Theory Guest Lecture 9 Taxation

1
Theory Guest Lecture 9Taxation

• Introductory Economics for the Treasury
• Dr. Paul Frijters

2
Outline

• Basic terms
• Australian and International tax statistics.
• The effects of different forms of taxation.

3
Basic tax terms

• Tax base what is deemed to be taxable. Examples
  incomes of individuals, assets of households.
• Tax unit the legal entity responsible for paying
  the tax. Examples individuals, couples,
  households, villages, provinces.
• Direct tax taxes paid by the unit directly to
  the tax authority. Example income tax, capital
  tax.
• Indirect taxes taxes that are transferred by one
  unit but paid by another. Example GST.

4
More terms

• Ad valorem taxes / proportional taxes taxes that
  are a of price, such as GST.
• Specific taxes a fixed tax per unit. Example
  airport tax.

5
Taxonomy




6
Historic trends in taxes
7
Commonwealth government tax revenue 2003-04
Fringe benefits tax 1.8
Indirect taxes 16.2
Agricultural Levies and Other taxes 0.9
Income tax Superannuation 3.3
Income tax Companies and PRRT 21.6
Income tax individuals and other withholding 56.
2

8
State and local government tax revenue 2001-02
Taxes on motor vehicles 6.4
Other 0.5
Insurance tax 4.2
Gambling tax 5.5
GST 40.6
Taxes on immovable property 14.1
Taxes on financial and capital transactions 14.4
Employers payroll tax 14..3

9
Australian tax breakdown
10
Total tax burden in the OECD as measured by
expenditure (outlays).
11
What is it spent on?
Note about 50 is transfers, 20 is investment,
the rest is public good provision and debt
payment.
12
Basic issues in effects of taxation

• 1. When taxing traded goods, does it matter
  whether you tax the buyer or the supplier for
  whom bears the ultimate tax burden?
• 2. What determines the welfare loss of taxation?

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Tax incidence \ tax burden

• Tax incidence is the study of who bears the
  burden of a tax.
• Taxes result in a change in the market
  equilibrium.
• Buyers pay more and sellers receive less,
  regardless of whom the tax is levied on.
• As we will see, the question who bears the tax
  burden has nothing to do with whom pays the tax
  directly but only with the elasticity of demand
  and supply.

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Impact of a 50 Tax on Buyers
Price of Medicine
Supply, S1
3.00
D1
Quantity of Medicine
0
100
15
Impact of a 50 Tax on Buyers
Price of Medicine
Supply, S1
3.00
A tax on buyers shifts the demand curve
downward by the size of the tax (0.50).
D1
Quantity of Medicine
0
100
16
Impact of a 50 Tax on Buyers
Price of Medicine
Supply, S1
3.00
A tax on buyers shifts the demand curve
downward by the size of the tax (0.50).
D1
D2
Quantity of Medicine
0
100
17
Impact of a 50 Tax on Buyers
Price of Medicine
Supply, S1
Price without tax
Equilibrium without tax
3.00
Equilibrium with tax
D1
D2
Quantity of Medicine
0
100
18
Impact of a 50 Tax on Buyers
Price of Medicine
Supply, S1
3.30
Equilibrium without tax
Tax (0.50)
2.80
Equilibrium with tax
D1
D2
Quantity of Medicine
0
100
90
19
Impact of a 50 Tax on Buyers
Price of Medicine
Supply, S1
Price buyers pay
3.30
Equilibrium without tax
3.00
2.80
Price sellers receive
Equilibrium with tax
D1
D2
Quantity of Medicine
0
100
90
20
Impact of a 50 Tax on Sellers
S1
3.00
Demand, D1
0
100
21
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S1
3.00
Equilibrium without tax
Demand, D1
0
100
22
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
S1
Equilibrium without tax
Demand, D1
0
100
23
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
S1
3.30
3.00
Demand, D1
0
100
90
24
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
Equilibrium
with tax
S1
3.30
3.00
Equilibrium without tax
Demand, D1
0
100
90
25
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
Equilibrium
with tax
S1
3.30
Tax (0.50)
3.00
Price without tax
2.80
Equilibrium without tax
Demand, D1
0
100
90
26
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
Price buyers pay
S2
Equilibrium
with tax
S1
3.30
Tax (0.50)
3.00
Price without tax
2.80
Equilibrium without tax
Price sellers receive
Demand, D1
0
100
90
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The Incidence of Tax

