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CHAPTER D YNAMIC P OWER P OINT ™ S LIDES BY S OLINA L INDAHL 6 Taxes and Subsidies.

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Presentation on theme: "CHAPTER D YNAMIC P OWER P OINT ™ S LIDES BY S OLINA L INDAHL 6 Taxes and Subsidies."— Presentation transcript:

1 CHAPTER D YNAMIC P OWER P OINT ™ S LIDES BY S OLINA L INDAHL 6 Taxes and Subsidies

2 CHAPTER OUTLINE Commodity Taxes Subsidies For applications, click herehere To Video To Video

3 B ACK TO Policy Shapes Incentives and Behavior Not only are more children born in late December than in early January, but also the extra births appear to be clustered among those who have the most to gain from a tax deduction Unless you’re a cynic, or an economist, I realize you might have trouble believing that the intricacies of the nation’s tax code would impinge on something as sacred as the birth of a child. But it appears that you would be wrong. - David Leonhardt The New York Times

4 B ACK TO Taxes "In this world nothing can be said to be certain, except death and taxes." - Benjamin Franklin “The difference between death and taxes is death doesn't get worse every time Congress meets.” - Will Rogers Will Rogers “No nation has ever taxed itself into prosperity” - Ronald Reagan “No Nation ever borrowed itself into prosperity” - Unknown “It’s as if people think that if the government imposed a tax on cows, the tax would be paid by the cows.” - Hebert Stein

5 B ACK TO Taxes “The power to tax is the power to destroy.” - John Marshall, American Jurist, Statesman “The Income Tax has made more liars out of the American people than golf has.” – Will Rogers Rich bachelors should be heavily taxed. It is not fair that some men should be happier than others.” – Oscar Wilde “Oh my God, what happened to my paycheck?” - Mike Mace, on receiving his first full-time paycheck in December 1977

6 B ACK TO Taxes Milton Friedman on taxes: “Inflation is taxation without legislation” “I am favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible.” “We have a system that increasingly taxes work and subsidizes non-work.” “The real cost of government is measured by what government spends, not by receipts labeled taxes.”

7 B ACK TO Taxes A Commodity Tax A Commodity Tax is a tax on goods. Some truths about commodity taxation: 1.Who pays the tax does not depend on who writes the check to the government; 2.Who pays the tax does depend on the relative elasticities of demand and supply; 3.Commodity taxation raises revenue and creates lost gains from trade (dead- weight loss).

8 B ACK TO Who Pays the Tax? A Tax on Sellers Shifts the Supply Curve Up by the Tax Quantity Price Demand Supply No Tax Q no tax Price (No Tax) a Supply With Tax tax Q with tax Price Paid by Buyers Price Received by Sellers b (new equilibrium) Buyers pay more than before… And sellers receive less than before

9 B ACK TO A Tax on Apple Sellers A $1 Tax on Sellers Shifts the Supply Curve Up by $1 Price rises by less than the tax ($1)

10 B ACK TO A Tax on Apple Buyers A $1 Tax on Buyers Shifts the Demand Curve Down by $1 Result? Same as if tax were levied on Sellers… Price rises by less than the tax ($1)

11 B ACK TO The Tax “Wedge” Since it doesn’t matter whether buyers or sellers are taxed, we can graph the tax as a simple “wedge” If the tax is $1, the price buyers pay must be $1 more than the price sellers receive. Q Demanded with $1 tax Quantity Price Supply Demand The $1 tax wedge Price Paid by Buyers: $2.65 Price Sellers Receive: $1.65 b a d

12 B ACK TO Who Pays the Tax? Depends. Who pays the tax? It depends on the relative elasticities of supply and demand. The less elastic side of the market will pay the greater share of a tax (bear more of the burden of a tax).

13 B ACK TO The Burden of a Tax When Demand is More Elastic than Supply Sellers Pay More of the Tax Quantity Price Demand Supply Q no tax Price (No Tax) a Q with tax Price Paid by Buyers Price Received by Sellers b d tax

14 B ACK TO The Burden of a Tax When Supply is More Elastic than Demand Buyers Pay More of the Tax Quantity Price Q with tax Price Paid by Buyers Price Received by Sellers b d tax Demand Supply Q no tax Price (No Tax) a

15 In a long-distance relationship, who will do more of the driving? Does the “tax” fall more heavily to the more committed partner?

16 B ACK TO SEE THE INVISIBLE HAND This pleasure boat seems like a good thing to tax… Or not: The Omnibus Budget Reconciliation Act of 1990 applied a 10% federal luxury tax to the retail sale of luxury goods like pleasure boats with a sales price above $100,000. Expected tax revenue? $9 billion. Reality? Sales of boats down 52.7%; Sales of boats down 52.7%; Net loss of 30,000 jobs; Net loss of 30,000 jobs; The federal government paid out > $7 million more in unemployment benefits to those workers than it collected in luxury tax revenues The federal government paid out > $7 million more in unemployment benefits to those workers than it collected in luxury tax revenues.

