2 For applications, click here Commodity TaxesSubsidiesFor applications, click hereTo Try it! questionsTo Video
3 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 deductionUnless 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 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 SteinInstructor Notes:
5 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 RogersRich 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 1977Instructor Notes:
6 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.”Instructor Notes:
7 A Commodity Tax is a tax on goods. TaxesA Commodity Tax is a tax on goods.Some truths about commodity taxation:Who pays the tax does not depend on who writes the check to the government;Who pays the tax does depend on the relative elasticities of demand and supply;Commodity taxation raises revenue and creates lost gains from trade (dead-weight loss).Instructor Notes:
8 A Tax on Sellers Shifts the Supply Curve Up by the Tax Who Pays the Tax?A Tax on Sellers Shifts the Supply Curve Up by the TaxQuantityPriceBuyers pay more than before…And sellers receive less than beforeSupply With TaxDemandSupply No TaxQno taxPrice (No Tax)ataxPrice Paid by Buyersb (new equilibrium)taxPrice Received by SellersQwith tax
9 A Tax on Apple SellersA $1 Tax on Sellers Shifts the Supply Curve Up by $1Price rises by less than the tax ($1)
10 A $1 Tax on Buyers Shifts the Demand Curve Down by $1 A Tax on Apple BuyersA $1 Tax on Buyers Shifts the Demand Curve Down by $1Result? Same as if tax were levied on Sellers… Price rises by less than the tax ($1)
11 The Tax “Wedge”Since it doesn’t matter whether buyers or sellers are taxed, we can graph the tax as a simple “wedge”QuantityPriceSupplyDemandPrice Paid by Buyers: $2.65bQDemanded with $1 taxThe $1 tax wedgeadPrice Sellers Receive: $1.65If the tax is $1, the price buyers pay must be $1 more than the price sellers receive.
12 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 When Demand is More Elastic than Supply Sellers Pay More of the Tax The Burden of a TaxWhen Demand is More Elastic than Supply Sellers Pay More of the TaxQuantityPriceDemandSupplyQno taxPrice (No Tax)aQwith taxPrice Paid by BuyersPrice Received by SellersbdtaxInstructor Notes: Figure 7.9: When Demand is More Elastic than Supply Sellers Pay More of the TaxNote that the price paid by buyers is only a little bit above the price without the tax while the price received by sellers falls well below the price without the tax. Thus, when demand is more elastic than supply, sellers pay more of the tax.
14 When Supply is More Elastic than Demand Buyers Pay More of the Tax The Burden of a TaxWhen Supply is More Elastic than Demand Buyers Pay More of the TaxQuantityPriceQwith taxPrice Paid by BuyersPrice Received by SellersbdtaxDemandSupplyQno taxPrice (No Tax)aInstructor Notes: Figure 7.10: When Demand is More Elastic than Supply Sellers Pay More of the TaxNote that the price received by sellers is only a little bit below the price without the tax while the price paid by buyers rises well above the price without the tax. Thus, when supply is more elastic than demand, buyers pay more of the tax.
15 In a long-distance relationship, who will do more of the driving In a long-distance relationship, who will do more of the driving? Does the “tax” fall more heavily to the more committed partner?To nextTry it!
16 Sales of boats down 52.7%; Net loss of 30,000 jobs; 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%;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.
17 The Burden of a TaxThe 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 The results were not what was expected by policy makers: The Burden of a TaxThe 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 The Burden of a TaxThe 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 The Burden of a TaxYou 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 The Burden of a TaxSo 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 The Burden of a Tax Other applications: Health Insurance Mandates and Tax AnalysisMandates requiring employers to provide health insurance to their workers may reduce wages if labor supply is less elastic than demand for workers.
23 Health Insurance Mandates and Tax Analysis The Burden of a TaxHealth Insurance Mandates and Tax AnalysisMany people believe that healthcare benefits are paid by their employerMost don’t realize that their wages are lower as a resultHealthcare tax mandate on employers raises the cost of labor supply
24 The Burden of a TaxWhich 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 downEmployees are unlikely to be able to quite working (if taxed) or less likely move overseas than their employersFor most workers, the elasticity of their supply of labor is lower than their employers’ elasticity of demand for labor
25 Health Insurance Mandates and Tax Analysis The Burden of a TaxHealth Insurance Mandates and Tax AnalysisIt is likely that workers will bear most of the cost of mandated health insurance via lower wagesThis is not to say that the law is a bad ideaWhat 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 Same argument applies to FICA and similar payroll taxes The Burden of a TaxSame argument applies to FICA and similar payroll taxesWorkers bear most of the tax burden even though employers “pay half the tax” via wages lower than without FICAWhy? The labor supply curve is more inelastic than the labor demand curveThere is no free lunch (the politician’s weapon of choice)
27 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 Who Pays the Cigarette Tax? The Burden of a TaxWho Pays the Cigarette Tax?Smokers have an inelastic demand for cigarettes of about .5Cigarette 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 taxesBuyers bear nearly all of the tax
29 The Burden of a Tax Real world example: Taxes range from $.07 in S. Carolina to $2.57/pack in New JerseyCigarettes sell for $3.35/pack in S. Carolina, while cigarettes in New Jersey are priced at $6.45After-tax price received by sellers is $3.28 in SC compared to $3.88 in NJPrices vary probably due to differences in related costs
30 In 2010, New York contemplated a $1/pack cigarette tax 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)Back to
31 A Tax Generates Revenue and Creates a Deadweight Loss The Effects of a TaxA Tax Generates Revenue and Creates a Deadweight LossPriceQuantityConsumer Surplus- consumers get thisDeadweight Loss- No one gets thisPno tax700 = Qno taxDemandSupplyPrice Buyer Pays = $2.65Tax Revenue= $500taxPrice Seller Receives = $1.65Instructor Notes: Figure 7.11: A Tax Generates Revenue and Creates a Deadweight LossTax Revenue- the government gets thisProducer Surplus- producers get this500 = Qtax
32 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 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? $350$450$100$550$350 = $1 (tax) x 350 (Q sold at the new price)To nextTry it!
