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Taxation

Taxation. Chapter 4c. Effects of Taxation on Economic Welfare. How are consumers affected by taxes? How are producers affected by taxes? What tax revenues are generated? Do taxes simply mean a transfer of income between one group of tax payers and another?. Market Equilibrium. Quantity.

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Taxation

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  1. Taxation Chapter 4c

  2. Effects of Taxation on Economic Welfare • How are consumers affected by taxes? • How are producers affected by taxes? • What tax revenues are generated? • Do taxes simply mean a transfer of income between one group of tax payers and another?

  3. Market Equilibrium Quantity Price Supply P E Demand Q E

  4. Welfare Without Taxes • dsdf S Consumer Surplus P E Producer Surplus D

  5. Supply Tax Demand The Costs of Taxation Price • A tax places a wedge between the price buyers pay and the price sellers receive. • Wedge=PT-PP PT PE Pp 0 Qty

  6. Supply Tax! Demand The Costs of Taxation • A tax places a wedge between the price buyers pay and the price sellers receive. • A tax results in a Deadweight Loss to society and the economy Loss! Qty

  7. Deadweight Loss of Taxation:Example • The current market situation of $0.50 per unit of a product results in 1,000 units being offered for sale and purchased. • A twenty cent tax ($0.20) is imposed on the suppliers. Sellers “collect” the tax and send the tax revenue to the government.

  8. Deadweight Loss of Taxation: Graphical Price $.50 Supply Demand 1000 Qty

  9. Deadweight Loss of Taxation: Graphical Price $.20 tax imposed Supply $1.00 PT=$.60 $.50 PP=$.40 Demand $.10 Qty 800 1000

  10. Deadweight Loss of Taxation: Example • The twenty cent tax results in new prices to consumers and producers: • Consumers pay $0.60 • Sellers receive $0.40 • The Tax Revenue from the imposed tax is =$160 i.e. [($0.20)*800]

  11. Deadweight Loss of Taxation: Graphical A Price Supply $.60 $.20 tax imposed B C $.50 E D $.40 F Demand Qty 800 1000

  12. Deadweight Loss of Taxation: Graphical • Without tax: Consumer Suplus = A+B+C • Without tax: Producer Surplus = D+E+F • Without tax: Total Surplus = A+B+C+D+E+F • With tax: Consumer Surplus = A • With tax: Producer Surplus = F • With tax: Tax Revenue = B+D • With tax Total Surplus = A+B+D+F

  13. Debate Over Effect of Income Taxes • Income taxes may be a tax on labor. • All taxes on wages and salaries result in almost 50% tax on the last dollar earned. • Does the income tax distort work decisions? • If the tax rate goes up, do people work less?

  14. Income Tax as % of Family Income, Projected 1999

  15. Debate Over Income Tax • Do workers adjust their work habits as wages increase, or decrease as when taxes rise? • Estimates of the tax elasticity of supply of labor services: • For men 25-60, near zero. • For women, large and approaching one.

  16. Debate Over Income Tax • Workers can adjust by working overtime, by finding second jobs. • Families may have second, even third earners. Those other family workers may have more flexibility than the primary earner. • The elderly may have more flexibility as a result of Social Security and pensions. • The Underground Economy

  17. Debate Over Income Tax • Tax on Consumption vs Income • Some economists and a number of politicians advocate eliminating the income tax in favor of consumption taxes. • Consumption could be difference between income and amount saved. C=DI-Saving • Encourages saving. But saving only postpones taxes; it does not avoid them.

  18. Debate Over Income Tax • Is income or consumption tax fairer? • In long-run, the tax burden of a consumption tax may be greater than an income tax. • Transition from income to consumption tax is a problem. • Relative efficiency of the two depends on elasticity of labor supply and tax elasticity of saving. • For debate on Tennessee tax issues see http://www.mtsu.edu/~berc/tnbiz/index.html

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