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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 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 Price Supply P E Demand Q E
Welfare Without Taxes • dsdf S Consumer Surplus P E Producer Surplus D
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
Supply Tax! Demand The Costs of Taxation S +T • 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
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.
Deadweight Loss of Taxation: Graphical Price $.50 Supply Demand 1000 Qty
Deadweight Loss of Taxation: Graphical Price S+Tax $.20 tax imposed Supply $1.00 PT=$.60 $.50 PP=$.40 Demand $.10 Qty 800 1000
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]
Deadweight Loss of Taxation: Graphical A Price Supply $.60 $.20 tax imposed B C $.50 E D $.40 F Demand Qty 800 1000
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
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?
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.
7. 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
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 the difference between income and amount saved. C=DI-Saving • Encourages saving. But saving only postpones taxes; it does not avoid them.
Debate Over Income Tax • Is income or consumption tax fairer? • In the 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