Tax Incidence

1
Institute of Chartered Accountants of
PakistanWebinar Series

• Tax Incidence and Tax Policy
• Presented by William P. Kittredge, PhD

2
Key Learning Objectives

• Understand the difference between the
  legislative, or statutory, incidence of a tax and
  the actual tax incidence.
• Gain insight into the economic impacts and
  economic development effects of various tax
  schemes.
• Survey the three rules of tax incidence, general
  equilibrium tax incidence and review the
  empirical evidence related to tax incidence.
• Understand why the statutory burden of a tax does
  not describe who really bears the tax and why
  this may be important to government officials and
  corporate officers.

3
Introduction

• A central question of tax incidence is who bears
  the burden of a tax?
• Tax incidence is assessing which party (consumers
  or producers) bear the true burden of a tax.
• When New Jersey raised the corporate income tax,
  companies claimed that the tax would just hurt
  their employees, while the governor claimed the
  tax would affect the wealth owners of the company.

4
Introduction

• Although the legal incidence of a tax is pretty
  obvious, markets do respond to taxes, so that the
  ultimate burden is not nearly so clear.
• As Figure 1 illustrates, the share of taxes paid
  by corporations has fallen by roughly two-thirds.

5
In 1960, corporations paid nearly one-quarter of
all taxes.
By 2003, corporations paid less than 8 percent of
total taxes.
6
Introduction

• Although this change in the share of taxes paid
  by corporations may be viewed as unfair, it is
  important to recall that corporate taxes are paid
  by the individuals who own, work for, and buy
  from corporations.

7
Introduction

• The goal of this webinar is to examine the equity
  implications of taxation.
• Three rules of tax incidence
• General equilibrium tax incidence
• Empirical evidence

8
THE THREE RULES OF TAX INCIDENCE

• There are three basic rules for figuring out who
  ultimately bears the burden of paying a tax.
• The statutory burden of a tax does not describe
  who really bears the tax.
• The side of the market on which the tax is
  imposed is irrelevant to the distribution of tax
  burdens.
• Parties with inelastic supply or demand bear the
  burden of a tax.

9
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• Statutory incidence is the burden of the tax
  borne by the party that sends the check to the
  government.
• For example, the government could impose a 50
  per gallon tax on suppliers of gasoline.
• Economic incidence is the burden of taxation
  measured by the change in resources available to
  any economic agent as a result of taxation.
• If gas stations raise gasoline prices by 25 per
  gallon, then consumers are bearing half of the
  tax.

10
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• When a tax is imposed on producers, they will
  raise prices to some extent to offset this tax
  burden.
• Producer tax burden (pretax price posttax
  price) tax payments of producers
• When a tax is imposed on consumers, they are not
  willing to pay as much for a good, so prices
  fall. The tax burden for consumers is
• Consumer tax burden (posttax price pretax
  price) tax payments of consumers

11
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• Figure 2 illustrates the impact of a 50 per
  gallon tax on suppliers of gasoline.

12
The burden of the tax is split between consumers
and producers
(a)
(b)
Price per gallon (P)
Price per gallon (P)
A 50 cent tax shifts the effective supply curve.
S2
Initially, equilibrium entails a price of 1.50
and a quantity of 100 units.
S1
S1
B
2.00
C
Consumer burden 0.30
P2 1.80
P1 1.50
P1 1.50
A
A
0.50
Supplier burden 0.20
D
D
Q1 100
Q2 90
Quantity in billions of gallons (Q)
Quantity in billions of gallons (Q)
13
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• The initial market equilibrium is 100 billion
  gallons sold at 1.50 per gallon.
• The 50 tax raises the marginal costs of
  production for the firm, shifting the supply
  curve up to S2.
• At the original market price, there is now excess
  demand of 20 billion gallons the price is bid up
  to 1.80, where there is neither a shortage nor a
  surplus.

