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Chapter 11

Chapter 11. Taxation, Prices, Efficiency, and the Distribution of Income. Lump-Sum Taxes. A Lump-sum tax is a fixed tax that is owed by everyone and is not subject to anything taxpayers can change. It is independent of income, consumption, or wealth.

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Chapter 11

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  1. Chapter 11 Taxation, Prices, Efficiency, and the Distribution of Income

  2. Lump-Sum Taxes • A Lump-sum tax is a fixed tax that is owed by everyone and is not subject to anything taxpayers can change. • It is independent of income, consumption, or wealth. • An example is a Head Tax, which is constant for everyone.

  3. Figure 11.1 A Price Distorting Tax Versus A Lump-Sum Tax A T L Y* T Expenditure on Other Goods per Year (Dollars) YT E' E Y1 E'' U1 U2 U3 B' L' B 0 QT QL Q1 Gasoline per Year (Gallons)

  4. Unit Taxes • A unit tax adds to the price by a fixed amount. Examples include the 32 cents per pack of cigarettes and 24 cents per gallon of gasoline in federal taxes.

  5. Tax Terms • The Gross Price (PG) is the price paid by consumers. • The Net Price (PN) is the price received by producers after the tax is paid. • PN = PG – T

  6. Figure 11.2 Impact of A Unit Tax on Market Equilibrium ST = MSC + $0.25 S = MSC Tax Revenue C PG 1.15 = Excess Burden 1.00 B PN 0.90 = Price (Dollars) A T = $0.25 D = MSB DQ Q1 Q* 0 Gasoline per Year (Gallons)

  7. Excess Burden of a Unit Tax DWL = 1/2TQ =1/2 ×T2 × (Q*/P*) × (ESED)/(ES – ED) Es = price elasticity of supply ED= price elasticity of demand Q* = pretax quantity P* = pretax market price

  8. Implication of the DWL Calculation • A doubling of the per-unit tax quadruples the Deadweight Loss.

  9. Figure 11.3 Excess Burden When Demand or Supply is Perfectly Inelastic A B Supply Demand Supply after Tax Supply Price Price Demand Net Price after Tax 0 q 0 q Quantity per Month Quantity per Month

  10. Efficiency Loss Ratio of a Tax • The Efficiency Loss Ratio is the deadweight loss per dollar of revenue raisedDWL/R . • Estimates of U.S. tax system place ELR at between 25 and 40 cents per dollar of tax revenue raised.

  11. Incidence of a Tax • The Legal Incidence is theburden of a tax as determined by those who are legally obligated to pay the tax.  • The Economic Incidence isthe burden of a tax as determined by how much the parties are affected in terms of paying higher prices, or receiving lower prices.

  12. Shifting of Taxes • Forward Shifting is the transfer of the burden of a tax from the seller, who is legally obligated to pay it, to a buyer.  • Backward Shifting is the transfer of the burden of a tax from the buyer, who is legally obligated to pay it, to a seller.

  13. Ad-Valorem Taxes • Ad-Valorem Taxes add a fixed percentage to the price of a good. • The primary example is sales taxes.

  14. Incidence of an Ad-valorem tax DWL = 1/2 TQ T = tPG = 1/2 t2PG2(Q*/P*) × (ESED)/(ES – ED) if t is very small, then this is approximately = 1/2 t2P*Q*(ESED)/(ES – ED)

  15. Using Excise Taxes on Alcohol to Internalize Externalities • Federal taxes on alcohol are per-unit rather than ad-valorem. • 32 cents per six-pack of beer ($.10/oz) • $13.50 per gallon of 100 proof liquor ($.25/oz) • Externalities associated with alcohol are estimated at $0.48 per ounce (of hard liquor).

  16. Figure 11.4 Impact of an Ad Valorem Tax on Labor S Excess Burden WG=5.20 E 5.00 E' WN=4.16 Wages (Dollars) D = Gross Wage Tax Revenue Net Wage= WG (I – t) 0 Q1 Q* Labor Hours per Year

  17. Figure 11.5 Incidence of a Tax Collected From Buyers S = MSC PG + T =1.15 C B 1.00 A PG = 0.90 Price (Dollars) D = MSB D' = MSB – T Q1 Q* 0 Price per Year (Gallons)

  18. Figure 11.6 The More Inelastic the Demand, the Greater the Portion of a Tax Borne by Buyers S = MC + $0.25 S = MC E C 1.20 1.15 1.00 B .95 A .90 Price (Dollars) D’ DQ’ D DQ’ 0 Q1 Q2 Q* Gasoline per Year (Gallons)

  19. Figure 11.7 Impact of a Tax on a Good with a Perfectly Elastic Supply E' MC + T = S' 60 Price (Cents) E MC = S' 50 D Q* 0 Housing per Month Square Feet Q 1

  20. Figure 11.8 Tax Incidence When Market Supply is Perfectly Inelastic S E WG* tw* Wages (Dollars) F WN= WG*(1-t) D = W WN= WG*(1-t) Q* 0 Labor Hours per Year G

  21. Government Taxes and Expenditures and the Distribution of Income • The Tax Incidence iswho bears the burden of a tax.  • The Expenditure Incidence is who receives the benefits of a government program. • The Budget Incidence is the net analysis of a program’s tax and expenditure incidence. • The Differential Tax Incidence is the change in the tax incidence that results from substituting one equal yield tax for another.

  22. The Lorenz Curve • The Lorenz Curve maps the cumulative percentage of households against their cumulative percentage of income.

  23. Figure 11.12 A Lorenz Curve A Area B Area E 100 Line of Equal Distribution 75 y 60 Percentage of Real Income 50 25 20 10 5 x D 3 10 25 50 75 100 0 Percentage of Households

  24. The Gini Coefficient • The Gini Coefficient is the ratio of the area between the Lorenz curve and the perfect equality line (Area A in the previous slide) to the area under the perfect equality line (Areas A and B).

  25. Income Category (in quintiles) Effective Tax Rate (percent) Lowest 4.5 Second 13.3 Third 18.9 Fourth 22.1 Highest 28.7 Effective Tax Rates for All Federal Taxes, 1998

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