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Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Lecture 6: Tax Incidence
October 1, 2019
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Overview
Course Administration
Ripped From Headlines
Income and Substitution Effects, Revisited
Taxation Overview
Three Rules of Tax Incidence
Tax Incidence Extensions
General Equilibrium Tax Incidence
Empirical Incidence of Taxation in the US
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Course Administration
1. Problem Sets• PS 6 posted• Returning PS 4• PS 4 answers posted
2. Midterm• Last year’s midterm posted• Work through this and starred problems
3. Midterm review• 10/12, 10:30 to 12:30• Duques 251• bring questions on old midterm
4. Anything else?
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Ripped from the Headlines
Next Week
Afternoon
Finder Presenter
Jason Cohn Roger JohnsonLydia Gebrehiwot Ryan Levin
Evening
Finder Presenter
Nahid Paiman John O’DonnellDidem Bayar James SetterlundShaun Stevenson Madison Grady
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Earned Income Tax CreditTax Credits for Low-Income Workers
• when benefits increase• substitution effect → more work• income effect → more work
• when benefits plateau• no change in price of work → no
substitution effect• income effect → more work
• when benefits decline• substitution effect → effective
wage declines → less work• income effect → more work
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Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Taxation Overview
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Many Types of Taxation
• Payroll tax
• Income tax
• Corporate tax
• Wealth taxes• Property tax• Estate tax
• Consumption tax• Sales tax• Excise tax – sales tax applied only to certain goods• Value added tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Type of Taxation Shifted Dramatically in US
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Key Tax Definitions
• Tax base: that on which the tax is levied• Base for property tax is value of properties• Base for sales tax is value of sales
• Tax rate: rate at which base is taxed• DC’s General tangible property and selected services tax rate is
5.75%• DC’s parking tax rate is 18%
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Three Rules
of Tax Incidence
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
You Levy a Tax – Who Pays?
The US income tax has shifted from a reliance on corporate taxesto income tax. Does this mean workers are paying more? “Whopays?” = tax incidence
Study the three rules of tax incidence
1. Statutory burden of tax 6= economic incidence of tax
2. Side of the market on which tax is imposed is irrelevant todistribution of tax burdens
3. Parties with inelastic supply or demand bear taxes
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
You Levy a Tax – Who Pays?
The US income tax has shifted from a reliance on corporate taxesto income tax. Does this mean workers are paying more? “Whopays?” = tax incidence
Study the three rules of tax incidence
1. Statutory burden of tax 6= economic incidence of tax
2. Side of the market on which tax is imposed is irrelevant todistribution of tax burdens
3. Parties with inelastic supply or demand bear taxes
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Types of Taxation
• specific excise tax: per unit tax
• ad valorem tax: tax that is a fixed percentage of the sale price
We will present everything with a specific excise tax. Results areequally applicable to an ad valorem tax.
U.S. excise tax examples
• federal tax on bows, archery equipment and and arrow shafts
• gasoline
• wine, varying by type, highest on “naturally sparkling”
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Types of Taxation
• specific excise tax: per unit tax
• ad valorem tax: tax that is a fixed percentage of the sale price
We will present everything with a specific excise tax. Results areequally applicable to an ad valorem tax.
U.S. excise tax examples
• federal tax on bows, archery equipment and and arrow shafts
• gasoline
• wine, varying by type, highest on “naturally sparkling”
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Key Phrases
Incidence ≡ who pays the tax, or who “bears the burden” of thetax.
• Statutory incidence: determined by who pays the tax to thegovernment
• Economic incidence: determined by whose economic resourceschange due to the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
