Public Goods

Types of Taxation

Three Rules of Tax Incidence

Tax Incidence Extensions

General Equilibrium Tax Incidence


Course Administration

1. Problem Set 11 posted, Problem Set 9 answers posted

2. Last year’s final posted

3. Elasticity note• Due final class• Post memo by 8 pm tonight to get included in my

group-making• Will post groups and suggested timeline under Handouts -¿

Elasticity memo by 5 pm Wed.: return comments by 8 pm11/22

• Feel free to modify terms with your group as you see fit


Ripped from the Headlines

Next Week

Afternoon

Finder Presenter

Carly Evans Michael Downey

Evening

Finder Presenter

Jenny Lewis Alysse HenkelKonark Sikka Tosin Ajayi


Public Goods Recap

• Podcasts• Lighthouses and autopsies• Asteroids, or destruction thereof

• Public goods not necessarily publicly provided goods!

• Questions?


Many Types of Taxation

• Payroll tax

• Income tax

• Corporate tax

• Wealth taxes• Property tax• Estate tax

• Consumption tax• Sales tax• Excise tax – sales tax applied only to certain goods• Value added tax


Type of Taxation Shifted Dramatically in US


Taxation Type Varies Substantially by Country


Key Tax Definitions

• Tax base: that on which the tax is levied• Base for property tax is value of properties• Base for sales tax is value of sales

• Tax rate: rate at which base is taxed• DC’s General tangible property and selected services tax rate is

5.75%• DC’s parking tax rate is 18%


Tax Fairness

• Vertical equity• People with more money should may “more taxes” (total, or

higher rate?) than people with less money

• Horizontal equity• Tax equivalent goods equally• Don’t tax hot dogs and fail to tax sausages• Hard to define in practice


You Levy a Tax – Who Pays?

The US income tax has shifted from a reliance on corporate taxesto income tax. Does this mean workers are paying more? “Whopays?” = tax incidence

Study the three rules of tax incidence

1. Statutory burden of tax 6= economic incidence of tax

2. Side of the market on which tax is imposed is irrelevant todistribution of tax burdens

3. Parties with inelastic supply or demand bear taxes


You Levy a Tax – Who Pays?

The US income tax has shifted from a reliance on corporate taxesto income tax. Does this mean workers are paying more? “Whopays?” = tax incidenceStudy the three rules of tax incidence

1. Statutory burden of tax 6= economic incidence of tax

2. Side of the market on which tax is imposed is irrelevant todistribution of tax burdens

3. Parties with inelastic supply or demand bear taxes


Types of Taxation

• specific excise tax: per unit tax

• ad valorem tax: tax that is a fixed percentage of the sale price

We will present everything with a specific excise tax. Results areequally applicable to an ad valorem tax.

U.S. excise tax examples

• federal tax on bows, archery equipment and and arrow shafts

• gasoline

• wine, varying by type, highest on “naturally sparkling”


Key Phrases

Incidence ≡ who pays the tax, or who “bears the burden” of thetax.

• Statutory incidence determined by who pays the tax to thegovernment

• Economic incidence determined by whose economic resourceschange due to the tax


1. Statutory Incidence 6= Economic IncidenceWhat Happens When you Levy a Tax on the Producer?

price pergallon of gas

quantity of gas in billions of gallons

S

D

Qo

Po


1. Statutory Incidence 6= Economic IncidenceWhat Are the New Equilibrium Price and Quantity?



S

D

S’

tax

Qo

Po


1. Statutory Incidence 6= Economic IncidenceHow Much Extra is the Consumer Paying?



S

D

S’

tax

Qo

Po

Pn

Qn


1. Statutory Incidence 6= Economic IncidenceHow Much Extra is the Producer Paying?



S

D

S’

tax

Qo

Po

Pn

Qn

consumer’s burden


1. Statutory Incidence 6= Economic IncidenceProducer and Consumer Share the Burden of the Tax



S

D

S’

tax

Qo

Po

Pn

Qn

consumer’s burden

producer’sburden


Defining Tax Burdens, Tax on Producer

• consumer tax burden• = (post-tax price - pre-tax price) + per-unit tax payment by

consumer• = benefit/loss in price change to consumer + per-unit tax

payment by consumer• = (Pn − Po)+ per-unit tax payments by consumers• = Pn − Po

• producer tax burden• = (pre-tax price - post-tax price) + per-unit tax payment by

producer• = per-unit tax payment by producer - benefit/loss in price

change to producer• = (Po − Pn)+ per-unit tax payments by producers• = tax− (Pn − Po) = tax + (Po − Pn)


Finding New Supply

• Suppose that the supply curve before the tax is QS = 2PS + 2.

• How does the supplier perceive a tax of $2/unit?

