Taxation

1
Chapter 8

• Taxation

2
Taxation and Tax Incidence

• Who pays? The answer might surprise you.
• Are taxes on business always passed along to
  consumers by charging higher prices?
• Or, do taxes stick where they are put?

3
Example of an Excise Tax

• An excise tax is a tax where the seller is
  legally responsible for collecting the money and
  turning it over to the government.
• Sales tax, taxes on airline tickets and long
  distance telephone calls.

4
Incidence of an Excise Tax?
STAX
Price
S
TAX
P1
P0
Ps
D
Quantity
Q0
Q1
5
Effect on Total Expenditure
STAX
Price
S
TAX
P1
P0
D
Quantity
Q0
Q1
6
How Much Tax Revenue is Collected?
STAX
Price
S
TAX
P1
Ps
D
Quantity
Q0
Q1
7
Incidence of an Excise Tax?
STAX
Price
S
TAX
P1
P0
Ps
D
Quantity
Q0
Q1
8
Tax Incidence and Elasticity of Demand and Supply

• Vertical demand curve
• Horizontal demand curve
• Vertical supply curve
• Horizontal supply curve

9
Vertical Demand Curve
Insulin
STAX
Price
D
S
TAX
PTAX
P0
Quantity
Q0
10
Horizontal Demand Curve
STAX
OIL
Price
S
TAX
D
P0
P-TAX
Quantity
Q0
Q1
11
Vertical Supply Curve
Land
Price
S
P0
P-TAX
D
Quantity
Q0
12
Horizontal Supply Curve
Sand/Soda Ash
Price
STAX
PTAX
TAX
S
P0
D
Quantity
Q0
Q1
13
Tax Incidence and Elasticity of Supply and Demand

• For a given supply curve, consumers pay more of
  the tax as demand becomes more inelastic
• For a given demand curve, consumers pay more of
  the tax as supply becomes more elastic.

14
Another ExampleSocial Security Tax

• 6.2 of first 80,400 in wages and salaries paid
  by employee
• 6.2 of first 80,400 in wages and salaries paid
  by employer

15
Incidence of the Employer Portion of this Tax
S
Labor
Wage
w0
w1
TAX
D
D-TAX
Q0
Q1
Quantity
16
Taxes and (In)efficiency

• Total burden of a tax is the dollar amount of the
  tax collected by the government plus any excess
  burden.
• Excess burden is often called a deadweight loss

17
Example of Deadweight Loss and Taxation
Price
STAX
p1
S
P0
D
Q1
Quantity
Q0
18
Another Example
Land
S
Price
P0
P-TAX
D
Quantity
Q0
19
AssignmentDemand for Coffee Mugs
Price Quantity 10 0 9 1
8 2 7 3 6 4 5 5
4 6 3 7
20
AssignmentRefer to Demand Schedule for Coffee
Mugs

• Suppose that the supply schedule for coffee mugs
  is horizontal and that a 2 excise tax is levied
  on each coffee mug produced
• Draw a demand/supply diagram showing the new
  price and quantity of coffee mugs
• Show the after-tax value of total expenditure and
  consumer surplus
• Who pays the tax? Consumers? Producers?