14
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• The gasoline tax has two effects
• It changes the market price
• Producers must now pay a tax to the government
• Recall that
• Consumer tax burden (posttax price pretax
  price) tax payments of consumers
• Consumer tax burden (1.80 - 1.50) 0 30
• Producer tax burden (pretax price posttax
  price) tax payments of producers
• Producer tax burden (1.50 - 1.80) 0.50
  20

15
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• This analysis reveals that the true burden on
  producers is not 50, but some smaller number,
  because part of the burden is borne by consumers
  in the form of a higher price.
• The tax wedge is the difference between what
  consumers pay and what producers receive from a
  transaction.
• The wedge in this case is the difference between
  the 1.80 consumers pay and the 1.30 producers
  receive.

16
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• The second question to examine is whether
  imposing the tax on the consumers, rather than
  producers, will change the analysis.
• Figure 3 illustrates the impact of a 50 per
  gallon tax on demanders of gasoline.

17
The economic burden of the tax is identical to
the previous case.
Price per gallon (P)
S
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.
Consumer burden
A
P1 1.50
Supplier burden
P2 1.30
C
B
1.00
0.50
D2
D1
Quantity in billions of gallons (Q)
Q1 100
Q2 90
18
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• The initial market equilibrium is 100 billion
  gallons sold at 1.50 per gallon.
• Although the overall willingness to pay for a
  unit of gasoline is unchanged, the 50 tax lowers
  the consumers willingness to pay producers by
  50 (since consumers must pay the government).
  Thus, the demand curve shifts to D2.
• At the original market price, there is now excess
  supply of gasoline producers lower their price
  until 1.30, where there is neither a shortage
  nor a surplus.

19
The three rules of tax incidence The statutory
burden does not describe who really bears the tax

• As before, the new gasoline tax has two effects
• It changes the market price
• Consumers must now pay a tax to the government
• Consumer tax burden (posttax price pretax
  price) tax payments of consumers
• Consumer tax burden (1.30 - 1.50) 0.50
  30
• Producer tax burden (pretax price posttax
  price) tax payments of producers
• Producer tax burden (1.50 - 1.30) 0 20

20
The three rules of tax incidence The side of
the market on which the tax is imposed is
irrelevant

• Note that these tax burdens are identical to the
  burdens when the tax was levied on producers.
• This illustrates an important lesson the side
  on which the tax is imposed is irrelevant for the
  distribution of tax burdens.

21
The three rules of tax incidence The side of
the market on which the tax is imposed is
irrelevant

• While there is only one market price when a tax
  is imposed, there are two different prices that
  economists track.
• The gross price is the price in the market.
• The after-tax price is the gross price minus the
  amount of the tax (if producers pay the tax) or
  plus the amount of the tax (if consumers pay the
  tax).

22
The three rules of tax incidence Inelastic
versus elastic supply and demand

• The third question to examine is how the tax
  burden varies with the elasticities of supply and
  demand.
• In all cases, elastic parties avoid taxes and
  inelastic parties bear them.
• Consider Figure 4, with perfectly inelastic
  demand for gasoline.

23
Price per gallon (P)
D
S2
S1
P2 2.00
With perfectly inelastic demand, consumers bear
the full burden.
Consumer burden
P1 1.50
0.50
Quantity in billions of gallons (Q)
Q1 100
24
The three rules of tax incidence Inelastic
versus elastic supply and demand

• The new equilibrium market price is 2.00, a full
  50 higher than the original price.
• Consumer tax burden (posttax price pretax
  price) tax payments of consumers
• Consumer tax burden (2.00 - 1.50) 0 50
• Producer tax burden (pretax price posttax
  price) tax payments of producers
• Producer tax burden (1.50 - 2.00) 50 0

25
The three rules of tax incidence Inelastic
versus elastic supply and demand

• Note that even though the tax was legally imposed
  on the producer, the full burden of the tax is
  borne by the consumer.
• Full shifting is when one party in a transaction
  bears all of the tax burden.
• With perfectly inelastic demand, consumers bear
  all of the tax burden.

26
The three rules of tax incidence Inelastic
versus elastic supply and demand

• Now consider Figure 5, with perfectly elastic
  demand for gasoline.

