Taxes, Efficiency and Equity

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Taxes, Efficiency and Equity
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What is the impact of taxes?

• On market equilibriums?
• On efficiency?
• On distribution? (i.e. who pays them?)

3
Economic Burden

• The reduction in total economic surplus that
  results from the adoption of a policy
• Also known as deadweight loss

4
Review of economic surplus the market for
potatoes
6
Consumer surplus
Economic surplus consumer surplus producers
surplus
5
4
Price (/pound)
Producer surplus
2
1
1
2
3
4
5
Quantity (millions of pounds/month)
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The Effect of a Tax on the Equilibrium Quantity
and Price of Potatoes
6
5
4
Price (/pound)
2
1
1
2
3
4
5
Quantity (millions of pounds/month)
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The Market for Potatoes Without Taxes
6
5
4
Price (/pound)
3
2
1
1
2
3
4
5
Quantity (millions of pounds/month)
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The Deadweight Loss Caused by a Tax
S
6
5
4
Price (/pound)
3
Transfer
NOTE An ad valorem tax would rotate the supply
curve upwards
2
1
D
1
2
3
4
5
Quantity (millions of pounds/month)
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Taxes and Efficiency

• How would you determine the impact of a tax on
  efficiency?

9
Review of elasticity

• Elasticity
• A measure of the extent to which quantity
  demanded and quantity supplied respond to
  variations in price, income, and other factors.
• What is the elasticity of demand for food?
• What is the elasticity of supply for milk?
• Short run vs. long run
• What is the elasticity of demand for tropical
  vacations?
• For Exxon gasoline?
• What is the elasticity of supply for land?

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Elasticity of Demand and the Deadweight Loss
from a Tax
Price (/unit)
Price (/unit)
Quantity (units/day)
Quantity (units/day)
The greater the elasticity of demand, the
greater the deadweight loss from a tax
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BUT

• The less elastic the demand, the greater share of
  the tax paid by the consumer.
• How effective are cigarette taxes at reducing
  smoking?
• How effective are cigarette taxes for earning
  revenue?
• What are the distributional implications of taxes
  on necessities?

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Differential taxes on inputs

• E.g. tax on labor vs. tax on capital
• Makes labor more expensive, capital is used as
  substitute
• What happens if we tax capital?
• The problem of capital flight

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Income tax and efficiency

• Income taxes theoretically change our consumption
  of work and leisure
• Theoretically produce an excess burden

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Taxes, Externalities and Efficiency

• Externalities are a cost imposed on society by
  producers
• Efficiency requires that producers/consumers pay
  the full cost of production/consumption

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Externalities in the Potato market pesticide
applications
MC MEC
6
5
4
Price (/pound)
3
2
1
1
2
3
4
5
Quantity (pounds/acre/year)
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Externalities in the Potato market pesticide
applications
STax
6
5
4
Price (/pound)
3
2
1
1
2
3
4
5
Quantity (millions of pounds/month)
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Double-dividend

• Taxes on negative externalities are efficient
• Pollution
• Loss of ecosystem services from resource
  depletion
• Tax bads and use revenue to reduce inefficient
  taxes on goods

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Land Taxes and efficiency

• What is the elasticity of supply for land?

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How do property taxes currently work?

• Tax on combined value of buildings and land.
• What is the impact on economic efficiency and
  distribution?

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Demand for Land

• What makes land valuable?
• Price is determined by demand
• What determines demand?
• Basic needs
• Factor of production
• Speculation
• Rent is major expenditure for poor

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Supply and demand of buildings
P
S1
CS
p1
PS
D
q1
Q
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TAX ON BUILDINGS - production cost
S2
P
S1
CS
p2
Deadweight loss
p1
PS
tax
tax
D
q1
q2
Q
What happens to rent when the supply of buildings
shifts?
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TAX ON LAND - no production cost
S
Buy land, they aint making any more.
-Will Rogers
P
P
tax?
P1
tax
tax
D
Q
Q1
Q
Whats the deadweight loss? Whats the impact on
speculation?
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Impact of shift in land tax

• Reduces speculative demand
• Land prices fall
• Capitalization theory
• Increases supply of buildings on most valuable
  land
• Where is the most valuable land?
• Rents fall
• Reduces urban sprawl
• Bank of America Study
• No deadweight loss

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Subsidies

• Same basic concept as a tax
• Distort production incentives
• Must be paid for, so a subsidy in one place
  implies a tax in another

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What do you think?

• What are the efficiency implications of federal
  subsidies for logging, mining, grazing and oil
  extraction?
• Requires higher taxes elsewhere, and increases
  negative externalities
• Are natural resources capital assets?
• What would be the impact on output of a tax on
  excess profits (i.e. profits above and beyond a
  fair return to the factors of production, also
  known as economic rent?)
• Why arent taxes being shifted to economic rent?

27
Taxes and equity

• Who Pays a Tax?
• Tax incidence
• Statutory incidence
• Who is legally responsible for paying?
• Economic incidence
• Who actually pays?

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Tax on producers
S
6
5
4
Price (/pound)
3
Transfer
2
1
D
1
2
3
4
5
Quantity (millions of pounds/month)
29
A tax on consumers
S
6
5
Transfer
4
Deadweight loss
3.5
Price (/pound)
3
It makes no difference if tax is placed on
producers or consumers
2.5
2
D
1
D after tax
1
2
3
4
5
2.5
Quantity (millions of pounds/month)
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Taxes and equity

• Who Pays a Tax?
• The more inelastic the demand, the more the
  consumer pays
• The more elastic the supply, the more the
  consumer pays
• When supply is perfectly inelastic, the tax falls
  entirely on the producer

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Elasticity of Demand and the Deadweight Loss
from a Tax
Price (/unit)
Price (/unit)
Quantity (units/day)
Quantity (units/day)
The lower the elasticity of demand, the greater
the share of a tax paid by the consumer
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What do you think?

• Who pays the social security tax, employees or
  employers?
• If the demand for food is inelastic, why is it
  not taxed in most states?
• What would be the impact of a gasoline tax on
  gasoline on equity?

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Tax progressivity

• What is progressivity?
• Higher marginal taxes?
• Paying for more than what you get?
• Are sales taxes progressive?
• Is the US income tax progressive?
• "Society is responsible for a very significant
  percentage of what I've earned," Warren Buffet
• It takes a village to raise a millionaire
• What can be said for and against progressive
  taxes?

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Taxes and stability

• High taxes slow down economic growth
• Stabilization policy
• Lower taxes when economy is bad
• Increase taxes when economy is good