1、Tax Incidence,Also known as, who bears the burden of taxation?,2,What do we get from a first pass at the data?,A first (partly nave) pass indicates that U.S. federal income tax is paid primarily by the rich: in 2006 data, the top 20% of income earners paid 84.2% of the taxes, and the top 1% alone pa
2、id 36.7% of the taxes. The bottom half of income earners paid negative (!) taxes in total. This reflects both the progressivity of the tax system, and the concentration of income in the United States.,3,4,5,6,Total tax burdens: Still a first pass.,Federal personal income taxes are just part of the f
3、ederal tax system. How do we assign burdens of Federal corporate income taxes Payroll taxes Excise taxes Estate and gift taxes Other taxes (e.g., tariffs) The payroll tax is particularly problematic, since subsequent benefits are tied to tax payments. Not clear whether it should be included. One way
4、 of doing this: assign tax burdens based on arbitrary assumptions (corporate tax paid by owners of capital, payroll tax paid by workers, excise taxes paid by consumers, estate tax paid by decedents). This assignment produces:,7,8,9,Might anything be wrong here?,Well yes, because many assumptions and
5、 potentially problematic definitions have gone into calculating these tax burdens. For example, who says that the burden of estate taxes falls only on those who receive, and not those who give? Or that the corporate tax burden is borne only by owners of capital, and not by workers or consumers? The
6、fundamental point is that it is a mistake to attribute tax burdens to those who remit the taxes, since the burden may lie elsewhere. For example, the burden of an excise tax may in part be borne by the seller, in the form of lower sales prices. Or if the government increases your tax rate, your wage
7、 may rise in part to compensate you, reflecting that, in the market, providers of services like yours will demand certain after-tax compensation. It is natural to forget about the determination of income in thinking about tax burdens, but it is a mistake to do so, since taxes may well influence rela
8、tive pretax incomes. Fortunately, there are undying principles that can and will guide our inquiry into who actually bears tax burdens.,10,Tax Incidence: Five Principles,Who cares who pays? People pay taxes. Inelasticity is expensive. Small things can be big. In general, anything can happen.,11,Who
9、cares who pays?,This is the principle that it does not matter for anything whether the seller or the buyer has the formal tax obligation, and therefore remits the revenue to the government. Total tax revenue is unaffected either way. Efficiency is the same either way. The burden on consumers is the
10、same. The burden on sellers is the same. In short, it really does not matter. Note: this is NOT intuitive. Social Security example: tax is paid half (7.65%) by employees, half (7.65%) by employers BUT THIS DIVISION DOES NOT MATTER, as long as prices are set by supply and demand. Proposed Social Secu
11、rity reforms in 1990 and at other times. Recent temporary reductions in worker contributions, though not employer contributions, to social security payroll taxes.,12,How can we be sure this works?,Think about there being a “tax jar” at the counter. In one regime, the customer pays for the good, then
12、 puts taxes in the jar. Alternatively, the seller can collect the tax, then the seller puts the tax in the jar. The difference between the customer paying the tax, or the seller, is clearly unimportant. This relies on the idea that prices are determined by supply and demand. In a competitive market
13、economy, such as that in the United States, this is how prices are determined. Occasionally prices are set some other way, perhaps by government regulation (e.g., as with a fixed minimum wage, or with regulated prices for utilities or other services), in which case it may well matter who remits the
14、taxes. And as a practical issue it may well make more sense to have certain parties remit taxes rather than others, since they can do so at lower cost, or can be audited with greater ease. But note that even these administrative considerations are largely about remittance, not attribution. The socia
15、l security tax, for example, could be “paid” 75% by employers and 25% by employees without affecting who remits and who keeps records.,13,What happens when a tax is imposed?,If the tax is imposed on buyers, the demand curve shifts DOWN. The demand curve shifts down because if consumers previously wa
16、nted 80 units at a price of $20/unit, then, with a $1/unit tax, they will want 80 units at a price of $19/unit. This is because the demand curve tells you what people want, not necessarily what they can get. Note the implication: the demand curve does NOT shift left, NOR does it shift to the southwe
17、st. If the tax is imposed on sellers, the supply curve shifts UP. If I wanted to sell 300 units at a price of $55/unit, I now want to sell 300 units at $56/unit. Example: in a competitive market, the supply curve is the marginal cost curve. Taxes raise the marginal cost of selling a good, thereby ra