27
Price per gallon (P)
S2
S1
0.50
With perfectly elastic demand, producers bear the
full burden.
D
P1 1.50
Supplier burden
1.00
Quantity in billions of gallons (Q)
Q1 100
Q2 90
28
The three rules of tax incidence Inelastic
versus elastic supply and demand

• The new equilibrium market price is 1.50, the
  same as the original price.
• Consumer tax burden (posttax price pretax
  price) tax payments of consumers
• Consumer tax burden (1.50 - 1.50) 0 0
• Producer tax burden (pretax price posttax
  price) tax payments of producers
• Producer tax burden (1.50 - 1.50) 50 50

29
The three rules of tax incidence Inelastic
versus elastic supply and demand

• In this case, the producer bears the full burden
  of the tax, because consumers will simply stop
  purchasing the product if prices are raised.
• These extreme cases illustrate a general point
• Parties with inelastic supply or demand bear
  taxes parties with elastic supply or demand
  avoid them.
• Demand is more elastic when there are many good
  substitutes (for example, fast food at
  restaurants). Demand is less elastic when there
  are few substitutes (for example, insulin
  medication).
• Supply is more elastic when suppliers have more
  alternative uses to which their resources can be
  put.

30
The three rules of tax incidence Inelastic
versus elastic supply and demand

• Figure 6 illustrates these cases holding demand
  constant, more inelastic supply leads to a
  greater tax burden on producers.

31
More inelastic supply, smaller consumer burden.
More elastic supply, larger consumer burden.
(a) Tax on steel producer
(b) Tax on street vendor
P
P
S2
S1
Tax
S2
B
B
P2
P2
Tax
Consumer burden
Consumer burden
S1
A
P1
A
P1
D
D
Q
Q
Q1
Q2
Q1
Q2
32
The three rules of tax incidence Inelastic
versus elastic supply and demand

• As illustrated in Figure 6a, when a tax is levied
  on an inelastic supplier the steel firm that is
  committed to a level of production by its fixed
  capital investment the consumer pays very
  little of the tax, and the producer almost all of
  it.
• In the second panel, with elastic supply, the
  consumer bears almost all of the tax.

33
The three rules of tax incidence Tax incidence
is about prices, not quantities

• Finally, it is important to note that even though
  quantities change dramatically with perfectly
  elastic demand, the focus of tax incidence is on
  prices, not quantities.
• We ignore quantities because at both the old and
  new equilibria, consumers are indifferent between
  buying the taxed good and spending the money
  elsewhere.

34
TAX INCIDENCE EXTENSIONS

• We extend the analysis by examining
• Factors of production
• Imperfectly competitive markets
• Accounting for the expenditure side

35
Tax incidence extensionsTax incidence in factor
markets

• Many taxes are levied on the factors of
  production, such as labor.
• Consider the labor market illustrated in Figure
  7a, before and after a tax on workers (the
  suppliers of labor) is imposed.

36
A tax on workers (the suppliers of labor),
lowers wages.
Wage (W)
S2
S1
Tax
B
W25.65
Firm burden
A
W15.15
Worker burden
C
W34.65
D1
Hours of labor (H)
H1
H2
37
Tax incidence extensionsTax incidence in factor
markets

• The 1 per hour tax lowers the return to work at
  every amount of labor.
• Thus, individuals require a 1 rise in their
  wages to supply any amount of labor, and the
  supply curve shifts upward.
• With labor demand unchanged, the new equilibrium
  wage is 5.65. In this case, the tax is borne
  equally by workers and firms.

38
Tax incidence extensionsTax incidence in factor
markets

• Now consider the labor market illustrated in
  Figure 7b, where a tax on firms (the demanders of
  labor) is imposed.

39
A tax on firms (the demanders of labor), also
lowers wages.
Wage (W)
S1
B
W25.65
Firm burden
A
W15.15
Worker burden
C
W34.65
Tax
D1
D2
Hours of labor (H)
H1
H2
40
Tax incidence extensionsTax incidence in factor
markets

• With the tax on firms, the demand curve shifts
  downward to D2, and market wages fall to 4.65.
• The firm pays workers 50 less than the original
  5.15, but must send 1 to the government. In
  effect, they are paying a wage of 5.65.
• As in output markets, the tax incidence of a
  payroll tax shows that it makes no difference on
  which side of the market it is levied, and the
  economic burden can differ from the statutory
  burden.