17 B ACK TO The Burden of a Tax The Omnibus Budget Reconciliation Act of 1990 applied a 10% federal luxury tax to the first retail sale of luxury goods such as pleasure boats with a sales price above $100,000. The tax was originally projected to generate revenues of $9 billion over five years after passage. The tax was widely popular among policy makers as a way to shift the burden of deficit reduction to those who can best afford it (i.e. the Rich).

18 B ACK TO The Burden of a Tax The results were not what was expected by policy makers: Sales of boats down 52.7%; Net loss of 30,000 jobs; The federal government paid out over $7 million more in unemployment benefits to those workers than it collected in luxury tax revenues.

19 B ACK TO The Burden of a Tax The elasticity of supply for boats was evidently less elastic than the elasticity of demand for boats. The federal luxury tax was quickly (and quietly) repealed in 1993

20 B ACK TO The Burden of a Tax You had to be an ignoramus to believe the luxury tax was only going to soak the rich. The only people it hurt was working people like myself,” -Judy Ott, an assembly worker at the Viking Yacht Company’s plant in New Jersey. “All these people suffered needlessly because the politicians in Washington needed a symbol to sell the American people a new tax increase,” - Viking’s co-founder Robert T. Healey.

21 B ACK TO The Burden of a Tax So the next time you vote for politicians who are going to “stick it” to the rich or corporations via taxes, remember the “little guys” who will lose their jobs as a result. Why could the current efforts in the U.S. and California (no less than THREE ballot initiatives to raise taxes on the rich) cause more harm than good? “Democracy is two wolves and a sheep voting on what’s for dinner”

22 B ACK TO The Burden of a Tax Other applications: Health Insurance Mandates and Tax Analysis Mandates requiring employers to provide health insurance to their workers may reduce wages if labor supply is less elastic than demand for workers.

23 B ACK TO The Burden of a Tax Health Insurance Mandates and Tax Analysis Many people believe that healthcare benefits are paid by their employer Most don’t realize that their wages are lower as a result Healthcare tax mandate on employers raises the cost of labor supply

24 B ACK TO The Burden of a Tax Which side of the market is more inelastic, the demand for labor or the supply of labor? Firms can substitute capital (machines) for labor, move overseas to avoid the tax, or simply close down Employees are unlikely to be able to quite working (if taxed) or less likely move overseas than their employers For most workers, the elasticity of their supply of labor is lower than their employers’ elasticity of demand for labor

25 B ACK TO The Burden of a Tax Health Insurance Mandates and Tax Analysis It is likely that workers will bear most of the cost of mandated health insurance via lower wages This is not to say that the law is a bad idea What is a bad idea is voters believing that somehow healthcare has been made “free.” They are being duped by less-than-forthcoming politicians, i.e. they are depending on your economic ignorance

26 B ACK TO The Burden of a Tax Same argument applies to FICA and similar payroll taxes Workers bear most of the tax burden even though employers “pay half the tax” via wages lower than without FICA Why? The labor supply curve is more inelastic than the labor demand curve There is no free lunch (the politician’s weapon of choice)

27 B ACK TO The Burden of a Tax Other applications: Who Pays the Cigarette tax? If manufacturers of cigarettes can easily dodge state taxes (via smuggling), then it’s possible the tax will not discourage smoking. National cigarette taxes are more effective in deterring smoking: no interstate tax- dodging occurs.

28 B ACK TO The Burden of a Tax Who Pays the Cigarette Tax? Smokers have an inelastic demand for cigarettes of about.5 Cigarette companies have a very high elasticity of supply to any one state since they can easily ship their products to other states with relatively lower taxes Buyers bear nearly all of the tax

29 B ACK TO The Burden of a Tax Real world example: Taxes range from $.07 in S. Carolina to $2.57/pack in New Jersey Cigarettes sell for $3.35/pack in S. Carolina, while cigarettes in New Jersey are priced at $6.45 After-tax price received by sellers is $3.28 in SC compared to $3.88 in NJ Prices vary probably due to differences in related costs

30 In 2010, New York contemplated a $1/pack cigarette tax. This video highlights the costs of the tax. Click on the picture. (1:22 minutes) B ACK TO

31 The Effects of a Tax Consumer Surplus- consumers get this Deadweight Loss- No one gets this tax Price Buyer Pays = $2.65 Price Seller Receives = $ = Q tax A Tax Generates Revenue and Creates a Deadweight Loss Price Quantity P no tax 700 = Q no tax Demand Supply Tax Revenue- the government gets this Producer Surplus- producers get this Tax Revenue = $500

32 B ACK TO The Deadweight Loss of a Tax Another example of DWL: Imagine that you want to go to New York on a trip. You value the trip at $50 and a bus ticket costs $40. Do you take the trip? A. Yes. The value ($50) of the trip exceeds the cost of the ticket ($40) so you travel to New York. How much consumer surplus (net value) do you get from the trip? A. $10=$50-$40.

33 B ACK TO The Deadweight Loss of a Tax The government taxes bus tickets which raises the price of a bus ticket to $60. Do you take the trip? A. No. The value of the trip is now less than the price of the ticket. What happened to the $10 consumer surplus which you used to get when there was no tax? A. It's gone since no trip takes place. Did the government get any tax revenue from you? A. No. Key idea: Consumers lose but the government does not gain from trips that are not taken.

