Taxation and Government Intervention

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Taxation and Government Intervention
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Taxation and Government Intervention

• Historical Perspective
• The Costs of Taxation
• The Benefits of Taxation
• Two Principles of Taxation
• Who Bears the Tax Burden

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Historical Perspective

• "The business of America is business."  (1925)
• "Public debt is a burden on all the people." 
  (1929)

Calvin Coolidge
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Historical Perspective

• The budget should be balanced not by more
  taxes, but by a reduction of follies.

Herbert Hoover
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Historical Perspective

• Wall Street crash in October, 1929 sends economy
  into 13 years of economic depression

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It was commonly accepted that governments should
provide fundamental goods and services needed by
society such as national defense, legislative and
judicial systems to protect private property
rights, and essential services and infrastructure
(basic education, roads, etc.) The private
business sector would provide all the rest.
Historical Perspective
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Historical Perspective

• Keynes suggests that government should attempt to
  influence economic outcomes through active fiscal
  policy changes.

J.M. Keynes (1883-1946)
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Historical Perspective

• Active Fiscal Policy Changes
• Alterations in government spending and taxing
  policies to either stimulate the economic growth
  and create jobs, or slow growth to fight
  inflation.

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Historical Perspective

• Employment Act of 1946
• Federal government took responsibility for
• Economic growth
• Full-employment
• Stable prices

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Historical Perspective
NewSchool
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Civil War
WW I
WW II

Korean Conflict
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Vietnam War
Percentage Fluctuations in Real GDP
0

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Financial Panics
Great Depression

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1860 65 70 75 80 85 90 95 1900 05
10 15 20 25 30 35 40 45 50 55
60 65 70 75 80 85 90 95 2000
Years
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Taxation and Government Intervention

• Historical Perspective
• The Costs of Taxation
• The Benefits of Taxation
• Two Principles of Taxation
• Who Bears the Tax Burden

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The Costs of Taxation

• Direct cost of revenue paid to government
• Loss of consumer and producer surplus
• Cost of administering the tax codes

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The Costs of Taxation
Price
20
S
10
D
2
Quantity
5
15
The Costs of Taxation
Price
20
S
10
D
2
Quantity
5
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The Costs of Taxation
Price
20
S
The difference between what consumers and
producers are willing and able to buy and sell a
for and the actual price is the consumer and
producer surplus.
Consumer Surplus
10
Producer Surplus
D
2
Quantity
5
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The Costs of Taxation
Price
20
15
14
Consumer surplus
10
Producer surplus
D
2
Quantity
5
18
The Costs of Taxation
Price
A
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Tax Revenue for Government B D B paid by
consumer D paid by producer
C
E
9
F
D
Quantity
5
4
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The Costs of Taxation
Price
A
14
Deadweight loss C E represent a welfare cost as
a result of the reallocation of resources due to
higher prices associated with tax.
B
C
E
D
9
F
D
Quantity
5
4
20
The Costs of Taxation
Price
14
9
D
Quantity
5
4
21
Effect of an Excise Tax
Taxation and Government Intervention
S
60
50
Price of Luxury Cars ( Thousands)
D
300 600 900
0
Quantity of Luxury Cars/Month
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Taxation and Government Intervention

• Political decisions can create disequilibrium
• Dairy Farmers use political pressure to receive
  prices that are above the equilibrium level.

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Taxation and Government Intervention
S
10.35
9.50
7.75
D
Quantity/Month (hundred pounds)
50
45
55
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Taxation and Government Intervention

• Political decisions can create disequilibrium
• In New York City the local government imposes
  rent control on certain rental properties.

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Taxation and Government Intervention
Rent Per Month
S
1,000
800
600
D
Quantity of Apartments
500
600
400
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Taxation and Government Intervention

• Historical Perspective
• The Costs of Taxation
• The Benefits of Taxation
• Two Principles of Taxation
• Who Bears the Tax Burden

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The Benefits of Taxation
What do we receive in return for taxes paid to
government?
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The Benefits of Taxation

• Government provides
• National Defense
• Legal and Judicial services
• Support for Education
• Health insurance for aged or infirmed
• Basic infrastructure roads, bridges, etc.
• A myriad of administrative services

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The Benefits of Taxation

• Measuring the benefits of government services is
  difficult because the benefits are not provided
  in a market setting (price determined by demand
  and supply).

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Taxation and Government Intervention

• Historical Perspective
• The Costs of Taxation
• The Benefits of Taxation
• Two Principles of Taxation
• Who Bears the Tax Burden

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Two Principles of Taxation

• The Benefit Principle (those receiving the
  benefit should pay the tax).
• The Ability to Pay Principle (those who are most
  able to bear the burden should pay the tax).

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Two Principles of Taxation

• Applying any principle of taxation often leads to
  debate because of the desire to avoid taxes and
  allow others to pay.
• To minimize the welfare loss of taxation,
  government should tax goods with inelastic demand
  or supply. (Broadly based taxes, such as income
  tax and sales tax do this).

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Taxation and Government Intervention

• Historical Perspective
• The Costs of Taxation
• The Benefits of Taxation
• Two Principles of Taxation
• Who Bears the Tax Burden

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Who Bears the Burden of a Tax?

• The person who pays the tax is not necessarily
  the same as the person who bears the burden of
  the tax.
• The burden of a tax depends upon the relative
  elasticity of demand and supply.

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The Costs of Taxation
Price
5 tax
14
consumer
producer
9
D
Quantity
5
4
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The Costs of Taxation
Price
5 tax
consumer
14
producer
9
D
Quantity
5
4
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The Costs of Taxation
Price
5 tax
14
consumer
producer
9
D
Quantity
5
4
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Taxation and Government Intervention
Social Insurance Taxes
Corporate Income Taxes
Individual Income Taxes
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Taxation and Government Intervention
Source U.S. Government Printing Office
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Taxation and Government Intervention
By statutory law social security tax is shared
50 is assessed to the employer and 50 is
assessed to the employee. The burden of the tax
falls on the employee because labor supply tends
to be less elastic than demand for labor.
Source U.S. Government Printing Office