1. Statutory Incidence 6= Economic IncidenceWhat Happens When you Levy a Tax on the Producer?
price pergallon of gas
quantity of gas in billions of gallons
S
D
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
1. Statutory Incidence 6= Economic IncidenceWhat Are the New Equilibrium Price and Quantity?
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
1. Statutory Incidence 6= Economic IncidenceHow Much Extra is the Consumer Paying?
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Qo
Po
Pn
Qn
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
1. Statutory Incidence 6= Economic IncidenceHow Much Does the Producer Sell for? And What Does He Keep?
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Qo
Po
Pn
Qn
consumer’s burden
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
1. Statutory Incidence 6= Economic IncidenceProducer and Consumer Share the Burden of the Tax
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Qo
Po
Pn
Qn
consumer’s burden
producer’sburden
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Defining Tax Burdens
• a burden is a bad thing for producers or consumers
• burden is expressed as a positive number
• think of it as the net effect of positive and negative pricechanges from the tax
• from the producer and consumer viewpoint separately
• producer and consumer tax burden sum to the amount of thetax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Defining Tax Burdens, Tax on Producer
• consumer tax burden= (post-tax price - pre-tax price) + per-unit tax payment byconsumer= benefit/loss in price change to consumer + per-unit taxpayment by consumer= (Pn − Po)+ per-unit tax payments by consumers= Pn − Po
• producer tax burden= (pre-tax price - post-tax price) + per-unit tax payment byproducer= per-unit tax payment by producer + benefit/loss in pricechange to producer= per-unit tax payments by producers −(Pn − Po)= tax− (Pn − Po)
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Defining Tax Burdens, Tax on Producer
• consumer tax burden= (post-tax price - pre-tax price) + per-unit tax payment byconsumer= benefit/loss in price change to consumer + per-unit taxpayment by consumer= (Pn − Po)+ per-unit tax payments by consumers= Pn − Po
• producer tax burden= (pre-tax price - post-tax price) + per-unit tax payment byproducer= per-unit tax payment by producer + benefit/loss in pricechange to producer= per-unit tax payments by producers −(Pn − Po)= tax− (Pn − Po)
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Writing the New Supply Curve
• Suppose that the supply curve before the tax is Q = 2P − 2.
• What is the new supply curve that includes a tax of $2/unit?
• Note that P-intercept on the new supply curve shifts upwardby the amount of the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Writing the New Supply Curve
• Suppose that the supply curve before the tax is Q = 2P − 2.
• What is the new supply curve that includes a tax of $2/unit?
• Note that P-intercept on the new supply curve shifts upwardby the amount of the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Writing the New Supply Curve: Equations
• The original supply curve is Q = 2P − 2• re-write in terms of P: P = 1 + (1/2)Q
• Note that Pat = Pbt + 2
• So we can write the after-tax supply curve as
P = 1 + (1/2)Q + 2
= 3 + (1/2)Q
• Note that you can re-write this as Q = 2P − 6
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
An Alternative Method to Finding New Supply
• The same original supply curve: QS = 2P − 2.
• How does the supplier perceive a tax of $2/unit?
• Pat = Pbt + 2→ Pbt = Pat − 2• where at denotes the after tax price bt the before tax price in
the supply curve
• We’d like to know market supply as a function of the taxedprice: Qtax
S = f (P)
QtaxS = 2Pbt − 2
QtaxS = 2(Pat − 2)− 2
QtaxS = 2Pat − 4− 2 = 2Pat − 6
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
An Alternative Method to Finding New Supply
• The same original supply curve: QS = 2P − 2.
• How does the supplier perceive a tax of $2/unit?• Pat = Pbt + 2→ Pbt = Pat − 2• where at denotes the after tax price bt the before tax price in
the supply curve
• We’d like to know market supply as a function of the taxedprice: Qtax
S = f (P)
QtaxS = 2Pbt − 2
QtaxS = 2(Pat − 2)− 2
QtaxS = 2Pat − 4− 2 = 2Pat − 6
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
2. Side of the Market on Which Tax is Imposed Irrelevantto Distribution of Tax Burden
• Suppose that the gasoline tax is levied on the consumer, notthe producer
• This means you buy some gas and send a check to thegovernment
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consumer Pays TaxWhat Happens When you Levy a Tax on the Consumer?
price pergallon of gas
quantity of gas in billions of gallons
S
D
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consumer Pays TaxWhat Are the New Equilibrium Price and Quantity?
price pergallon of gas
quantity of gas in billions of gallons
S
Dt
Qo
Po
D’
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consumer Pays TaxHow Much Lower Price Does the Producer Suffer?
price pergallon of gas
quantity of gas in billions of gallons
S
Dt
Qo
PoPn
Qn
D’
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consumer Pays TaxHow Much Does the Consumer Pay?