41
Tax incidence extensionsTax incidence in factor
markets

• This analysis will not be correct if there are
  impediments to wage adjustments, however.
• The minimum wage is a legally mandated minimum
  amount that workers must be paid for each hour of
  work.
• The current US federal minimum wage is 10.10 per
  hour.

42
Tax incidence extensionsTax incidence in factor
markets

• With a minimum wage, wages cannot fully adjust,
  so the incidence will be different.
• Consider, first, Figure 8a, which imposes the tax
  on workers.

43
Wage (W)
S2
A binding minimum wage changes the analysis,
however.
When imposed on employees, the analysis is
similar to before.
S1
Tax
B
W25.65
Firm burden
A
Wm5.15
Worker burden
W34.65
C
D1
Hours of labor (H)
H1
H2
44
Tax incidence extensionsTax incidence in factor
markets

• With a tax on workers, the labor supply curve
  shifts upward as before. Workers are paid 10.10
  per hour, but are forced to pay 1 of that to the
  government for taxes.
• The incidence is borne in the same manner as when
  there was no minimum wage.

45
Tax incidence extensionsTax incidence in factor
markets

• Now consider, Figure 8b, which imposes the tax on
  firms.

46
Without wage shifting, would end up at C.
In this case, the firm bears the economic burden.
Wage (W)
Employers cannot fully wage shift with the
binding minimum wage.
When imposed on employers, the incidence differs!
S1
B
With fully shifting wages, would end up at C.
W211.10
Firm burden
A
C
Wm10.10
9.60
C
Tax
D1
D2
Hours of labor (H)
H2
H3
H1
47
Tax incidence extensionsTax incidence in factor
markets

• With a tax on firms, the labor demand curve
  shifts downward. Without wage impediments, the
  market wage would fall from 10.10 to 9.60, and
  the firm would also pay 1 to the government.
  Hours of work would be H2.
• With the minimum wage, wages cannot adjust
  downward, so the firm instead demands H3ltH2 hours
  of labor, pays 10.10 per hour, and also pays 1
  to the government. The economic burden of the
  tax falls on the firm.

48
Tax incidence extensionsTax incidence in factor
markets

• When there are barriers to reaching the
  competitive market equilibrium, the side of the
  market on which the tax is levied can matter.
• Minimum wages
• Workplace norms
• Union rules
• There are more frequent in input markets than
  output markets.

49
Tax incidence extensionsTax incidence in
imperfectly competitive markets

• The analysis has so far focused on competitive
  markets.
• Monopoly markets are markets in which there is
  only one supplier of a good.
• Monopolists are price makers, not price takers
  this includes government enterprises.
• Figure 9a shows the determination of equilibrium
  in monopoly markets.

50
Monopolist sets MRMC, chooses quantity Q1.
P
A
P1
S
D1
A
P
MR1
Q
Q1
51
Tax incidence extensionsTax incidence in
imperfectly competitive markets

• Unlike a perfect competitor, the monopolist faces
  a downward sloping marginal revenue curve,
  because it must lower its price on all units to
  sell another unit.
• The marginal revenue curve, MR1, is therefore
  everywhere below the demand curve. Setting
  MR1MC, the quantity Q1 initially maximizes
  profits.
• Now consider a tax on consumers, illustrated in
  Figure 9b.

52
With a tax, both D and MR change, as does the
quantity.
P
P1
S
S
B
P2
D1
A
B
D2
MR1
MR2
Q2
Q
Q1
53
Tax incidence extensionsTax incidence in
imperfectly competitive markets

• The tax on consumers shifts the demand curve
  downward to D2, and the associated marginal
  revenue curve to MR2.
• Setting MR2MC, the quantity Q2 now maximizes
  profits.
• The monopolists price falls from P1 to P2, so it
  bears some of the tax, just as a competitive firm
  does.
• The three rules of tax incidence continue to
  apply for a monopolist.