18、ising the supply curve.,14,Price per gallon (P),P1 = $1.50,Quantity in billions of gallons (Q),Q1 = 100,A,D,S1,(a),(b),A,D,S1,S2,C,P2 = $1.80,Q2 = 90,$0.50,$2.00,Consumer burden = $0.30,Supplier burden = $0.20,Price per gallon (P),Quantity in billions of gallons (Q),B,P1 = $1.50,Initially, equilibri
19、um entails a price of $1.50 and a quantity of 100 units.,A 50 cent tax shifts the effective supply curve.,The burden of the tax is split between consumers and producers,15,P2 = $1.30,P1 = $1.50,Q1 = 100,Q2 = 90,D1,S,D2,$1.00,$0.50,A,B,C,Supplier burden,Consumer burden,Price per gallon (P),Quantity i
20、n billions of gallons (Q),Imagine imposing the tax on demanders rather than suppliers.,The new equilibrium price is $1.30, and the quantity is 90.,The quantity is identical to the case when the tax was imposed on the supplier.,The economic burden of the tax is identical to the previous case.,16,OK,
21、so it works.,Principle #1 works because prices are determined by the intersection of demand and supply. It works even if markets are monopolized, consumers are silly (though they are aware of taxes), or other problems are present, as long as there is unconstrained price determination based on demand
22、 and supply.,17,Principle #2: People pay taxes.,This principle serves as a reminder that organizations (for example, corporations or cities) do not themselves ultimately shoulder the burden of taxation. Consider the tax on corporate income. The (considerable) burden of this tax must be borne by one
23、or more of: Owners of corporate shares (lower share values, reduced dividends). Owners of capital in general (lower rates of return). Workers (lower wages). Consumers (higher prices for goods they buy). Foreigners. Other people. When you get right down to it, economics is all about people.,18,Princi
24、ple #3: Inelasticity is expensive.,The burden of a tax is borne by the side of the market (demand or supply) that is less elastic (i.e., less price sensitive). In an extreme case of perfectly inelastic demand, the burden of the tax is borne by buyers entirely (and not at all by sellers). In the oppo
25、site extreme of perfectly elastic demand, the burden of the tax is borne by sellers entirely. (Note that consumers do not bear the burden of the tax even though they wind up reducing their purchases).,19,P2 = $2.00,P1 = $1.50,Q1 = 100,D,S1,S2,$0.50,Quantity in billions of gallons (Q),Price per gallo
26、n (P),Consumer burden,With perfectly inelastic demand, consumers bear the full burden.,20,P1 = $1.50,Q1 = 100,Q2 = 90,D,S1,S2,$0.50,Price per gallon (P),Quantity in billions of gallons (Q),$1.00,Supplier burden,With perfectly elastic demand, producers bear the full burden.,21,Why does it work this w
27、ay?,With inelastic demand, the total quantity does not change after the tax is imposed. Since you have to pay the suppliers a certain amount to get them to sell you this quantity, there is no scope for shifting the burden onto sellers. Hence the burden falls on buyers. With perfectly elastic demand,
28、 the price that consumers face cannot change, since they will simply purchase other substitutes, hence consumers do not bear the burden of the tax. A similar logic applies to sellers: inelastic supply implies that sellers bear the tax burden, elastic supply that buyers bear the tax burden.,22,P1 = $
29、1.50,Q1 = 100,S,D,Quantity in billions of gallons (Q),Price per gallon (P),Hence the price to consumers does not change.,Supply curve does not change when it shifts up.,23,D,P,Q,S1,S2,(a) Tax on steel producer,Q1,Q2,P1,P2,D,P,Q,S1,S2,(b) Tax on street vendor,Q1,Q2,P1,P2,A,B,A,B,Tax,Tax,Consumer burd
30、en,Consumer burden,More inelastic supply, smaller consumer burden.,More elastic supply, larger consumer burden.,24,How should one think about these burdens?,When the price rises, and its something I buy, then I lose. Likewise, when the price falls, and its something I sell, then I also lose. But how
31、 much do I lose can we make that more precise? Well, yes: consumers lose consumer surplus, and sellers lose producer surplus. The lost consumer plus producer surplus equals the total tax collected plus the deadweight loss produced by the tax.,25,Tax incidence in monopolized markets,Works roughly the
32、 same way as competitive markets, except that prices are determined by the intersection of MR (marginal revenue) and MC (marginal cost), rather than demand and MC. As a general matter, the burden of a tax will be borne partly by sellers and partly by buyers. Depending on the details of demand functi
33、ons, tax burdens may fall more heavily on sellers in monopoly markets than they do in the case of competitive markets. You get a smaller quantity reaction for a given tax, which in turn leads to a smaller effect on consumer price. Reflects that monopoly supply is somewhat less responsive to cost tha
34、n supply in competitive markets. For example, if a monopolist has a horizontal MC curve, then the price response to the imposition of a tax is less than one-for-one; if the market were instead competitive, with the same MC curve, the price response to a tax would instead be one-for-one.,26,Principle