• In what proportions is the burden of the tax
  divided?
• How do the effects of taxes on sellers compare to
  those levied on buyers?

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The Incidence of Tax

• The answers to these questions depends on the
  elasticity of demand and the elasticity of supply.

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How is the burden of the tax divided?

• The burden of a tax falls more heavily on the
  side of the market that is less elastic.

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Elasticity and Tax Incidence

• The more inelastic the demand and the more
  elastic the supply, the larger the buyers share
  of the tax.
• The more elastic the demand and the more
  inelastic the supply, the larger the sellers
  share of the tax.

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Elastic Supply, Inelastic Demand
Price
Supply
Price without tax
Demand
Quantity
0
32
Elastic Supply, Inelastic Demand
Price
Supply
Tax
Price without tax
Demand
Quantity
0
33
Elastic Supply, Inelastic Demand
Price
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
Demand
Quantity
0
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Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic than demand...
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
Demand
Quantity
0
35
Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic than demand...
Price buyers pay
Supply
2. ...the incidence of the tax falls more heavily
on consumers...
Tax
Price without tax
Price sellers receive
Demand
Quantity
0
36
Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic than demand...
Price buyers pay
Supply
2. ...the incidence of the tax falls more heavily
on consumers...
Tax
Price without tax
Price sellers receive
Demand
3. ...than on producers.
Quantity
0
37
Inelastic Supply, Elastic Demand
Price
Supply
Price without tax
Demand
Quantity
0
38
Inelastic Supply, Elastic Demand
Price
Supply
Price without tax
Tax
Demand
Quantity
0
39
Inelastic Supply, Elastic Demand
Price
Price buyers pay
Supply
Price without tax
Tax
Demand
Price sellers receive
Quantity
0
40
Inelastic Supply, Elastic Demand
1. When demand is more elastic than supply...
Price
Price buyers pay
Supply
Price without tax
Tax
Demand
Price sellers receive
Quantity
0
41
Inelastic Supply, Elastic Demand
1. When demand is more elastic than supply...
Price
Price buyers pay
Supply
Price without tax
Tax
Demand
Price sellers receive
2. ...the incidence of the tax falls more
heavily on producers...
Quantity
0
42
Inelastic Supply, Elastic Demand
1. When demand is more elastic than supply...
Price
Price buyers pay
Supply
Price without tax
3. ...than on consumers.
Tax
Demand
Price sellers receive
2. ...the incidence of the tax falls more
heavily on producers...
Quantity
0
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The welfare loss of taxation

• Recap from previous lectures the more demand
  and/or supply respond to price changes, the
  larger the welfare loss of taxation.

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Tax Distortions and Elasticity
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Tax Distortions and Elasticity
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Implications

• 1. The more inelastic demand (supply), the more a
  tax is carried by the buyers (suppliers).
• 2. Taxing inelastic products changes the quantity
  traded less and hence affects total surplus less.
• Basic tax principle you tax that which cannot
  hide or run away (has substitutes) and is hence
  inelastically demanded or supplied.

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Debt savings Ricardian equivalence

• Idea when individuals are rational and
  infinitely lived, then government taxes do not
  impact on peoples consumption. They will simply
  save less with higher taxes and save more with
  lower taxes.
• In that case budget deficits are irrelevant for
  the economy.
• Only government expenditure impacts upon
  consumption the more the government spends, the
  less the individual.
• Nobody believes this to be the case but everyone
  knows the idea.