Taxation, Prices, Efficiency, and the Distribution of Income

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Chapter 11

• Taxation, Prices, Efficiency, and the
  Distribution of Income

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Lump-Sum Taxes

• A Lump-sum tax is a fixed tax that is owed by
  everyone and is not subject to anything taxpayers
  can change.
• It is independent of income, consumption, or
  wealth.
• An example is a Head Tax, which is constant for
  everyone.

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Figure 11.1 A Price Distorting Tax Versus A
Lump-Sum Tax
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Unit Taxes

• A unit tax adds to the price by a fixed amount.
  Examples include the 32 cents per pack of
  cigarettes and 24 cents per gallon of gasoline in
  federal taxes.

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Tax Terms

• The Gross Price (PG) is the price paid by
  consumers.
• The Net Price (PN) is the price received by
  producers after the tax is paid.
• PN PG T

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Figure 11.2 Impact of A Unit Tax on Market
Equilibrium

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Excess Burden of a Unit Tax
DWL 1/2T?Q 1/2 T2 (Q/P) (ESED)/(ES
ED) Es price elasticity of supply ED price
elasticity of demand Q pretax quantity P
pretax market price
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Implication of the DWL Calculation

• A doubling of the per-unit tax quadruples the
  Deadweight Loss.

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Figure 11.3 Excess Burden When Demand or Supply
is Perfectly Inelastic
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Efficiency Loss Ratio of a Tax

• The Efficiency Loss Ratio is the deadweight loss
  per dollar of revenue raised DWL/R .
• Estimates of U.S. tax system place ELR at between
  25 and 40 cents per dollar of tax revenue raised.

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Incidence of a Tax

• The Legal Incidence is the burden of a tax as
  determined by those who are legally obligated to
  pay the tax. 
• The Economic Incidence is the burden of a tax as
  determined by how much the parties are affected
  in terms of paying higher prices, or receiving
  lower prices.

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Shifting of Taxes

• Forward Shifting is the transfer of the burden of
  a tax from the seller, who is legally obligated
  to pay it, to a buyer. 
• Backward Shifting is the transfer of the burden
  of a tax from the buyer, who is legally obligated
  to pay it, to a seller.

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Ad-Valorem Taxes

• Ad-Valorem Taxes add a fixed percentage to the
  price of a good.
• The primary example is sales taxes.

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Incidence of an Ad-valorem tax
DWL 1/2 T?Q
T tPG
1/2 t2PG2(Q/P) (ESED)/(ES ED) if t is
very small, then this is approximately 1/2
t2PQ(ESED)/(ES ED)
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Using Excise Taxes on Alcohol to Internalize
Externalities

• Federal taxes on alcohol are per-unit rather than
  ad-valorem.
• 32 cents per six-pack of beer (.10/oz)
• 13.50 per gallon of 100 proof liquor (.25/oz)
• Externalities associated with alcohol are
  estimated at 0.48 per ounce (of hard liquor).

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Figure 11.4 Impact of an Ad Valorem Tax on Labor
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Figure 11.5 Incidence of a Tax Collected From
Buyers
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Figure 11.6 The More Inelastic the Demand, the
Greater the Portion of a Tax Borne by Buyers
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Figure 11.7 Impact of a Tax on a Good with a
Perfectly Elastic Supply
Q
1
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Figure 11.8 Tax Incidence When Market Supply is
Perfectly Inelastic
G



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Government Taxes and Expenditures and the
Distribution of Income

• The Tax Incidence is who bears the burden of a
  tax. 
• The Expenditure Incidence is who receives the
  benefits of a government program.
• The Budget Incidence is the net analysis of a
  programs tax and expenditure incidence.
• The Differential Tax Incidence is the change in
  the tax incidence that results from substituting
  one equal yield tax for another.

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The Lorenz Curve

• The Lorenz Curve maps the cumulative percentage
  of households against their cumulative percentage
  of income.

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Figure 11.12 A Lorenz Curve
E
100
Line of Equal Distribution
75
y
60
Percentage of Real Income
50
25
20
10
5
x
D
3
10
25
50
75
100
0
Percentage of Households
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The Gini Coefficient

• The Gini Coefficient is the ratio of the area
  between the Lorenz curve and the perfect equality
  line (Area A in the previous slide) to the area
  under the perfect equality line (Areas A and B).

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Effective Tax Rates for All Federal Taxes, 1998