Ch. 18 - Tax Incidence

• The tax burden is the true economic weight of a tax


  difference between the individual’s real income before and after the tax has been imposed
• If wages fall, we say that the tax shifted backward
• If wages fall by the full amount of the tax, we say that they have been fully shifted; if wages fall by less than the amount of the tax, we say they have been partially shifted
• If prices rise, we say that the tax shifted forward
• If, as a result of the tax, demand for labor falls and wages fall, the tax is partially borne by workers, not investors
• If the tax makes investing in the corporate sector less attractive, capital will move out of the sector, decreasing return to capital in the unincorporated (not organized as corporations) sector. Thus, part of the burden of the corporate tax is on capital as a whole, not just capital in the corporate sector
• Just as two taxes that look similar—in that both are imposed on corporations—can have markedly different effects, two taxes that look different, in that they are imposed differently, can have identical effects. Such taxes are said to be equivalent.
• The incidence of a tax depends on several factors most importantly

  whether economy is competitive; and if it is competitive, on the shape of the demand and supply curves
• In competitive markets, firms produce at the level at which price equals marginal costs. If the firm has to pay the tax, then its effective cost of production has been increased, by the amount of the tax. Accordingly, the amount it is willing to supply at the price p0 is reduced.

  
• The market supply curve gives the total amount that all firms are willing to supply at each price. It is simply the “sum” of the supply curves of each firm
• the quantity that each firm is thus willing to supply at the price p0 after the tax is the same as it would have been willing to supply at the price p0 before the tax. In effect, the supply curve is shifted up by the amount of the tax

  
• Assume that the tax on each producer is 10 cents per bottle of beer. The supply curve shifts up by that amount, and the price rises. Although the tax was nominally imposed on producers, consumers are forced to pay a part of the increased cost, through higher prices. Notice, however, that in this example, the price rises by less than 10 cents, to $1.05. Producers cannot shift the entire cost of the tax to consumers because as price rises, the quantity demanded falls.

  
• Who bears the burden in this graph?

  Consumers

  
• The effects of a tax can be viewed as either a downward shift in the demand curve (burden on consumers) or an upward shift in the supply curve (burden on producers).
• it makes no diff erence whether Congress imposes the tax on the producers of beer or on the consumers of beer because the consumer must pay p1, and the level of demand is Q1, just as it would be if, in the before-tax situation, producers had charged p1+t
• specific tax has a fixed amount per unit output
• In competitive markets, an ad valorem tax (a tax that is a fixed percentage of the price) and a specific tax (a tax that is a fixed amount per unit purchased) that raise the same revenue have the same effect on output.
• In effect, the specific tax discriminates against lower-quality goods
• The administrative difficulty of monitoring prices, particularly when firms deal in multiple taxed commodities, influences the design and choice of taxation forms. Policymakers may opt for tax structures that are easier to administer and less prone to manipulation, considering the challenges associated with accurately assessing the value of goods subject to different ad valorem tax rates.
• Monitoring the quantity of a good sold is often considered easier than monitoring its price, particularly for firms that sell a variety of commodities. Quantity is a more tangible and measurable aspect of a transaction.
• The amount by which price rises—the extent to which consumers bear a tax —depends on the shape of the demand and supply curves, not on whom the tax is levied
• levy: impose (a tax, fee, or fine)
• In two limiting cases, the price rises by the full 10 cents, so the entire burden is borne by consumers. This occurs when the supply curve is perfectly horizontal or when the demand curve is perfectly vertical
• In two limiting cases, the price rises by the full 10 cents, so the entire burden is borne by consumers. This occurs when the supply curve is perfectly horizontal or when the demand curve is perfectly vertical
• In two cases, the price paid by consumers does not rise at all; that is, the tax is borne entirely by producers, as shown in Figure 18.6. This occurs when the supply curve is perfectly vertical—the amount supplied does not depend at all on price— or when the demand curve is perfectly horizontal
• In two cases, the price paid by consumers does not rise at all; that is, the tax is borne entirely by producers, as shown in Figure 18.6. This occurs when the supply curve is perfectly vertical —the amount supplied does not depend at all on price— or when the demand curve is perfectly horizontal
• the steeper the demand curve or the flatter the supply curve, the more the tax will be borne by consumers
• the flatter the demand curve or the steeper the supply curve, the more the tax will be borne by producers
• the elasticity of demand gives the percentage change in the quantity of the good consumed due to a percentage change in its price.
• We thus say that the horizontal demand curve, on which a small reduction in the price results in an enormous increase in demand, is infinitely elastic; and the vertical demand curve, on which demand does not change at all with a reduction in price, has zero elasticity
• We thus say that a vertical supply curve, on which the supply does not change at all with a price change, has zero elasticity, whereas a horizontal supply curve has infinite elasticity.
• It makes no difference whether a tax on labor is imposed on consumers (in this case, the firms that pay for the use of labor) or on producers (in this case, the individuals who are selling their labor services)
• There may be a short-run difference. If Congress had imposed the entire tax on firms, it is unlikely that wages would have fallen immediately. In the short run, the labor market would not have been in equilibrium, and firms would have absorbed a large part of the Social Security tax
• The effect of a tax on labor is to shift the demand curve for labor down. A tax on labor will lead to a lower wage and a lower level of employment
• In a traditional upward-sloping supply curve for labor, higher wages generally induce individuals to supply more labor. However, a backward-bending supply schedule suggests that, beyond a certain point, higher wages may lead individuals to reduce their labor supply.
• If a tax is imposed on wages, it could result in a reduction in the take-home pay for workers. In the context of a backward-bending supply schedule, individuals might respond to the reduced net income by choosing to work less.
• Just as taxes imposed on perfectly inelastic factors of production are borne totally by the factor, taxes on perfectly elastic factors are not borne at all by the taxed factor; they are entirely shifted
• Just as taxes imposed on perfectly inelastic factors of production are borne totally by the factor, taxes on perfectly elastic factors are not borne at all by the taxed factor; they are entirely shifted
• Taxing a Monopoly

  With linear demand and horizontal marginal cost curves, the price paid by consumers rises by exactly half the tax; consumers and producers share the burden of the tax.
• Taxing a Monopoly 


  With linear demand and horizontal marginal cost curves, the price paid by consumers rises by exactly half the tax; consumers and producers share the burden of the tax.