1、Tax Incidence and the Efficiency Cost of Taxation,Topic 9,Outline,The Economics of Taxation The role of taxation. The main types of taxation.,Outline,The Economics of Taxation The role of taxation. The main types of taxation. The Efficiency Cost of Taxation Marginal excess burden. Marginal cost of p
2、ublic funds.,Outline,The Economics of Taxation The role of taxation. The main types of taxation. The Efficiency Cost of Taxation Marginal excess burden. Marginal cost of public funds. Tax Incidence Formal and effective incidence. Tax capitalisation.,Outline,The Economics of Taxation The role of taxa
3、tion. The main types of taxation. The Efficiency Cost of Taxation Marginal excess burden. Marginal cost of public funds. Tax Incidence Formal and effective incidence. Tax capitalisation. Equity: Efficiency Trade offs in the design of the Tax System The structure of income taxes. Trade offs btwn equi
4、ty and efficiency. Income distribution and the structure of commodity taxes.,1. The Role of Taxation,One potential classification of government functions from an economic perspective would be Efficiency To reduce distortions in competition. To alleviate the problems of incomplete markets,1. The Role
5、 of Taxation,One potential classification of government functions from an economic perspective would be Efficiency To reduce distortions in competition. To alleviate the problems of incomplete markets Equity To provide merit goods To alleviate poverty.,1. The Role of Taxation,One potential classific
6、ation of government functions from an economic perspective would be Efficiency To reduce distortions in competition. To alleviate the problems of incomplete markets Equity To provide merit goods To alleviate poverty. Stabilization (Macroeconomic Management) To manage risks individuals face (insuranc
7、e). Macroeconomic stabilization,Taxation has a role in each of these,Efficiency Controls externalities. Raises revenue for the provision of public goods. Equity Can redistribute income Can generate revenues that provide other forms of poverty alleviation. Stabilization A key instrument in controllin
8、g aggregate demand And the balance of trade,Taxation and Politics,Tax policy is highly politicised (an important election issue).Taxes signal societies values and approval/disapproval.Often there are intertemporal issues (balancing the budget today versus long term growth).Hidden taxes,What are the
9、criteria for a good tax system?,Fairness Horizontal Equity Vertical Equity,What are the criteria for a good tax system?,Fairness Horizontal Equity Vertical Equity Efficiency Minimize the excess burden Poll tax Fiscal neutrality The correction of externalities,What are the criteria for a good tax sys
10、tem?,Fairness Horizontal Equity Vertical Equity Efficiency Minimize the excess burden Poll tax Fiscal neutrality The correction of externalities Compliance and Administration Costs Compliance Costs = time, money inconvenience Administration costs,UK Fiscal Revenues 2003-04 = 407 bn,Income Tax 122.1
11、30%,UK Fiscal Revenues 2003-04 = 407 bn,Income Tax 122.1 30% Corporation Tax 30.8 7.6%,UK Fiscal Revenues 2003-04 = 407 bn,Income Tax 122.1 30% Corporation Tax 30.8 7.6% National Insurance 74.5 18.3% Other Inland Revenue 13.0 3.2%,UK Fiscal Revenues 2003-04 = 407 bn,Income Tax 122.1 30% Corporation
12、Tax 30.8 7.6% National Insurance 74.5 18.3% Other Inland Revenue 13.0 3.2% VAT 66.6 16.4% Excise Duties fuel 23.0 5.6% - tobacco 8.0 2.0% - alcohol 7.4 1.8% Other Customs & Excise 7.8 1.9%,UK Fiscal Revenues 2003-04 = 407 bn,Income Tax 122.1 30% Corporation Tax 30.8 7.6% National Insurance 74.5 18.3
13、% Other Inland Revenue 13.0 3.2% VAT 66.6 16.4% Excise Duties fuel 23.0 5.6% - tobacco 8.0 2.0% - alcohol 7.4 1.8% Other Customs & Excise 7.8 1.9% Business Rates 18.6 4.6% Council Tax 18.6 4.6% Vehicle Excise Duties 4.8 1.2% Other 11.9 2.9%,2. The Efficiency Costs of Taxation,Let us consider a Perfe
14、ctly Competitive Market.In the Long Run we might treat supply as being a horizontal straight line.,Equilibrium Before a Tax P*Q*,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Now Introduce a Tax,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply Curve including tax,P*,Tax,Q*,Some Obvious Consequ
15、ences,Consumers are paying more for each unit. (bad) Government is earning taxes. (might be good) Consumers are buying fewer units. (bad) Firms are making fewer units. (Neutral here as perfect competition implies they make zero profit)How do these costs and benefits add up?,Tax Revenue = Tax x Numbe
16、r of Units,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply Curve including tax,P*,Tax Revenue,Q*,Tax Revenue = Exactly the losses of consumers who still buy,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply Curve including tax,P*,Extra Paid by Consumers,Q*,This gain and loss exactly cancel