price pergallon of gas
quantity of gas in billions of gallons
S
Dt
Qo
PoPn
Qn
producer’sburden
D’
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consumer Pays TaxProducer and Consumer Share the Burden of the Tax
price pergallon of gas
quantity of gas in billions of gallons
S
Dt
Qo
PoPn
Qn
consumer’s burden
D’
producer’sburden
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consider Burdens
• When tax is levied on consumers• consumer burden
= t − (Po − Pn)• producer burden = Po − Pn
• total burden = t − (Po − Pn) + Po − Pn = t
• When tax is levied on producers• consumer burden = Pn − Po
• producer burden = t − (Pn − Po)• total burden = Pn − Po + t − (Pn − Po) = t
• Note that• In both cases, total burden is tax. t• The total price change faced by producers and consumers is
equal regardless of the side of the market with the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consider Burdens
• When tax is levied on consumers• consumer burden = t − (Po − Pn)• producer burden
= Po − Pn
• total burden = t − (Po − Pn) + Po − Pn = t
• When tax is levied on producers• consumer burden = Pn − Po
• producer burden = t − (Pn − Po)• total burden = Pn − Po + t − (Pn − Po) = t
• Note that• In both cases, total burden is tax. t• The total price change faced by producers and consumers is
equal regardless of the side of the market with the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consider Burdens
• When tax is levied on consumers• consumer burden = t − (Po − Pn)• producer burden = Po − Pn
• total burden
= t − (Po − Pn) + Po − Pn = t
• When tax is levied on producers• consumer burden = Pn − Po
• producer burden = t − (Pn − Po)• total burden = Pn − Po + t − (Pn − Po) = t
• Note that• In both cases, total burden is tax. t• The total price change faced by producers and consumers is
equal regardless of the side of the market with the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consider Burdens
• When tax is levied on consumers• consumer burden = t − (Po − Pn)• producer burden = Po − Pn
• total burden = t − (Po − Pn) + Po − Pn = t
• When tax is levied on producers• consumer burden = Pn − Po
• producer burden = t − (Pn − Po)• total burden = Pn − Po + t − (Pn − Po) = t
• Note that• In both cases, total burden is tax. t• The total price change faced by producers and consumers is
equal regardless of the side of the market with the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consider Burdens
• When tax is levied on consumers• consumer burden = t − (Po − Pn)• producer burden = Po − Pn
• total burden = t − (Po − Pn) + Po − Pn = t
• When tax is levied on producers• consumer burden = Pn − Po
• producer burden = t − (Pn − Po)• total burden = Pn − Po + t − (Pn − Po) = t
• Note that• In both cases, total burden is tax. t• The total price change faced by producers and consumers is
equal regardless of the side of the market with the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Consider Burdens
• When tax is levied on consumers• consumer burden = t − (Po − Pn)• producer burden = Po − Pn
• total burden = t − (Po − Pn) + Po − Pn = t
• When tax is levied on producers• consumer burden = Pn − Po
• producer burden = t − (Pn − Po)• total burden = Pn − Po + t − (Pn − Po) = t
• Note that• In both cases, total burden is tax. t• The total price change faced by producers and consumers is
equal regardless of the side of the market with the tax
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Visual Comparison of Burdens
Statutory incidence falls on
Producers
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Qo
Po
Pn
Qn
consumer’s burden
producer’sburden
Consumersprice pergallon of gas
quantity of gas in billions of gallons
S
Dt
Qo
PoPn
Qn
consumer’s burden
D’
producer’sburden
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax Wedge
• Tax wedge is sum of consumer and producer burdens
• Does the wedge change if the tax is levied on consumers?
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
In-Class Problem
The demand for rutabagas is Q = 1, 900− 100P, and the supply ofrutabagas is Q = 300P − 100.
1. Re-write one of the curves if the producer bears the statutoryincidence of a $4/unit tax on the sale of rutabagas.
2. Find the post-tax equilibrium price.
3. Find the consumer burden.
4. Find the producer burden.
5. Describe who bears the economic incidence of this tax.
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
3. Inelastic Party Bears Tax Burden
• Return to statutory tax burden levied on producers
• Consider inelastic demand
• Consider elastic demand
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Inelastic DemandWhat Does Inelastic Demand Look Like?
price pergallon of gas
quantity of gas in billions of gallons
S
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Inelastic DemandWhat is the Original Equilibrium P and Q?
price pergallon of gas
quantity of gas in billions of gallons
SD
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Inelastic DemandHow Does the Tax Shift Production?
