PowerPoint Slides
to accompany
Prepared by Apostolos Serletis
University of Calgary
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1
Chapter13
Taxes
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Taxes in Canada
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Types of Taxes
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Types of Taxes
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Types of Taxes
• Taxes fall on forms of income: individual income
taxes, corporate profits taxes, and contributions
for Social Security.
• Other taxes are based on expenditures: sales
taxes, excise taxes, and customs duties.
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Types of Taxes
• The marginal tax rate is the additional tax paid
on an additional dollar of income. The average
tax rate is the ratio of total taxes paid to total
income.
– An important property of the Canadian federal
individual income tax is that the marginal tax rate
rises with income.
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Types of Taxes
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Types of Taxes
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Types of Taxes
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Taxes in the Model
• Household Budget Constraint
C + (1/P)·ΔB + ΔK
= (w/P)·Ls+ r·(B/P+K) + V − T
• Let τw be the marginal tax rate on labour income.
– a higher τw will generate more tax revenue for the
government unless the amount of labour income falls
sharply.
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Taxes in the Model
• Let τw be the marginal tax rate on labour income.
– a higher τw will generate more tax revenue for the
government unless the amount of labour income falls
sharply.
• After-tax real wage rate = (1−τw)·(w/P)
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Taxes in the Model
• If the marginal tax rate, τw, rises, for a given w/P,
(1−τw)·(w/P) falls.
– We predict that the household would reduce the
quantity of labour supplied, take more leisure time,
and consume less.
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Taxes in the Model
• V − T = −G.
– Therefore, if government purchases, G, are
unchanged real transfers net of real taxes, V − T,
must also be unchanged.
– For given G, we do not get any changes in
household real income through the term V − T.
– In other words, if G is fixed, there are no income
effects from a change in τw.
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Taxes in the Model
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Taxes in the Model
• For a given pretax real wage rate, w/P, a higher
τw implies a lower after-tax real wage rate, (1 −
τw) · (w/P) .
• A rise in τw shifts the labour supply curve
leftward from the blue one labeled Ls to the
green one labeled (Ls)ʹ .
• This decrease in labour supply reflects the
substitution effect from the higher labour-income
tax rate, τw
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Taxes in the Model
• A higher marginal tax rate on labour income, τw,
lowers the quantity of labour input, L.
• This effect will spill over to the market for capital
services because the reduction in L tends to
reduce the marginal product of capital services,
MPK.
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Taxes in the Model
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Taxes in the Model
Y = A· F(κ K, L)
– We found that a rise in the labour-income tax rate, τw,
reduced the quantities of labour, L, and capital
services, κK.
– A higher marginal tax rate on labour income, τw, leads
to a reduction in overall market activity, as gauged by
real GDP, Y.
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Taxes in the Model
• A Tax on Asset Income
C+ (1/P)·ΔB+ΔK
= (w/P)·Ls + r · ( B/P +K) + V − T
– Suppose now that real taxes, T, depend on a
household’s real asset income, r · (B/P + K)
r = ( R/ P) · κ − δ(κ)
– Let τr be the marginal tax rate on asset income.
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Taxes in the Model
• A Tax on Asset Income
– For the choice between C1 and C2 is the after-tax
real interest rate, (1 - τr)·r . If τr rises, for given r, (1−
τr)·r declines.
– Households have less incentive to defer consumption,
and react by increasing C1 compared to C2.
– For given real income in year 1, an increase in τr
motivates households to consume more and save
less in year 1.
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Taxes in the Model
• A Tax on Asset Income
(1−τr) · r = (1−τr)·[(R/P)·κ−δ(κ) ]
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A Tax on Asset Income
• We know that a decrease in (1 − τr ) · r has intertemporalsubstitution effects on consumption.
• The household raises year 1’s consumption, C1, compared to year
2’s, C2.
• For given real income in year 1, the household consumes more and
saves less in year 1. Recall that year 1’s real GDP, Y1, does not
change, and that Y1 = C1 + I1 + G1. We are assuming that
government purchases, G1, are unchanged.
• The increase in C1 must correspond to an equal-sized reduction in
year 1’s gross investment, I1.
• Thus, the key result is that a higher tax rate, τr , on asset income
leads to higher C1 and lower I1.
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An Increase in Government Purchases
Financed by a Labour Income Tax
• In Chapter 12, we examined the effects from a
permanent increase in government purchases,
G. We assumed that the increase in G was
financed by lump-sum taxes.
– Our finding was that an increase in G by one unit left
real GDP, Y, unchanged and reduced consumption,
C, by about one unit.
– Gross investment, I, was unchanged.
– Also unchanged were the real wage rate, w/P, the
real rental price, R/P, and the real interest rate, r.
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An Increase in Government Purchases
Financed by a Labour Income Tax
• We will get different results if the combination of
permanently increased government purchases,
G, and the higher marginal income tax rate, τw,
affects the quantity of labour supplied, Ls.
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An Increase in Government Purchases
Financed by a Labour Income Tax
• The various forces that affect Ls.
– An increase by one unit in each year’s government
purchases, G, required real taxes less real transfers,
T − V, to rise by one unit in each year.
– We found in this chapter that the substitution effect
from a higher marginal tax rate, τw, on labour income
reduces the quantity of labour supplied.
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An Increase in Government Purchases
Financed by a Labour Income Tax
• We see that the overall effect from a rise in
government purchases, G, on the quantity of
labour supplied, Ls, depends on the offsetting
influences from an income effect and a
substitution effect.
• The income effect predicts that Ls would rise.
The substitution effect predicts that Ls would fall.
The overall effect on Ls is uncertain.
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An Increase in Government Purchases
Financed by a Labour Income Tax
• Empirically, the overall effect from permanently
increased government purchases, G, on the
quantity of labour supplied, Ls , seems to be
small.
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The Laffer Curve
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Transfer Payments
• Suppose that the government increases real transfers,
V, and finances these expenditures with increased real
taxes, T, collected by a tax on labour income.
• In this case, marginal income tax rates, τw, rise for two
reasons.
– First, the rise in T goes along with a higher τw for households that
pay individual income taxes.
– Second, for households that are receiving transfers—such as
poor welfare recipients—the expansion of the transfer program
raises the implicit marginal income tax rate, τw, because of the
income testing for benefits.
• We therefore predict even stronger effects In particular,
labour input, L, capital services, κK, and real GDP, Y,
tend to decline.
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