17、,The tax revenue= The extra paid by the consumers who still buy the taxed commodity.This is just a redistribution of income not an inefficiency.Summary:One effect of taxes is to transfer resources to the government.This reduces taxpayers disposable incomes.,The Substitution Effect,The price of this
18、commodity has risen relative to other commodities. This affects the incentives of the private sector. It distorts markets.,The Substitution Effect,The price of this commodity has risen relative to other commodities. This affects the incentives of the private sector. It distorts markets.It generates
19、“rents”A tax on tobacco makes growing it less attractive, therefore land prices fall.Tobacco machinery manufacturers lose as do tobacco workers. (Any input into a taxed commodity suffers.),This person was prepared to pay this much for the good.,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply C
20、urve including tax,P*,Q*,Actually had to pay less.,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply Curve including tax,P*,Q*,But after the tax did not buy the good so this value was lost,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply Curve including tax,P*,Q*,Adding all these values the
21、n gives societys total loss.,Price,Quantity,Demand Curve,Supply Curve,P*,Q*,Supply Curve including tax,P*,Q*,The Excess Burden,This inefficiency is called“An Excess Burden”“A Deadweight Loss”,The Excess Burden,This inefficiency is called“An Excess Burden”“A Deadweight Loss” A poll tax (or any non-pr
22、ice related tax) will not have these costs.A US estimate has 20-30% of every $ raised generates this much extra burden.,The Excess Burden,Marginal Excess Burden := The excess burden of an extra raised in taxes. (This is generally higher than the average burden, as should tax least distorting commodi
23、ties first.),The Excess Burden,Marginal Excess Burden := The excess burden of an extra raised in taxes. (This is generally higher than the average burden, as should tax least distorting commodities first.)A good tax system should impose taxes with least excess burden first.,The Excess Burden,Margina
24、l Excess Burden := The excess burden of an extra raised in taxes. (This is generally higher than the average burden, as should tax least distorting commodities first.)A good tax system should impose taxes with least excess burden first. Then move on to those taxes with higher excess burden.,The Exce
25、ss Burden,Marginal Excess Burden := The excess burden of an extra raised in taxes. (This is generally higher than the average burden, as should tax least distorting commodities first.)A good tax system should impose taxes with least excess burden first. Then move on to those taxes with higher excess
26、 burden. Optimally, the marginal excess burden of each tax instrument should be the same.,3. Tax Incidence,In other words who bears the burden of taxes?,3. Tax Incidence,In other words who bears the burden of taxes?An important distinction:Formal Incidence: Who is legally obliged to pay the tax.Effe
27、ctive Incidence: Who actually bears the burden of the tax?,3. Tax Incidence,In other words who bears the burden of taxes?An important distinction:Formal Incidence: Who is legally obliged to pay the tax.Effective Incidence: Who actually bears the burden of the tax?These differ because prices can chan
28、ge as a result of a tax.,Taxes On Business,All taxes formally incident on business will have their final incidence on customers, shareholders and employees:,Taxes On Business,All taxes formally incident on business will have their final incidence on customers, shareholders and employees:Sales Taxes
29、Are Passed on and affect prices and customers also output and employees.,Taxes On Business,All taxes formally incident on business will have their final incidence on customers, shareholders and employees:Sales Taxes Are Passed on and affect prices and customers also output and employees.Profits Tax
30、Affect shareholders and investment decisions (suppliers of capital).,Taxes On Business,All taxes formally incident on business will have their final incidence on customers, shareholders and employees:Sales Taxes Are Passed on and affect prices and customers also output and employees.Profits Tax Affe
31、ct shareholders and investment decisions (suppliers of capital).Asset Taxes Affect investment decisions.,Effective Incidence is all that Matters to an Economist,Who is legally obliged to pay a tax is largely irrelevant if the taxed individuals can take actions to mitigate the effects the tax has.,Th
32、e Effect of a Sales Tax on a Market,A market before a tax is imposed at equilibrium,Price,Q,s,Q,D,The Effect of a Sales Tax on a Market,The tax raises the price paid by consumers. It lowers the price received by suppliers.,Price,Q,s,Q,D,TAX,Why Does this Happen?,Suppose the firms tried to raise thei
33、r prices and pass on all the tax increase to the consumers, then:,Why Does this Happen?,Suppose the firms tried to raise their prices and pass on all the tax increase to the consumers, then:(1) The higher price for consumers would mean they would choose to buy less.,Why Does this Happen?,Suppose the
