Taxation, income distribution, and efficiencyBegin Unit 4TaxationTaxation and income distributionSome terminologySlide 6Slide 7Partial equilibrium modelsUnit taxSlide 10Ad valorem taxesOther types of taxesTax incidence and capitalizationSlide 14Slide 15General equilibrium modelsChanges in consumption due to taxesStudy of taxation graphicallyRecall double dividend hypothesisAn economist’s analysisThe real worldHow does personal income get taxed?Today vs. tomorrowSummaryTaxation, income distribution, and efficiencyToday: Some basic tax theoryBegin Unit 4TodayChapters 14 and 15An introduction to some basic theories related to taxationTaxationTaxes are typically used to finance public projectsDeadweight loss comes with most forms of taxationTaxation and income distributionThe US federal tax system has been set up so that people with high incomes have higher average tax ratesDo people consume more leisure with high marginal tax rates?To be answered laterPublic project financingPeople with high tax rates probably have high willingness to pay for many public projectsSee Table 14.3, p. 327Some terminologyStatutory incidenceWho legally has to pay for the taxEconomic incidenceHow much does real income change to all parties due to a tax?Some terminologyLump sum taxA tax that has to be paid no matter how a person behavesProportional taxAverage tax rate is independent of incomeProgressive taxAverage tax rate increases with incomeRegressive taxAverage tax rate decreases with incomeSome terminologyUnit taxA tax that is paid per unit of a goodAd valorem taxA tax that is a percentage of the purchase pricePartial equilibrium modelsWith partial equilibrium models, only one market is examined at any one timeIgnores possible spillover effectsUsually easier to analyze than general equilibrium modelsTwo types of taxes analyzedUnit taxAd valorem taxUnit taxYou have likely seen unit taxes beforeEcon 1 (or equivalent)Econ 100A/B (or equivalent)Either the buyer or seller pays a given dollar amount for each unit sold or purchasedBefore Tax After TaxConsumers PaySuppliers Receive$1.40$1.00$1.20$1.20D0S0D1S1Partial Equilibrium ModelsQuantity$Ad valorem taxesAssume that the consumer pays an ad valorem taxExample: 6% sales taxThe ad valorem tax shifts the demand curve by the same percentage (relative to the horizontal axis)See Figure 14.7, p. 315Other types of taxesTaxes from workingIncome taxSocial Security taxHospital insurance tax (Medicare)Capital taxesTaxes on profitsAccounting profitsEconomic profitsTax incidence and capitalizationSuppose that we value land as the net present value of the yearly income from the landAssume that the land has value for T yearsT could be infinityThen the value of the land will bePR = $R0 + $R1/(1 + r) + $R2/(1 + r)2 + … + $RT/(1 + r)TTax incidence and capitalizationSuppose that a new tax is implemented on each piece of landYearly income falls by the amount of the taxNew value of the landPR’ = $(R0 – u0) + $(R1 – u1)/(1 + r) + $(R2 – u2)/(1 + r)2 + … + $(RT – uT)/(1 + r)TValue of the land drops by u0 + u1/(1 + r) + u2/(1 + r)2 + … + uT/(1 + r)TTax incidence and capitalizationCapitalization processWhen a new tax is implemented, the new price falls by the net present value of the total taxes that will have to be paidGeneral equilibrium modelsWhen a tax affects a large portion of the economy, partial equilibrium models may not accurately predict the overall effects to the economyGeneral equilibrium models are needed to analyze situations that affect more than one marketChanges in consumption due to taxesRecall that people typically consume less of a good or service once it is taxedExample: Yacht tax in the early 1990sTax on yachts over $100,000 purchased in the USPeople bought yachts in other countriesNet economic impact$16.6 million in taxes collected (less than the $31 million predicted)Less income tax paid by workers (7,600 jobs lost in the US)Study of taxation graphicallyIndividual behaviorSee Figure 15.2, p. 333Excess burden in a market with horizontal supplySee Figure 15.5, p. 340Taxes on laborSee Figure 15.7, p. 343, and Figure 15.9, p. 347SubsidiesSee Figure 15.6, p. 342Pigouvian taxesSee Figure 5.4, p. 83Recall double dividend hypothesisIndustry with negative externalityPigouvian tax  Reduces excess burdenIf tax proceeds are used to reduce other taxes, excess burden from these taxes are loweredCriticism: An environmental tax could lead to an increase in the excess burden in the labor marketAn economist’s analysisGiven an amount of revenue that is generated, taxes should be imposed such that one of the following goals is achievedExcess burden is minimizedSocial welfare is maximizedThe real worldTaxes are often imposed that have the lowest amount of political resistanceExcess burden seems less important than revenue generationSometimes efficiency is completely ignoredHow does personal income get taxed?The personal tax system used by the federal government requires many steps to understandChapter 17Highlight the basic structure, marginal tax rates, and other aspects of the federal tax structureFor next lecture: Read p. 380-406Today vs. tomorrowWith a tax system currently in place, we should ask how changes in tax policy affect current and future behaviorChapter 16 has more on thisMarginal excess burdenTax avoidance versus tax evasionFocus reading on p. 353-362 and 370-376 for next lectureSummaryTaxation of efficient markets typically leads to excess burdenUnit taxAd valorem taxTaxes on land lower the income potential for the land, lowering its valueSubsidies usually lead to excess burden