price pergallon of gas
quantity of gas in billions of gallons
SD
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Inelastic DemandWhat Are the New Equilibrium P and Q?
price pergallon of gas
quantity of gas in billions of gallons
SD
S’
tax
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Inelastic DemandWhat is the Consumer’s Burden?
price pergallon of gas
quantity of gas in billions of gallons
SD
S’
tax
Qo=Qn
Po
Pn
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Inelastic DemandConsumer Cannot Run Away From Tax
price pergallon of gas
quantity of gas in billions of gallons
SD
S’
tax
Qo=Qn
Po
Pnconsumer’s burden
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Elastic DemandWhat Does Elastic Demand Look Like?
price pergallon of gas
quantity of gas in billions of gallons
S
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Elastic DemandHow Does Tax on Producer Shift Supply?
price pergallon of gas
quantity of gas in billions of gallons
S
DPo
Qo
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Elastic DemandWhat are the New Equilibrium P and Q?
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Po
Qo
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Elastic DemandProducer Bears Entire Burden
price pergallon of gas
quantity of gas in billions of gallons
S
D
S’
tax
Pn=Po
QoQn
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
And the Same is True for Supply
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax Incidence Extensions
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Three Extensions
1. Tax incidence in factor markets
2. (skip) Tax incidence in imperfectly competitive markets
3. (skip) Balanced budget tax incidence
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax Incidence in Factor Markets
• Suppose a tax is levied on a factor of production• tax on labor• tax on capital, such as land or steel
• Do wages decrease? Or do product prices increase?
• Who bears the burden of the tax?
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax Incidence in Factor Markets
• Suppose a tax is levied on a factor of production• tax on labor• tax on capital, such as land or steel
• Do wages decrease? Or do product prices increase?
• Who bears the burden of the tax?
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers
• Suppose the government decides to levy a tax on workers
• It can either charge workers via a payroll tax
• Or it can charge employers via a payroll tax
• Does it matter?
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)How Does Tax on Workers (=Producers) Shift Supply?
tax on workers
D
S
Qo
Po
tax on firms
D
S
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)What Are the New Equilibrium P and Q?
tax on workers
D
S
Qo
Po
t
S’
tax on firms
D
S
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)What is the Consumer (Labor Purchaser) Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)What is the Producer (Worker/Supplier) Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)What if Firms Pay the Payroll Tax?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)New Equilibrium P and Q?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)Producer (Worker) Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Pn
Qn
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)Consumer (Labor Purchaser) Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Pn
Qn
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax on Workers (Producers) vs. Tax on Firms (Consumers)Doesn’t Matter Who Pays the Tax
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Pn
Qn
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
But What If There is an Impediment to Adjustment?
• Suppose that there is a minimum wage
• Compare payroll tax levied on workers
• To payroll tax levied on employers
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageHow Does Tax on Workers=Producers Shift Supply?
tax on workers
D
S
Qo
Po
tax on firms
D
S
Qo
Po
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageWhat Are the New Equilibrium P and Q?
tax on workers
D
S
Qo
Po
t
S’
tax on firms
D
S
Qo
Po
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageWhat is the Consumer (Labor Purchaser) Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageWhat is the Producer (Worker Supplier) Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageWhat if Firms Pay the Payroll Tax?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageNew Equilibrium P and Q?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageWhat Quantity of Workers Can Firms Get?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Pdesired
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageWho Bears the Burden?
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Pdesired
Qmw
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax with a Minimum WageConsumers of Labor (Firms) Bear the Burden
tax on workers
D
S
Qo
Po
t
Qn
Pn
S’
tax on firms
D
S
Qo
Po
D’
t
Pdesired
Qmw
min wage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Summary of Taxes on Inputs
• Barriers to reaching the competitive market equilibrium canmatter for tax incidence
• Other barriers include workplace norms, such as norm for notcutting nominal wages
• More likely to see these features in input, rather than outputmarkets
• Therefore, the party on whom the tax is levied may mattermore in input than output markets
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium
Tax Incidence
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Considerations
1. Illustrative example
2. Issues to consider• time period• scope• spillovers between product markets
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Taxing Restaurants in Lexington, MA
• Suppose that the city of Lexington, MA passes a restauranttax
• Suppose that demand is perfectly elastic – you can go to thenext town to eat dinner
• Who bears the tax: restaurants or diners?