35、 #4: Small things can be big.,This is the principle that a tax may have a very small effect on some market price (such as the price of labor, or the rate of interest), but nonetheless have a very large effect on tax burdens. Take an example: a tax on business activity in Rhode Island. (Note: Rhode I
36、sland is a very small part of a very large country.),27,Business tax in Rhode Island.,Make the following stylized assumptions: Rhode Island is very small (good assumption!) All output is produced by a combination of labor and capital. Labor is immobile: people live their whole lives in the states in
37、 which they are born. The total amount of capital in the United States is fixed, but capital is freely mobile between states. Then what happens when we tax businesses in Rhode Island? The after-tax rate of return to investing in businesses in Rhode Island CANNOT FALL, since if it did, capital owners
38、 would just invest in California, Florida, New York, or Texas instead. Hence the owners of Rhode Island businesses DO NOT bear the burden of the Rhode Island tax.,28,How does that work?,In order to keep capital in Rhode Island, it must be the case that the pre-tax rate of return to investing there r
39、ises when the tax is imposed. This happens because capital FLEES RHODE ISLAND and with less capital, the stuff that is left earns higher rates of return. So who bears the burden of the Rhode Island tax? Workers in Rhode Island! Why? Since capital does not bear the burden, workers are whats left (and
40、 workers cant leave, by assumption). With less capital in Rhode Island, labor becomes less productive, and wages fall to reflect that. By the way, this is what really happens!,29,What about the rest of the country?,The Rhode Island capital goes to California, where it has the effect of Slightly redu
41、cing the rate of return to capital in California and the rest of the country (greater supply of capital reduces returns earned by capital), and Wages rise slightly in California, since labor there is now more productive due to the added capital. Butarent these effects awfully small? After all, Rhode
42、 Island is tiny compared to California, and any effect on the rate of return might be to reduce it from (say) 7% to (say) 6.998%. Yes, except,30,Small things can be big!,The total effect of the Rhode Island tax change on capital returns in California is the product of the change in the rate of retur
43、n and the total amount of capital in CA. The first is tiny, the second is huge. Zero times infinity is not necessarily zero. In this case, it can be shown that a Rhode Island business tax that raises $100m will Reduce wages in Rhode Island by $100m. Reduce the return to capital in the whole United S
44、tates by $100m. (Why? Because we started by assuming that the total amount of capital in the United States is fixed. Since U.S. capital is inelastically supplied, capital bears the whole tax burden though since the amount of capital in Rhode Island is NOT fixed, but instead very elastic, that portio
45、n of the capital bears just a tiny tax burden.) Increase wages in the whole United States by $100m. (This because the total tax burdens have to sum to $100m.),31,Principle #5: In general, anything can happen.,What this principle means is that, In General Equilibrium, Anything Can Happen. What is gen
46、eral equilibrium? It is the state of all markets in the economy, not just one at a time. (One at a time is partial equilibrium.) Why can anything happen? Because in general equilibrium, everything affects everything else, and does so in two ways: Through supply. Through demand.,32,General equilibriu
47、m reasoning.,In analyzing tax policies (or any other policies) in general equilibrium, it becomes necessary to trace the effects that markets have on each other. Thus, for example, when a tax imposes a burden on buyers of a good (as would be the case, for example, if the supply of the good is extrem
48、ely elastic), we then ask what happens to their demands for other goods and services in the economy, and how their prices are affected. There can often be significant spillovers into other markets. Strictly speaking, it is necessary to find the effects of a tax (or other government policy) on all th
49、e prices and incomes in the economy, though in practice, we usually just look for the most important effects.,33,Can odd things happen? Well yes.,Consider the case of a tax on ground coffee. (This example is from Vickrey, 1960.) Say that the tax is paid by sellers. This can have the strange effect o
50、f actually reducing (!) the consumer price of ground coffee (and also reducing the consumer price of unground coffee beans). How might that work? Assume: coffee drinkers can buy either ground or bean coffee from the store, but ground is more convenient. Only problem is that the process of grinding c
51、offee in the store is very inefficient, in that lots of coffee is wasted (falls through cracks in the machine). This makes ground coffee more expensive, though its still worth it to many consumers who do not like the messiness of grinding coffee at home. Assume that consumers do not waste any coffee when they grind it at home, since they are so careful when they do so.,