• Pt = PS + 2 → PS = Pt − 2

• Market supply is still QS = 2PS + 2

• We’d like to know market supply as a function of the taxedprice

• QS = 2Ps + 2• QS = 2(Pt − 2) + 2• QS = 2Pt − 4 + 2 = 2Pt − 2

• If you prefer, you can think of the intercept of the supplycurve shifting up by 2

• so express PS in terms of QS

• plug into Pt = PS + 2


Finding New Supply


• How does the supplier perceive a tax of $2/unit?• Pt = PS + 2

→ PS = Pt − 2



• QS = 2Ps + 2• QS = 2(Pt − 2) + 2• QS = 2Pt − 4 + 2 = 2Pt − 2





Finding New Supply


• How does the supplier perceive a tax of $2/unit?• Pt = PS + 2 → PS = Pt − 2



• QS = 2Ps + 2• QS = 2(Pt − 2) + 2• QS = 2Pt − 4 + 2 = 2Pt − 2





2. Side of the Market on Which Tax is Imposed Irrelevantto Distribution of Tax Burden

• Suppose that the gasoline tax is levied on the consumer, notthe producer

• This means you buy some gas and send a check to thegovernment


Consumer Pays TaxWhat Happens When you Levy a Tax on the Consumer?



S

D

Qo

Po


Consumer Pays TaxWhat Are the New Equilibrium Price and Quantity?



S

Dt

Qo

Po

D’


Consumer Pays TaxHow Much Lower Price Does the Producer Suffer?



S

Dt

Qo

PoPn

Qn

D’


Consumer Pays TaxHow Much Does the Consumer Pay?



S

Dt

Qo

PoPn

Qn

producer’sburden

D’


Consumer Pays TaxProducer and Consumer Share the Burden of the Tax



S

Dt

Qo

PoPn

Qn

consumer’s burden

D’

producer’sburden


Consider Burdens

• When tax is levied on consumers• consumer burden

= t − (Pn − Po) = t + (Po − Pn)• producer burden = Pn − Po + 0

• When tax is levied on producers• producer burden = t − (Pn − Po)• consumer burden = Pn − Po

• Note that• In both cases, total burden is tax• The total price change faced by producers and consumers is

equal regardless of the side of the market with the tax (moreclear in factor market analysis)


Consider Burdens

• When tax is levied on consumers• consumer burden = t − (Pn − Po) = t + (Po − Pn)• producer burden

= Pn − Po + 0





Consider Burdens

• When tax is levied on consumers• consumer burden = t − (Pn − Po) = t + (Po − Pn)• producer burden = Pn − Po + 0





Tax Wedge

• Tax wedge is sum of consumer and producer burdens

• Does the wedge change if the tax is levied on consumers?


In-Class Problem

The demand for rutabagas is Q = 2, 000− 100P, and the supply ofrutabagas is Q = 200P − 100.

1. Who is likely to bear the statutory incidence of a $2/unit taxon the sale of rutabagas? Re-write one of the curvesappropriately.

2. Who bears the economic incidence of this tax?


3. Inelastic Party Bears Tax Burden

• Return to statutory tax burden levied on producers

• Consider inelastic demand

• Consider elastic demand


Inelastic DemandWhat Does Inelastic Demand Look Like?



S


Inelastic DemandWhat is the Original Equilibrium P and Q?



SD


Inelastic DemandHow Does the Tax Shift Production?



SD

Qo

Po


Inelastic DemandWhat Are the New Equilibrium P and Q?



SD

S’

tax

Qo

Po


Inelastic DemandWhat is the Consumer’s Burden?



SD

S’

tax

Qo=Qn

Po

Pn


Inelastic DemandConsumer Cannot Run Away From Tax



SD

S’

tax

Qo=Qn

Po

Pnconsumer’s burden


Elastic DemandWhat Does Elastic Demand Look Like?



S

Po


Elastic DemandHow Does Tax on Producer Shift Supply?



S

DPo

Qo


Elastic DemandWhat are the New Equilibrium P and Q?



S

D

S’

tax

Po

Qo


Elastic DemandProducer Bears Entire Burden



S

D

S’

tax

Pn=Po

QoQn


And the Same is True for Supply


3 Extensions

1. Tax incidence in factor markets

2. (skip) Tax incidence in perfectly competitive markets

3. (skip) Balanced budget tax incidence


Tax Incidence in Factor Markets

• Suppose a tax is levied on a factor of production• tax on labor• tax on capital, such as land or steel

• Do wages decrease? Or do product prices increase?

• Who bears the burden of the tax?


Tax on Workers

• Suppose the government decides to levy a tax on workers

• It can either charge workers via a payroll tax

• Or it can charge employers via a payroll tax

• Does it matter?