the restaurants
• And what happens to the quantity of restaurant mealsconsumed? declines
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Taxing Restaurants in Lexington, MA
• Suppose that the city of Lexington, MA passes a restauranttax
• Suppose that demand is perfectly elastic – you can go to thenext town to eat dinner
• Who bears the tax: restaurants or diners? the restaurants
• And what happens to the quantity of restaurant mealsconsumed?
declines
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Taxing Restaurants in Lexington, MA
• Suppose that the city of Lexington, MA passes a restauranttax
• Suppose that demand is perfectly elastic – you can go to thenext town to eat dinner
• Who bears the tax: restaurants or diners? the restaurants
• And what happens to the quantity of restaurant mealsconsumed? declines
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
But That’s Not the End
• A restaurant doesn’t pay taxes. In the end, people pay taxes.
• Restaurants use capital and labor – who bears the burden?
• Perhaps in the short run, labor is more elastic than capital, socapital bears the burden =⇒ restaurant owner makes lessmoney
• In the long run? restaurants leave, and landowners make lessmoney
• In economics, land is the one absolutely fixed thing
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
But That’s Not the End
• A restaurant doesn’t pay taxes. In the end, people pay taxes.
• Restaurants use capital and labor – who bears the burden?
• Perhaps in the short run, labor is more elastic than capital, socapital bears the burden =⇒ restaurant owner makes lessmoney
• In the long run?
restaurants leave, and landowners make lessmoney
• In economics, land is the one absolutely fixed thing
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
But That’s Not the End
• A restaurant doesn’t pay taxes. In the end, people pay taxes.
• Restaurants use capital and labor – who bears the burden?
• Perhaps in the short run, labor is more elastic than capital, socapital bears the burden =⇒ restaurant owner makes lessmoney
• In the long run? restaurants leave, and landowners make lessmoney
• In economics, land is the one absolutely fixed thing
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Issues: Time Period
Overarching rule for general equilibrium tax incidence is to followthe incidence until you get to a person.
• Long and short-run elasticities should differ – examples?
• In general, the longer the period, the more elastic all factorsare
• Except for land!
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Issues: Time Period
Overarching rule for general equilibrium tax incidence is to followthe incidence until you get to a person.
• Long and short-run elasticities should differ – examples?
• In general, the longer the period, the more elastic all factorsare
• Except for land!
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Issues: Time Period
Overarching rule for general equilibrium tax incidence is to followthe incidence until you get to a person.
• Long and short-run elasticities should differ – examples?
• In general, the longer the period, the more elastic all factorsare
• Except for land!
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Issues: Scope
• Scope of tax matters: elasticity of response to tax onrestaurants in Lexington is different than tax on restaurants inMassachusetts
• Is the supply of workers for the state-wide tax more or lesselastic?
less elastic
• Compare tax on soda to tax on sugar
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Issues: Scope
• Scope of tax matters: elasticity of response to tax onrestaurants in Lexington is different than tax on restaurants inMassachusetts
• Is the supply of workers for the state-wide tax more or lesselastic? less elastic
• Compare tax on soda to tax on sugar
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
General Equilibrium Issues: Cross-Product Market Effects
• Tax from one market could spill over in another – examples?
• Textbook uses restaurant meals and babysitters
• Think tax on internet and Netflix usage
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Tax Incidence in the United States
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Distributional Analysis of Taxes Depends on AssumptionsAbout Incidence
Here’s what two major non-partisan organizations assume
Tax Type Incidence
Income by households that pay themPayroll by workers (even the employer part)Excise shifted to prices, so in proportion to consumption
Corporateshifted to owners of capital, so in proportion tocapital income
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Today: Tax Incidence
• Tax incidence: who bears the burden of the tax
1. Statutory incidence 6= economic incidence2. Without impediments, side of the market on which the tax is
levied does not impact incidence3. Less elastic factor bears the burden of the tax
• When there are impediments to reaching market equilibrium,which side of the market bears the tax matters
• General equilibrium tax incidence: the most inelastic factorbears the burden
• Rules of thumb for welfare analysis
Admin RFH I & S Overview 3 Rules Extensions GE Tax Emp. Incdnc
Next Class
• Read GLS, Chapter 6 – omit technical change
• Following class is midterm, then fall break