Principles of Tax Analysis
© Allen C. Goodman, 2014
1
Lots of Different Taxes
Income/Business
Personal Income
Corporate Income
Value-Added
License
Consumption
Sales
Use
Motor Fuel
Alcoholic Beverage
Hotel/Motel
Restaurant Meals
Most economists
Telephone Call
Don’t like this one.
Gambling
Wealth
Property
Estate
Inheritance
Transfer
Why?
2
Lots of Different Taxes
Income/Business
Consumption
Wealth
Personal Inc.
Corporate Inc.
Value-Added
License
Sales
Use (e.g. Roads)
Motor Fuel
Alcoholic Beverage
Hotel/Motel
Restaurant Meals
Telephone Call
Gambling
Property
Estate
Inheritance
Transfer
3
Lots of Different Taxes
Income/Business
Consumption
Wealth
Personal Inc.
Corporate Inc.
Value-Added
License
Sales
Use (e.g. Roads)
Motor Fuel
Alcoholic Beverage
Hotel/Motel
Restaurant Meals
Telephone Call
Gambling
Property
Estate
Inheritance
Transfer
Why good?
Why bad?
4
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?
5
Tax Incidence and Burden
• Progressive Tax
These are real slopes,
but it’s hard to see them.
Following slides will
be similar but not to scale.
– Tax Burden/income ↑
as income ↑
• Proportional Tax
– Tax Burden/income
is constant as
income ↑
Tax
• Regressive Tax
– Tax Burden/income ↓
as income ↑
Income
6
Ave  Ray to origin
Not to Scale
Mgl  slope
Progressive Tax
Average
Marginal
ΔT
T
• Progressive Tax
– Tax Burden/income ↑
as income ↑
– Slope of ray = T/Y
– Mgl Tax Rate =
ΔT/ΔY
• Example – Gas
Guzzler Tax
• Federal Income Tax
ΔY
Y
Tax
Mgl.
Tax
Rate
Ave.
Tax
Rate
T
Y1
Y2 Y3
Income
7
Ave  Ray to origin
Not to Scale
Proportional Tax
Mgl  slope
Average
Marginal
ΔT
T
• Proportional Tax
– Tax Burden/income
constant as income ↑
– Slope of ray = T/Y
– Mgl Tax Rate =
ΔT/ΔY
Y
ΔY
Tax
• Example – Medicare
Tax
Y1
Y2 Y3
Income
8
Ave  Ray to origin
Not to Scale
Mgl  slope
Regressive Tax
Average
Marginal
ΔT
T
• Regressive Tax
– Tax Burden/income ↓
as income ↑
– Slope of ray = T/Y
– Mgl Tax Rate =
ΔT/ΔY
ΔY
Y
Tax
Mgl.
Tax
Rate
• Example – FICA tax
for Social Security
Y1
Y2
Y3
Income
9
FICA and Medicare
FICA is
Regressive
FICA, Medicare Taxes - 2014
8000
7000
6000
Taxes
5000
FICA Tax
4000
Medicare Tax
3000
2000
1000
0
0
20000
40000
60000
80000
Income
100000
120000
140000
160000
Medicare is
Proportional
10
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
11
Efficient
Quantity!
WHY?
Taxes and Efficiency
• Excise Tax
– Tax on a particular
good.
– Look at a unit (as
oppose to percentage)
tax.
D
S
$
P0
• Partial eq’m analysis
looks at a single
market.
Q0
12
Q
Taxes and Efficiency
• Excise Tax
– Tax on a particular good.
– Look at a unit (as oppose to
percentage) tax.
• $1 Tax Collected on
DEMANDERS
Suppose you buy gasoline at $3.00 per
gallon.
D
S
$
Why is this treated
as a downward shift?
P0
3.0
$1
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.
Q0
13
Q
Taxes and Efficiency
• Excise Tax
– Tax on a particular
good.
– Look at a unit (as
oppose to percentage)
tax.
D
S
$
D'
P1
P0
3.0
Total Revenue
$1
• $1 Tax Collected on
DEMANDERS
Who Pays?
Q1 Q0
14
Q
Taxes and Efficiency
• Excise Tax
– Tax on a particular
good.
– Look at a unit (as
oppose to percentage)
tax.
D
S
$
P1
Con.
P0
3.0
DW
Prod.
$1
• $1 Tax Collected on
DEMANDERS
What’s DW$
Q1 Q0
15
Q
EXACTLY the
same result.
Suppose the $1 is on Suppliers?
• Excise Tax
– Tax on a particular
good.
– Look at a unit (as
opposed to
percentage) tax.
D
S
$
P1
P0
3.0
Cons.
Total RevenueDW
Prod.
• $1 Tax Collected
on SUPPLIERS
Who Pays?
Q1 Q0
16
Q
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?
17
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
18
Marketplace Fairness Act
of 2013
Has passed
Senate, but not
yet passed
House.
• The Marketplace Fairness Act grants states the authority
to compel
that they
will pass.
online and catalog retailers ("remote sellers"),Something
no matterlike
where
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 eightyfive 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.
19
http://www.marketplacefairness.org/what-is-the-marketplace-fairness-act/
20
http://www.streamlinedsalestax.org/uploads/images/state%20map%202014_1_1.jpg
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 outof-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.
21
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?
22
Another Gas Tax Example S'
• 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.
Who Pays?
Price ↑ a little;
Quantity ↓ a lot
Most is paid by
producers.
S
$
$1
P1
Consumer
P0
Total (yellow)
D
by producer
Q1
Q0
23
Quantity
Another Gas Tax Example S'
• 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.
Who Pays?
S
$
P1
$1
Tax
Collected
P0
D
Price ↑ a lot;
Quantity ↓ a little
Most is paid by
consumers.
WHY?
Q1
Q0
24
Quantity
Excess Burden of Excise Taxes – Gen’l
Eq’m
Other Goods
• 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.
• We can’t measure U1 – U2,
but we CAN, in principle,
measure the cost in $ of
this excess burden.
EB is like DW Loss
U1
U2
U0
Excess
Burden
25
Gasoline
Even if Q doesn’t change! – Gen’l Eq’m
Other Goods
• 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.
• 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.
U0
U1
U2
26
Gasoline