Tax Incidence

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Tax Incidence

• Economic of Public Policy
• PADM 625
• Ben Muse

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Key Points

• Focus on first part of Chapter 18
• Competitive markets
• Specific and ad valorem taxes
• Goods and factor markets

3
Key Points

• The parties on whom the tax is imposed may not be
  the parties who actually, ultimately, pay it
• Actual burden of the tax may be shared by
  different parties
• The division of the burden will depend on
  elasticities of supply and demand

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Key Points

• Allocation of burden doesnt depend on who pays
  the tax (consumer or producer for sales tax
  workers or firms for social security payroll tax)
• Similar incidence analysis can be applied to a
  subsidy

5
Key points

• Tax is borne completely by consumers if demand is
  perfectly inelastic
• and is borne completely by producers if supply is
  completely inelastic
• Application of elasticity analysis to factors of
  production

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A sales or excise tax is

• A tax on goods and services
• ad valorem vs specific
• usually paid to the government by businesses
• we will treat it as basically an increase in the
  cost of doing business

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Two types

• Specific
• a tax of some many dollars on each unit of the
  good sold
• so, 100/ton or 1/pack, etc.

• Ad valorem
• a percentage of the value of the goods or
  services sold
• so, 5 or 6

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Start with the axes
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Add the supply and demand curves
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Now impose the tax

• Assume a specific tax
• Perhaps a tax on alcohol or tobacco
• Assume the tax is to be paid to the government by
  merchants
• Basically, this is an increase in the merchants
  costs
• shift the supply curve up

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Shift the supply curve up
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Price rises, quantity falls
13
Price rise depends on demand curve
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Less elastic demand

• Means a higher price increase
• In extreme - perfectly inelastic demand means
  price rise equals the tax
• also means that quantity demanded drops

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Taxes are shared by buyer and seller

• Buyers may pay part of tax
• Sellers may pay part of tax
• The amounts paid by each depend on elasticity of
  demand
• This is called the incidence of the tax

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Remember this diagram
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PS stands for price to seller
18
Tax payments fall on buyer and seller
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Perfectly inelastic demand - consumers pay full
tax
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Things to note

• Amount sold drops
• price paid by buyers rises
• price received by sellers falls
• price rises less than the amount of the tax
• consumption change depends on elasticity of the
  demand curve

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More things to note

• Tax is shared by sellers and buyers
• who pays how much also depends on the elasticity
• tax revenues shouldnt be calculated based on
  original output

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• Question 1
• Consider a mineral that is in fixed supply, Qs4.
  The demand for the mineral is given by Qd
  10-2p, where p is the price per pound, and Qd is
  the quantity demanded. The government imposes a
  tax of 2 per pound on the consumer.

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• What does the supply curve look like?
• What does the demand curve look like?
• What is the price before the tax?

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The supply curve
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Demand and supply
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Price before the tax
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• What is the price after the tax?
• What is the price received by the producers?
• How much revenue is raised?

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• Question 2
• Consider a small town in which workers are highly
  mobile (i.e., they can be induced to leave the
  town if opportunities elsewhere improve
  slightly). What do you think the incidence of a
  tax on wages in that town would be, compared to
  the incidence in a town in which workers are
  immobile?

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• Question 4
• It is often asserted that gasoline taxes used to
  finance highway construction and maintenance are
  fair because they make users of roads pay for
  them. Who do you think bears the burden of such
  taxes?