Taxes

1. Taxes

2. Preview • Two ways to implement at tax • Tax the producer • Tax the consumer • But who pays the tax by law, isn’t who really pays the tax in practice. • Show the effect of a tax on supply and demand. • Show the effect on equilibrium • Show welfare losses from taxation • Show who pays for those losses

3. Tax on the consumer • Suppose every time you purchase a good at price P, you also had to pay a tax T?

4. Demand • At price P, you wanted to buy Q. P P D Q Q

5. Demand • At price P, you wanted to buy Q. • With a tax of T, the producer would have to charge P-T for you to still want to by Q. P P T P-T D Q Q

6. Demand • At price P, you wanted to buy Q. • With a tax of T, the producer would have to charge P-T for you to still want to by Q. • Thus, a unit tax of T causes the demand curve to shift down everywhere by T. P P T D D` Q Q

7. Equilibrium • Demand decreased • Quantity demanded decreased P S P* T D D` Q* Q

8. Equilibrium • Demand decreased • Quantity demanded decreased • The price charged by the firm decreased. P S T P* D D` Q* Q

9. Equilibrium • Demand decreased • Quantity demanded decreased • The price charged by the firm decreased. • The price paid by the consumer increased P S P*+T T T P* D D` Q* Q

10. Pre-Tax Surplus P S P* D Q* Q

11. Post-Tax Consumer Surplus • Before the tax, consumer surplus was a + b + c +d +e. P S a b P*+T c d e T P* D D` Q* Q

12. Post-Tax Consumer Surplus • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b P S a b P*+T c d e T P* D D` Q* Q

13. Post-Tax Producer Surplus • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. P S a b P*+T c d e h i f T P* g D D` Q* Q

14. Post-Tax Producer Surplus • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. • After the tax, producer surplus is g. P S a b P*+T c d e h i f T P* g D D` Q* Q

15. Government Revenue • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. • After the tax, producer surplus is g. • Tax revenue is T*Q*: c + d + f + h. P S a b P*+T c d e h i f T P* g D D` Q* Q

16. Government Revenue • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. • After the tax, producer surplus is g. • Tax revenue is T*Q*: c + d + f + h. • The consumer provided c and d, while the producer provided f and h. P S a b P*+T c d e h i f T P* g D D` Q* Q

17. Social Losses of Taxation • The government could give c and d back to consumers. • The government could give f and h back to producers. • BUT, e and i would be lost forever. • e + i is the deadweight loss of taxation. P S P*+T c d e h i f T P* D D` Q* Q

18. Equilibrium and the Firm MC P P ATC S P* P = MR P* D D` Q* q* Q Q

19. Equilibrium and the Firm MC P P ATC S P = MR=AR P* D D` Q* q* Q Q

20. Equilibrium and the Firm MC P P ATC S P = MR=AR P* D D` Q* q* Q Q Profit has gone down.

21. Tax on the producer • Suppose instead, every time a good was sold, the producer had to pay a tax of T. • Essentially, the marginal cost of producing each unit has increased by T.

22. Supply S` • Since the supply curve is the firm’s marginal cost curve, if the MC curve shifts up by T, then S shifts up by T. P S D Q

23. Supply S` • Since the supply curve is the firm’s marginal cost curve, if the MC curve shifts up by T, then S shifts up by T. • Supply decreased • “at any price paid by consumers, firms are willing to supply less.” P S D Q

24. Supply S` • Supply decreased • Quantity supplied decreased P S P* D Q* Q

25. Supply S` • Supply decreased • Quantity supplied decreased • Equilibrium price increased. P S P* D Q* Q

26. Supply S` • Supply decreased • Quantity supplied decreased • Equilibrium price increased. • Since the firm has to pay T for every unit sold, the price the firm receives (P* - T) decreased. P S P* T P*-T D Q* Q

27. Pre-Tax Surplus P S P* D Q* Q

28. Post-Tax Consumer Surplus S` • Before the tax, consumer surplus was a + b + c +d +e. P S a b T P* c d e P*-T D Q* Q

29. Post-Tax Consumer Surplus S` • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b P S a b T P* c d e P*-T D Q* Q

30. Post-Tax Producer Surplus S` • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. P S a b T P* c d e h i f P*-T g D Q* Q

31. Post-Tax Producer Surplus S` • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. • After the tax, producer surplus is g. P S a b T P* c d e h i f P*-T g D Q* Q

32. Government Revenue S` • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. • After the tax, producer surplus is g. • Tax revenue is T*Q*: c + d + f + h. P S a b T P* c d e h i f P*-T g D Q* Q

33. Government Revenue S` • Before the tax, consumer surplus was a + b + c +d +e. • After the tax, consumer surplus is a + b. • Before the tax, producer surplus was f + g + h + i. • After the tax, producer surplus is g. • Tax revenue is T*Q*: c + d + f + h. • The consumer provided c and d, while the producer provided f and h. P S a b T c d e h i f g D Q* Q

34. Social Losses of Taxation S` • The government could give c and d back to consumers. • The government could give f and h back to producers. • BUT, e and i would be lost forever. • e + i is the deadweight loss of taxation. P S T P* c d e h i f P*-T D Q* Q

35. Equivalence S` P P S S T P* P*+T c d e c d e h i h i f f P*-T T P* D D D` Q* Q* Q Q

36. Equivalence A “T shift up” in supply is the same as a “T shift down” in demand. The consumer pays P* in both cases. The consumer gets P* - T in both cases. S` P S T P* c d e h i f P*-T D D` Q* Q

37. Equivalence A “T shift up” in supply is the same as a “T shift down” in demand. The consumer pays P* in both cases. The consumer gets P* - T in both cases. S` P S T P* P*-T T D D` Q* Q The economic burden of the tax is independent of the statutory burden of the tax.