34 What is the tax revenue that the government collects from the tax on gadgets? a)$350 b)$450 c)$100 d)$550

35 B ACK TO Deadweight Loss and Elasticity Deadweight Losses are Larger the More Elastic the Demand Curve: If the demand is inelastic, a tax will not deter many trades.

36 B ACK TO Subsidies A subsidy A subsidy is a reverse tax where the government gives money to consumers (or producers). Subsidy = Price Received by Sellers – Price Paid by Buyers Some facts about subsidies: 1.Who gets the subsidy does not depend on who receives the check from the government; 2.Who benefits from the subsidy does depend on the relative elasticities of demand and supply; 3.Subsidies must be paid for by taxpayers and they create inefficient increases in trade (deadweight loss).

37 B ACK TO The Subsidy “Wedge” A subsidy drives a wedge between the price received by sellers and the price paid by the buyers. If the subsidy is $1, the price buyers pay must be $1 less than the price sellers receive. Q Demanded with $1 subsidy Quantity Price Supply Demand The $1 subsidy wedge Price received by Sellers: $2.40 Price paid by Buyers: $1.40 b a d

38 B ACK TO Subsidies When demand is more elastic than supply, suppliers bear more of the burden of a tax and receive more of the benefit of a subsidy.

39 King Cotton and the Deadweight Loss of Water Subsidies Who benefits most from the large agricultural water subsidy? Farmers in California’s Central Valley typically pay $20-$30 an acre-foot for water that costs $200-$500 an acre-foot Hint: which is more elastic: demand or supply for cotton? a)California cotton suppliers b)California cotton buyers

40 B ACK TO Subsidies King Cotton and the Deadweight Loss of Water Subsidies In the Central Valley of California, farmers pay $20-$30 an acre-foot for water that costs $200- $500 an acre-foot The difference represents the government subsidy Rice, cotton, alfalfa are grown in a “Cadillac Desert” Other subsidies abound Ex) crop subsidies for cotton Ex) Subsidized water used to grow subsidized corn to feeds cows producing subsidized milk

41 B ACK TO Subsidies All of these subsidies represent “deadweight loss” since such crops can be grown more cheaply elsewhere Who benefits from the water subsidy? Cotton suppliers or cotton buyers? Remember that the benefit of a subsidy falls on the more inelastic side of the market Elasticity of demand for California cotton is much higher than the elasticity of supply. Why?

42 B ACK TO Subsidies Demand elasticity is very high since cotton grown outside of California is a perfect substitute (i.e. many substitutes) Supply elasticity is lower as a result, hence subsidy flows to producers Without the subsidies, there would be much less water intensive farming Would definitely affect the debate on environmental issues in Central Valley

43 B ACK TO Subsidies Should Los Angeles subsidize the Cirque du Soleil? In 2009 the Los Angeles City Council approved a $30m loan for a 10-year Production of Cirque du Soleil in Hollywood What are the costs? Benefits? Should the government be in the entertainment business? See Alex Tabarrok’s post herehere

44 B ACK TO Wage Subsidies The minimum wage is the clearest example of a price floor in the United States. Such a policy, however, can hurt low-skilled workers by reducing employment. Some economists believe that a better approach would be to subsidize employers (demanders of labor). This approach leads to a higher wage and a higher level of employment.

45 B ACK TO Some Subsidies have Serious Benefits: Wage Subsidies Increase Employment A wage subsidy costs the government money but increases employment from Q m to Q s (and reduces welfare payments) QsQs Quantity of Labor Wage Supply of Labor Demand for Labor The $4 subsidy wedge Wage received by Workers: $12 Wage paid by Firms: $8 b a d Market Wage: $10.50 QmQm QdQd

46 B ACK TO Wage Subsidies Suggested by Edmund Phelps. Nobel Prize winner in Economics It would be expensive, paid by taxpayers Would result in more low skilled workers being employed Costs could be offset by social benefits: less crime, less dependency, etc Similar to EITC program

47 Which of the following statements are true? I.A $0.50 tax on each fishing lure sold raises the price per lure by $0.50. II.A tax on sellers is equivalent to a tax on buyers. III.A tax on buyers is analyzed by shifting the demand curve up by the amount of the tax. a)I and II b)II and III c)II only d)I, II, and III

48 If demand of some good is more elastic than supply and a tax is imposed on the consumption of the good, who will bear more of the burden of the tax? a)Producers, because consumers have a greater ability to change their behavior in response to the tax. b)Both parties will share the burden equally. c)Consumers, because they pay the tax out of pocket. d)The government, because the tax will cause less of the good to be produced and consumed.

49 Junk food has been criticized for being unhealthy and too cheap, enticing the poor to adopt unhealthy lifestyles. Suppose that the state of Oklakansas imposes a tax on junk food. What needs to be true for the tax to actually deter the most people from eating junk food: Should junk food demand be elastic or should it be inelastic? a)Demand should be perfectly inelastic. b)Demand should be elastic. B ACK TO


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