35 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 SubsidiesA subsidy is a reverse tax where the government gives money to consumers (or producers).Subsidy = Price Received by Sellers – Price Paid by BuyersSome facts about subsidies:Who gets the subsidy does not depend on who receives the check from the government;Who benefits from the subsidy does depend on the relative elasticities of demand and supply;Subsidies must be paid for by taxpayers and they create inefficient increases in trade (deadweight loss).
37 The Subsidy “Wedge”A subsidy drives a wedge between the price received by sellers and the price paid by the buyers.QuantityPriceSupplyDemandPrice received by Sellers: $2.40QDemanded with $1 subsidybThe $1 subsidy wedgeadPrice paid by Buyers: $1.40If the subsidy is $1, the price buyers pay must be $1 less than the price sellers receive.
38 SubsidiesWhen 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-footHint: which is more elastic: demand or supply for cotton?California cotton suppliersCalifornia cotton buyersSince supply is less elastic than demand, suppliers will receive more of the benefit of any subsidy.To nextTry it!
40 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-footThe difference represents the government subsidyRice, cotton, alfalfa are grown in a “Cadillac Desert”Other subsidies aboundEx) crop subsidies for cottonEx) Subsidized water used to grow subsidized corn to feeds cows producing subsidized milk
41 SubsidiesAll of these subsidies represent “deadweight loss” since such crops can be grown more cheaply elsewhereWho 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 marketElasticity of demand for California cotton is much higher than the elasticity of supply. Why?
42 SubsidiesDemand 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 producersWithout the subsidies, there would be much less water intensive farmingWould definitely affect the debate on environmental issues in Central Valley
43 Subsidies Should Los Angeles subsidize the Cirque du Soleil? See the post on government subsidy of LA’s production of Cirque de SoleilHere is the text of the article: (Panel OKs $30-million loan for Cirque du Soleil in Hollywood) A five-member committee of the Los Angeles City Council voted this morning to move ahead with a $30- million loan that would bring a decade of Cirque du Soleil performances to the Kodak Theatre in Hollywood.The council’s Housing, Community and Economic Development Committee unanimously forwarded the loan proposal to the full council for a vote, saying the deal would boost the economy by drawing tourists to the Hollywood & Highland shopping mall, where the theater is located.Under the proposed loan agreement, TheatreDreams LA/CHI would promise to create no fewer than 858 jobs and stage the acrobatic show 368 times per year.“This is really going to be, outside of the Academy Awards, the landmark show in Hollywood,” said Council President Eric Garcetti, whose district includes the mall.The Community Development Department, which is processing the loan, estimated the city already has invested $127 million in the Hollywood & Highland complex, with a majority of that money going toward the construction of the underground parking garage and the theater.On Tuesday, Councilman Dennis Zine questioned whether so much federal loan money should be devoted to a single economic development project. But Councilman Tony Cardenas said this morning that critics were taking aim at the deal simply because the facility is “so high-profile and so pretty.”CIM Group, which owns Hollywood & Highland, sought the loan. The company is also relying on the city for financial help with development projects planned in Mid-City and Reseda. CIM Group leases the Kodak Theatre from the city, and its Urban Real Estate Fund is part of TheatreDreams LA/CHI. Under the proposal, the theater will continue to serve as the home of the annual Academy Awards ceremony.-- David ZahniserPhoto: Christian Fitzharris clowns around a crowd gathered in May in Santa Monica. Credit: Ken Hively / Los Angeles Times.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 HollywoodWhat are the costs? Benefits?Should the government be in the entertainment business? See Alex Tabarrok’s post here
44 Wage SubsidiesThe 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 Some Subsidies have Serious Benefits: Wage Subsidies Increase Employment A wage subsidy costs the government money but increases employment from Qm to Qs (and reduces welfare payments)Quantity of LaborWageSupply of LaborDemand for LaborWage received by Workers: $12bQsThe $4 subsidy wedgeMarket Wage: $10.50aWage paid by Firms: $8dNobel Prize Winner Edmund Phelps is a big fan of wage subsidies. A subsidy to firms that hire low-wage workers drives a wedge between the wage received by workers ($12) and wage paid by firms ($8). The subsidy increses the wages received by workersand reduces the wage paid by firms. As a result, employment increses from Qm to Qs. The cost of the subsidy to the governmentis the subsidy amount, $4, times the number of workers employed, Qs.QdQm
46 Wage SubsidiesSuggested 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.I and IIII and IIIII onlyI, II, and IIITo nextTry it!
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?Producers, because consumers have a greater ability to change their behavior in response to the tax.Both parties will share the burden equally.Consumers, because they pay the tax out of pocket.The government, because the tax will cause less of the good to be produced and consumed.To nextTry it!
49 Demand should be perfectly inelastic. Demand should be elastic. 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?Demand should be perfectly inelastic.Demand should be elastic.Back to