54
Tax incidence extensionsTax incidence in
imperfectly competitive markets

• Most markets fall somewhere between perfect
  competition and monopoly.
• Oligopoly markets are markets in which firms have
  some market power in setting prices, but not as
  much as a monopolist.
• There is less consensus on how to model these
  markets.
• Economists tend to assume the tax incidence
  results apply in these markets as well.

55
Tax incidence extensionsBalanced budget tax
incidence

• One final extension asks how the money that is
  raised will be spent.
• Balanced budget incidence is tax incidence
  analysis that account for both the tax and the
  benefits it brings.
• It is inconvenient, however, to worry about both
  the taxation and expenditure side at the same
  time.

56
GENERAL EQUILIBRIUM TAX INCIDENCE

• Our models so far have focused on partial
  equilibrium.
• Partial equilibrium tax incidence is analysis
  that considers the impact of a tax on a market in
  isolation.
• To study the effects on related markets, we use
  general equilibrium analysis.
• General equilibrium tax incidence is analysis
  that considers the effects on related markets of
  a tax imposed on one market.

57
General equilibrium tax incidenceEffects of a
restaurant tax

• Consider the demand for restaurant meals in a
  single town, as illustrated in Figure 10.
• The demand for such meals is likely to be highly
  elastic.

58
Price per meal (P)
S2
S1
In this case demand for meals is perfectly
elastic.
1
B
A
D
P1 20
Meals sold per day (Q)
Q1 1000
Q2 950
59
General equilibrium tax incidenceEffects of a
restaurant tax

• In such a case, a 1 tax on firms shifts the
  supply curve, and the firm bears the full burden
  of the tax.
• But in reality, firms are not self-functioning
  entities, but are a technology for combining
  capital and labor to produce an output.
• With a restaurant, capital is best viewed as
  financial capital the money that buys physical
  capital inputs like the building, the ovens,
  tables, etc.

60
General equilibrium tax incidenceEffects of a
restaurant tax

• The 1 tax on meals is borne by the firm, meaning
  that it is borne by the factors of production
  (labor and capital).
• We move back to the input market in Figure 11.

61
The incidence is shifted backward to labor and
capital.
Capital is inelastically supplied.
(a) Labor
(b) Capital
Rate of return (r)
Wage (W)
S
We assume the supply of labor in the locality is
perfectly elastic.
Labor therefore does not bear any of the tax
burden.
D1
Capital bears the tax.
D2
A
B
A
W1 8
S
r1 10
B
r2 8
D1
D2
Hours of labor (H)
Investment (I)
H1 1,000
H2 900
I1 50 million
62
General equilibrium tax incidenceIssues to
consider in GE incidence analysis

• As illustrated, the supply of labor (restaurant
  workers) is perfectly elastic, because those
  workers can easily find a job in another
  locality.
• The tax on output, restaurant meals, would reduce
  the firms demand for labor, reducing the number
  of workers hired, but not their wage rate.
• On the other hand, in the short-run, the supply
  of capital is likely to be fixed. The firms
  demand for capital shifts in, lowering the rate
  of return on capital.
• In the short run, the owners of capital bear the
  tax in the form of a lower return on their
  investment.

63
General equilibrium tax incidenceIssues to
consider in GE incidence analysis

• In the longer-run, the supply of capital is not
  inelastic.
• Investors can close or sell the restaurant, take
  their money, and invest it elsewhere.
• In the long-run, capital is likely to be
  perfectly elastic as there are many good
  substitutes for investing in a particular
  restaurant in a particular town.

64
General equilibrium tax incidenceIssues to
consider in GE incidence analysis

• If both labor and capital are highly elastic in
  the long run, who bears the tax?
• The one additional inelastic factor in the
  restaurant production process is land.
• The supply is clearly fixed.
• When both labor and capital can avoid the tax,
  the only way restaurants can stay open is if they
  pay a lower rent on their land.