34、 firms tried to raise their prices and pass on all the tax increase to the consumers, then:(1) The higher price for consumers would mean they would choose to buy less.(2) However, the firms would still want to supply the same amount.,Why Does this Happen?,Suppose the firms tried to raise their price
35、s and pass on all the tax increase to the consumers, then:(1) The higher price for consumers would mean they would choose to buy less.(2) However, the firms would still want to supply the same amount.(3) The market has Supply Demand and prices will fall.,Why Does this Happen?,Suppose the firms tried
36、 to raise their prices and pass on all the tax increase to the consumers, then:(1) The higher price for consumers would mean they would choose to buy less.(2) However, the firms would still want to supply the same amount.(3) The market has Supply Demand and prices will fall.(4) Thus prices for firms
37、 will fall until Supply(Price less tax) = Demand (Price including tax),The Effect of a Sales Tax on a Market,Notice also less goods are produced.Some consumers dont buy at the higher price.Some sellers dont produce at the lower price.,Price,Q,s,Q,D,This reduces consumer surplus and producer surplus,
38、P,Q,s,Q,D,Lost consumer surplus,This reduces consumer surplus and producer surplus,P,Q,s,Q,D,Lost consumer surplus,Lost producer surplus,But generates tax revenue,P,Q,s,Q,D,Giving a net loss in value of t xQ,t,DQ,P,Q,s,Q,D,WHO PAYS THE TAX?,When buyers are price sensitive “demand is elastic” it is t
39、he sellers who pay the tax.,WHO PAYS THE TAX?,When buyers are price sensitive “demand is elastic” it is the sellers who pay the tax.,WHO PAYS THE TAX?,When buyers are price sensitive “demand is elastic” it is the sellers who pay the tax.,Tax Incidence on Buyers,WHO PAYS THE TAX?,When buyers are pric
40、e sensitive “demand is elastic” it is the sellers who pay the tax.,Tax Incidence on Buyers,Tax Incidence on Sellers,WHO PAYS THE TAX?,When sellers are price sensitive “supply is elastic” it is the buyers who pay the tax.,Tax Incidence on Buyers,Tax Incidence on Sellers,Questions:,Who pays the taxes
41、on Cigarettes Alcohol Petrol Labour?,Capitalization of Asset Taxes,If you own an asset and there is a permanent change in the assets price that reflects its changed tax status.,Capitalization of Asset Taxes,If you own an asset and there is a permanent change in the assets price that reflects its cha
42、nged tax status.When the owner of the asset comes to sell it they get an increased/decreased price that reflects its changed tax status. Say “Tax changes have been capitalized”,Capitalization of Asset Taxes,If you own an asset and there is a permanent change in the assets price that reflects its cha
43、nged tax status.When the owner of the asset comes to sell it they get an increased/decreased price that reflects its changed tax status. Say “Tax changes have been capitalized”Any subsequent owner receives no benefits/costs of the taxes.,Example,Land gets taxed:When you come to sell your land, it is
44、 of reduced value because of its tax liability.,Example,Land gets taxed:When you come to sell your land, it is of reduced value because of its tax liability. The price of land falls to include the total cost of the taxes you must pay on it.,Example,Land gets taxed:When you come to sell your land, it
45、 is of reduced value because of its tax liability. The price of land falls to include the total cost of the taxes you must pay on it.Buyers will pay less.,Example,Land gets taxed:When you come to sell your land, it is of reduced value because of its tax liability. The price of land falls to include
46、the total cost of the taxes you must pay on it.Buyers will pay less. Only the initial owner pays the tax.There is a reduction of taxes on housing.Only the owners at the time benefit.They gain twice (1) lower current taxes (2) higher eventual sale price.,Policy Implications,One off asset tax increase
47、s have very big costs to current owners.Even announcing a tax change is important as it will affect asset prices even if the tax change does not eventually occur.,4. Taxation and Equity,IF policy makes care about equity they will care about the winners and losers associated with tax changes.Recall A
48、 tax is progressive if payment as a % of income increases as income rises. A tax is regressive if payment as a % of income decreases as income rises. A tax is neutral if payment as a % of income constant as income rises.,Distributional Effects of Taxes,We can assess the distributional effects of one tax or of the tax system as a whole.The overall incidence is more important than the effects of single taxes. But introducing progressive taxes may improve a regressive system. Remember it is still important to focus on the economic incidence of taxes not the formal incidence.,
