Chapter 12 Taxation and Income Distribution
I.
Impact of taxes on income distribution hard to determine because of tax incidence
II.
Tax Incidence
a.
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. 50 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 prices 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
f. 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.
Tax paid by
Consumers
Consumer
Demand
Pg
Po
Pn
Deadweight Loss
from Tax
Supply Consumer Losses
and Producers
losses
Supplier
Perceived
Demand
Q1 Q0
Tax paid by
Suppliers
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
Tax paid by
Consumers
Consumer
Perceived
Supply
Demand
Supply
Pg
Po
Pn
Deadweight Loss
Consumer Losses and
Producer losses
Q1 Q0
Tax paid by
Suppliers
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
Tax paid by
Consumers
Consumer
Demand
140
120
95
Deadweight Loss
from Tax
Supply Consumer Losses
and Producers
losses
Supplier
Perceived
Demand
300 400
Tax paid by
Suppliers
Tax paid by
Consumers
Consumer
Perceived
Supply
200
Demand
Supply
140
120
95
Deadweight Loss
Consumer Losses and
Producer losses
20
300 400
Tax paid by
Suppliers
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 12.7
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