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1REVENUE SYSTEMTAX INCIDENCE in GENERALEQUILIBRIUM FRAMEWORKPlanPlan! Determinants of the economic incidence" General equilibrium framework: Harbergermodel! Assumptions of the model! Tax equivalence resultsGoal of the Analysis! Assess the economic incidence of taxesimposed in a variety of markets" all taxes raise the same revenue" “full” effect of taxes will be considered (generalequilibrium framework)! Note that taxes that generate the samechanges in prices have equivalent incidenceeffectsSimple version of theSimple version of theHarbergerHarbergerModelModelAssumptionsAssumptions! Technology." There are two sectors:! food! manufacturing" Both operate under the constant returns to scale! Factor supplies (K,L) are perfectly mobile! Market structure: perfect competition! Total factor supplies are fixed:! All consumers have identical preferences! Taxes are “very small”! Government spends the tax revenue in the same way asconsumers would have done in the absence of taxes! Incidence framework: differential" government expenditures (amount to be raised via taxes) isconstantLLLKKKMFMF=+=+ ;2Possible ad Possible ad valoremvaloremtaxes in the taxes in the modelmodel! Partial factor taxes (those levies on a factor only in someof its uses)" .! General taxes on factors:" .! Commodity taxes:" .! Broad based taxes:" Income tax t" Value Added Tax" General Sales tax" Expenditure tax,,,LMLFKMKFttttKLtt ,MFtt ,Broad Based TaxesBroad Based Taxes! All broad based taxes have the same basis:national income! Each tax is levied on a different flow of theincome (at a different stage of incomecreation)! Some of the taxes are paid by the “sellers”,some of them are paid by the “buyers”! Therefore economic incidence of all thebroad based taxes is the same.Tax Incidence of the Income tax Tax Incidence of the Income tax and equal taxes on commoditiesand equal taxes on commodities! Consumer: both the income tax t and equalrate commodity taxes lead to aparallel shift of the budget constraint! Commodity markets impact.! Factor markets impact.MFtt ,Further equivalence relationsFurther equivalence relations! Factor tax and equal partial factor taxes:" ." .! Income tax and equal general factor taxes:" .! Commodity tax and equal partial factor taxesproducing this commodity:KFKMKttt,andLFLMLttt,andLKttt,andLFKFFttt,andLMKMMttt,and3Incidence of a Commodity TaxIncidence of a Commodity Tax" Suppose a tax on food is imposed" How will the optimal consumer bundle change?" What will be the effect on the demand?" Suppose that food industry is more capitalintensive, so that the capital to labor ratio ishigher in the food industry.! What will be the effect of this tax on the capital market?" Who will bear the bigger burden the owners of thecapital or the laborers?Partial Factor TaxPartial Factor Tax! Assume that tax on capital in manufacturingis imposed." factor markets: K escapes to the other sector,returns to capital falls (relative to that of labor)" manufacturing market: cost of production rises,relatively more labor is released to the otherproduction (food), relative price of labor falls, thusrelative price of capital risesCrucial AssumptionsCrucial Assumptions! Mobility of factors! Fixed Supply of


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CU-Boulder ECON 4211 - REVENUE SYSTEM

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