Tax on Workers (Producers) vs. Tax on Firms (Consumers)How Does Tax on Workers (=Producers) Shift Supply?

tax on workers

D

S

Qo

Po

tax on firms

D

S

Qo

Po


Tax on Workers (Producers) vs. Tax on Firms (Consumers)What Are the New Equilibrium P and Q?

tax on workers

D

S

Qo

Po

t

S’

tax on firms

D

S

Qo

Po


Tax on Workers (Producers) vs. Tax on Firms (Consumers)What is the Consumer (Labor Purchaser) Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po


Tax on Workers (Producers) vs. Tax on Firms (Consumers)What is the Producer (Worker/Supplier) Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po


Tax on Workers (Producers) vs. Tax on Firms (Consumers)What if Firms Pay the Payroll Tax?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po


Tax on Workers (Producers) vs. Tax on Firms (Consumers)New Equilibrium P and Q?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t


Tax on Workers (Producers) vs. Tax on Firms (Consumers)Producer (Worker) Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

Pn

Qn


Tax on Workers (Producers) vs. Tax on Firms (Consumers)Consumer (Labor Purchaser) Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

Pn

Qn


Tax on Workers (Producers) vs. Tax on Firms (Consumers)Doesn’t Matter Who Pays the Tax

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

Pn

Qn


But What If There is an Impediment to Adjustment?

• Suppose that there is a minimum wage

• Compare payroll tax levied on workers

• To payroll tax levied on employers


Tax with a Minimum WageHow Does Tax on Workers=Producers Shift Supply?

tax on workers

D

S

Qo

Po

tax on firms

D

S

Qo

Po

min wage


Tax with a Minimum WageWhat Are the New Equilibrium P and Q?

tax on workers

D

S

Qo

Po

t

S’

tax on firms

D

S

Qo

Po

min wage


Tax with a Minimum WageWhat is the Consumer (Labor Purchaser) Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

min wage


Tax with a Minimum WageWhat is the Producer (Worker Supplier) Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

min wage


Tax with a Minimum WageWhat if Firms Pay the Payroll Tax?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

min wage


Tax with a Minimum WageNew Equilibrium P and Q?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

min wage


Tax with a Minimum WageWhat Quantity of Workers Can Firms Get?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

Pdesired

min wage


Tax with a Minimum WageWho Bears the Burden?

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

Pdesired

Qmw

min wage


Tax with a Minimum WageConsumers of Labor (Firms) Bear the Burden

tax on workers

D

S

Qo

Po

t

Qn

Pn

S’

tax on firms

D

S

Qo

Po

D’

t

Pdesired

Qmw

min wage


Summary of Taxes on Inputs

• Barriers to reaching the competitive market equilibrium canmatter for tax incidence

• Other barriers include workplace norms, such as norm for notcutting nominal wages

• More likely to see these features in input, rather than outputmarkets

• Therefore, the party on whom the tax is levied may mattermore in input than output markets


General Equilibrium Considerations

1. Illustrative example

2. Issues to consider• time period• scope• spillovers between product markets


Taxing Restaurants in Lexington, MA

• Suppose that the city of Lexington, MA passes a restauranttax

• Suppose that demand is perfectly elastic – you can go to thenext town to eat dinner

• Who bears the tax: restaurants or diners?

the restaurants

• And what happens to the quantity of restaurant mealsconsumed? declines





• Who bears the tax: restaurants or diners? the restaurants

• And what happens to the quantity of restaurant mealsconsumed?

declines





• Who bears the tax: restaurants or diners? the restaurants

• And what happens to the quantity of restaurant mealsconsumed? declines


But That’s Not the End

• A restaurant doesn’t pay taxes. In the end, people pay taxes.

• Restaurants use capital and labor – who bears the burden?

• Perhaps in the short run, labor is more elastic than capital, socapital bears the burden =⇒ restaurant owner makes lessmoney

• In the long run? restaurants leave, and landowners make lessmoney

• In economics, land is the one absolutely fixed thing






• In the long run?

restaurants leave, and landowners make lessmoney







• In the long run? restaurants leave, and landowners make lessmoney



General Equilibrium Issues: Time Period

Overarching rule for general equilibrium tax incidence is to followthe incidence until you get to a person.

• Long and short-run elasticities should differ – examples?

• In general, the longer the period, the more elastic all factorsare

• Except for land!


General Equilibrium Issues: Scope

• Scope of tax matters: elasticity of response to tax onrestaurants in Lexington is different than tax on restaurants inMassachusetts

• Is the supply of workers for the state-wide tax more or lesselastic?

less elastic

• Compare tax on soda to tax on sugar


General Equilibrium Issues: Scope

• Scope of tax matters: elasticity of response to tax onrestaurants in Lexington is different than tax on restaurants inMassachusetts

• Is the supply of workers for the state-wide tax more or lesselastic? less elastic

• Compare tax on soda to tax on sugar


General Equilibrium Issues: Cross-Product Market Effects

• Tax from one market could spill over in another – examples?

• Textbook uses restaurant meals and babysitters

• Think tax on internet and Netflix usage


Today: Tax Incidence

• Tax incidence: who bears the burden of the tax

1. Statutory incidence 6= economic incidence2. Without impediments, side of the market on which the tax is

levied does not impact incidence3. More elastic factor bears the burden of the tax

• When there are impediments to reaching market equilibrium,which side of the market bears the tax matters

• General equilibrium tax incidence: the most inelastic factorbears the burden


Next Class

• Last full lecture

• Gruber Chapter 12: Social insurance

lecture 12: tax incidencelfbrooks/leahweb/teaching/pppa6085/...november 17, 2015 adminrfhpgtax...

Documents