65
General equilibrium tax incidenceIssues to
consider in GE incidence analysis

• The scope of a tax matters for tax incidence as
  well. Consider imposing a restaurant tax on the
  entire state rather than just a city.
• Demand in the output market is less elastic
  consumers bear some of the burden.
• Labor supply is less elastic as well.
• The scope of the tax matters to incidence
  analysis because it determines which elasticities
  are relevant to the analysis taxes that are
  broader based are harder to avoid than taxes that
  are narrower, so the response of producers and
  consumers to the tax will be smaller and more
  inelastic.

66
General equilibrium tax incidenceIssues to
consider in GE incidence analysis

• There are also potentially spillovers into other
  output markets from the restaurant tax, not just
  input markets.
• Consider the statewide restaurant tax that raises
  the price of meals
• It has an income effect for consumers.
• It increases consumption of goods that are
  substitutes for restaurant meals, such as meals
  at home.
• It decreases consumption of goods that are
  complements for restaurant meals, such as valets.
• A complete general equilibrium analysis must
  account for the effects in these other markets.

67
THE INCIDENCE OF TAXATION IN THE UNITED
STATESCBO incidence assumptions

• The Congressional Budget Office (CBO) has
  examined the incidence of taxation in the U.S.
• The CBO assumes
• Income taxes are fully borne by the households
  that pay them.
• Payroll taxes are fully borne by workers,
  regardless of the statutory incidence.
• Excise taxes are fully shifted forward to prices.
• Corporate taxes are fully shifted forward to the
  owners of capital.

68
The incidence of taxation in the United
StatesCBO incidence assumptions

• These assumptions are generally consistent with
  empirical evidence.
• For example, Poterba (1996) shows full shifting
  to prices from increases in the sales tax.
• The most questionable assumption relates to the
  corporate income tax. It is likely that
  consumers and workers bear some of the tax. The
  corporate tax will be discussed in detail in
  Chapter 24.

69
The incidence of taxation in the United
StatesResults of CBO incidence analysis

• Table 1 shows the effective tax rates over time,
  by income quintile.
• The effective tax rate is taxes paid relative to
  total income.

70
Effective Tax Rates (in percent) Effective Tax Rates (in percent) Effective Tax Rates (in percent) Effective Tax Rates (in percent) Effective Tax Rates (in percent) Effective Tax Rates (in percent)
1979 1985 1990 1995 2001
Total effective tax rate Total effective tax rate Total effective tax rate Total effective tax rate Total effective tax rate
All households 22.2 20.9 21.5 22.6 21.5
Bottom quintile 8.0 9.8 8.9 6.3 5.4
Top quintile 27.5 24.0 25.1 27.8 26.8
Effective Income Tax Rate Effective Income Tax Rate Effective Income Tax Rate Effective Income Tax Rate Effective Income Tax Rate
All households 11.0 10.2 10.1 10.2 10.4
Bottom quintile 0.0 0.5 -1.0 -4.4 -5.6
Top quintile 15.7 14.0 14.4 15.5 16.3
Effective Payroll Tax Rate Effective Payroll Tax Rate Effective Payroll Tax Rate Effective Payroll Tax Rate Effective Payroll Tax Rate
All households 6.9 7.9 8.4 8.5 8.4
Bottom quintile 5.3 6.6 7.3 7.6 8.3
Top quintile 5.4 6.5 6.9 7.2 7.1
Effective Corporate Tax Rate Effective Corporate Tax Rate Effective Corporate Tax Rate Effective Corporate Tax Rate Effective Corporate Tax Rate
All households 3.4 1.8 2.2 2.8 1.8
Bottom quintile 1.1 0.6 0.6 0.7 0.3
Top quintile 5.7 2.8 3.3 4.4 2.9
Effective Excise Tax Rate Effective Excise Tax Rate Effective Excise Tax Rate Effective Excise Tax Rate Effective Excise Tax Rate
All households 1.0 0.9 0.9 1.0 0.9
Bottom quintile 1.6 2.2 2.0 2.4 2.4
Top quintile 0.7 0.7 0.6 0.7 0.6
Effective tax rates for the poor have fallen over
time.
Effective tax rates for the rich have risen since
1985.
71
The incidence of taxation in the United
StatesResults of CBO incidence analysis

• The table shows that effective tax rates for the
  poor in the US have fallen since 1985, while the
  effective rate for the rich have risen.
• The distribution of various components of the tax
  system varies, however.
• The payroll tax, for example, is regressive.
• Effective corporate tax rates are small relative
  to income and payroll tax rates, and have fallen
  at both the top and bottom of the income
  distribution.

