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Tax Incidence
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Tax Incidence Extensions
To recap:
The statutory burden of a tax does not describe who
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Tax Incidence Extensions
Tax Incidence in Factor Markets
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Tax Incidence Extensions
Tax Incidence in Factor Markets
Impediments to Wage Adjustment
minimum wage Legally mandated
minimum amount that workers must
be paid for each hour of work.
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Tax Incidence Extensions
Tax Incidence in Factor Markets
Impediments to Wage Adjustment
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Tax Incidence Extensions
Tax Incidence in Imperfectly Competitive Markets
monopoly markets
Markets in which there is
only one supplier of a good.
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Tax Incidence Extensions
Tax Incidence in Imperfectly Competitive Markets
Background: Equilibrium in Monopoly Markets
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Tax Incidence Extensions
Tax Incidence in Imperfectly Competitive Markets
Taxation in Monopoly Markets
Even though the monopolist has market power, a tax on either
side of the market results in the same sharing of the tax burden.
Monopolists cannot exploit their market power to avoid the
rules of tax incidence.
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Tax Incidence Extensions
Balanced Budget Tax Incidence
balanced budget incidence
Tax incidence analysis that
accounts for both the tax and
the benefits it brings.
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General Equilibrium Tax Incidence
partial equilibrium tax incidence
Analysis that considers the impact
of a tax on a market in isolation.
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General Equilibrium Tax Incidence
Effects of a Restaurant Tax: A General Equilibrium Example
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General Equilibrium Tax Incidence
Effects of a Restaurant Tax: A General Equilibrium Example
General Equilibrium Tax Incidence
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General Equilibrium Tax Incidence
Issues to Consider in General Equilibrium
Incidence Analysis
Effect of Time Period on Tax Incidence: Short Run
Versus Long Run
Factors that are always inelastically demanded or supplied
in both the short and long run bear taxes in the long run.
What does it mean for capital supply to be elastic? Think of capital investments
already made as irretrievable; that is why capital supply is inelastic in the short run. In
the long run, however, restaurants need new infusions of capital to stay afloat. The
elasticity of capital supply in the long run arises from the ability of investors to choose
whether to reinvest in a firm. If there is a tax on the good produced by the firm, and
this tax is passed on to capital investors in the form of a lower return, then they are
less likely to reinvest in the restaurant.
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General Equilibrium Tax Incidence
Issues to Consider in General Equilibrium
Incidence Analysis
Effect of Tax Scope on Tax Incidence
The scope of the tax matters to incidence analysis because
it determines which elasticities are relevant to the
analysis: taxes that are broader based are harder to avoid
than taxes that are narrower, so the response of producers
and consumers to the tax will be smaller and more
inelastic.
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General Equilibrium Tax Incidence
Issues to Consider in General Equilibrium
Incidence Analysis
Spillovers Between Product Markets
Consider the tax on restaurant meals in the state of Massachusetts.
A higher after-tax price has three effects on other goods as well:
1. Consumers have lower incomes and may therefore purchase
fewer units of all goods (the income effect).
2. Consumers may increase their consumption of goods and
services (such as movies) that are substitutes for restaurant
meals because they are now relatively cheaper than the taxed
meals (the substitution effect).
3. Consumers may reduce their consumption of goods or services
(such as valet parking services) that are complements to
restaurant meals because they are consuming fewer restaurant
meals (the complementary effect).
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The Incidence of Taxation in the United States
CBO Incidence Assumptions
The CBO analysis considers the incidence of the full set of taxes
levied by the federal government. Their key assumptions follow:
1. Income taxes are borne fully by the households that pay them.
2. Payroll taxes are borne fully by workers, regardless of
whether these taxes are paid by the workers or by the firm.
3. Excise taxes are fully shifted to prices and so are borne by
individuals in proportion to their consumption of the taxed item.
4. Corporate taxes are fully shifted to the owners of capital and
so are borne in proportion to each individuals capital income.
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E M PI R I C AL E V I D E N C E
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The Incidence of Taxation in the United States
Results of CBO Incidence Analysis
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The Incidence of Taxation in the United States
Results of CBO Incidence Analysis
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The Incidence of Taxation in the United States
Current Versus Lifetime Income Incidence
current tax incidence The
incidence of a tax in relation to
an individuals current resources.
lifetime tax incidence The
incidence of a tax in relation to
an individuals lifetime resources.
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Conclusion
The fairness of any tax reform is one of the primary considerations in policy
makers positions on tax policy.
Therefore, it is crucial for public finance economists to have a deep
understanding of who really bears the burden of taxation so that we can best
inform these distributional debates over the fairness of a proposed or existing
tax.
Vertical equity: the principle that groups with more resources should pay
higher taxes than groups with fewer resources
Progressive: tax system in which effective average tax rates rise with income
Proportional: tax system in which effective average tax rates do
not change with income
Regressive: tax system in which effective average tax rates
fall with income
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Example1.Impactandincidenceofaproducertax
onapples
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