72
The incidence of taxation in the United
StatesResults of CBO incidence analysis

• Table 2 shows the top and bottom quintiles share
  of income and tax liabilities.

73
Top and Bottom Quintiles Share of Income and Tax Liabilities (in percent) Top and Bottom Quintiles Share of Income and Tax Liabilities (in percent) Top and Bottom Quintiles Share of Income and Tax Liabilities (in percent) Top and Bottom Quintiles Share of Income and Tax Liabilities (in percent) Top and Bottom Quintiles Share of Income and Tax Liabilities (in percent) Top and Bottom Quintiles Share of Income and Tax Liabilities (in percent)
1979 1985 1990 1995 2001
Top Quintile Top Quintile Top Quintile Top Quintile Top Quintile
Share of income 45.5 48.6 49.5 50.2 52.4
Share of tax liabilities 56.4 55.8 57.9 61.9 65.3
Bottom Quintile Bottom Quintile Bottom Quintile Bottom Quintile Bottom Quintile
Share of income 5.8 4.8 4.6 4.6 4.2
Share of tax liabilities 2.1 2.3 1.9 1.3 1.1
The share of taxes paid by the top quintile has
risen over time.
While that of the poor has always been low, and
falling over time.
74
The incidence of taxation in the United
StatesResults of CBO incidence analysis

• The bottom quintile of taxpayers has always paid
  a very small share of taxes, and that share has
  fallen over time.
• The top quintile has always paid the majority of
  taxes, and that share has risen over time.
• The top 20 earn more than half of all income,
  and pay almost two-thirds of the taxes.

75
The incidence of taxation in the United
StatesCurrent versus lifetime income incidence

• Tax incidence can be based on current or lifetime
  income, and the results can differ greatly for
  some types of taxes.
• Current tax incidence is the incidence of a tax
  in relation to an individuals current resources.
• Lifetime tax incidence is the incidence of a tax
  in relation to an individuals lifetime
  resources.
• Recent estimates show that 60 of Americans
  change income quintiles within a decade.

76
The incidence of taxation in the United
StatesCurrent versus lifetime income incidence

• This income mobility, and the use of lifetime
  incidence, has a number of implications for tax
  policy.
• Imagine that there was a tax on college
  textbooks. On the surface, this seems extremely
  regressive using current income, since college
  students have very low incomes.
• On a lifetime basis, however, college graduates
  have income twice as those who did not attend
  college. On a lifetime basis, the tax incidence
  is progressive.

77
Recap of The Equity Implications of Taxation Tax
Incidence

• The Three Rules of Tax Incidence
• Tax Incidence Extensions
• General Equilibrium Tax Incidence
• The Incidence of Taxation in the United States

78
References

• Fullerton, Don Metcalf, Gilbert E., 2002. "Tax
  incidence," Handbook of Public Economics, in A.
  J. Auerbach M. Feldstein (ed.), Handbook of
  Public Economics, edition 1, volume 4, chapter
  26, pages 1787-1872 Elsevier.
• Malik, M. H., Najam us Saqib. (1989). Tax
  Incidence by Income Classes in Pakistan. The
  Pakistan Development Review, 28(1), 1325.
  Retrieved from http//www.jstor.org/stable/4125921
  0
• Refaqat, S., International Monetary Fund.
  (2003). Social incidence of the general sales tax
  in Pakistan (IMF working paper, WP/03/216 IMF
  working paper, WP/03/216). Washington, D.C.
  International Monetary Fund. http//bibpurl.oclc.o
  rg/web/24285/2003/wp03216.pdf http//www.imf.org/e
  xternal/pubs/ft/wp/2003/wp03216.pdf