1. Taxation & Government Intervention
Chapter 6
Taxation & Government Intervention

2. Adjust for Undesired Market Results
A progressive tax is one whose rates increase as a person's income increases.
Canadian income tax is an example.
A regressive tax is one whose effect decreases as income rises.
Canadian sales tax is an example.

3. Adjust for Undesired Market Results
A proportional tax is one whose rates are constant at all income levels, regardless of the taxpayer's total annual income.

4. Adjust for Undesired Market Results
Demerit goods and activities are those considered to be bad for a person, although one may like them.
Addictive drugs are a demerit good; using addictive drugs is a demerit activity.

5. Adjust for Undesired Market Results
Merit goods and activities are things believed to be good for a person, although one may not engage in them.
Motorcycle helmets are a merit good; using helmets while driving a motorcycle is a merit activity.

6. Market Failures and Government Failures
Market failures are reasons for government intervention.
Market failures are situations where the market does not lead to a desired result.

7. Market Failures and Government Failures
Government intervention, however, need not improve the outcome.
Government failures are situations where the government intervenes and makes the situation worse.

8. Costs of Taxation The costs of taxation include:
The direct cost of the revenue paid to government
The loss of consumer and producer surplus caused by the tax
The administrative costs of collecting the tax.

9. Costs of Taxation
The welfare loss triangle – a geometric representation of the welfare loss in terms of misallocated resources caused by a deviation from a supply-demand equilibrium.

10. Costs of Taxation Price S1 Consumer surplus S0 Demand A tax P1 Q1 B C
Deadweight loss P0 Q0 E D
P1–t
Producer surplus F
Quantity

11. Benefit Principle
The benefit principle states that the individuals who receive the benefit of the good or service should pay the cost (opportunity cost) of the resources used to produce the good.
Examples are gasoline taxes and airport taxes, both paid by travelers.

12. Ability-to-Pay Principle
The ability-to-pay principle –individuals who are most able to bear the burden of the tax should pay the tax.
The best example of this is a progressive tax, such as the Canadian income tax.

13. Applying the Principles of Taxation

14. Burden Depends on Relative Elasticity
The person who physically pays the tax is not necessarily the person who bears the burden of the tax.
The burden of the tax depends on relative elasticity.
The burden of the tax is rarely shared equally since elasticities are rarely equal.

15. Who Bears the Burden of a Tax?
Demand is inelastic. S1
Price of luxury boats
$70,000
60,000
50,000
40,000
30,000
20,000
10,000
Quantity of luxury boats
600
200
400 S0
Demand
tax
Consumer pays
Supplier pays
590

16. Who Bears the Burden of a Tax?

17. Inelastic Demand and Incentives to Restrict Supply
When demand is inelastic, producers have incentives to lobby the government to restrict supply.
Farming is a good example.
Advances in productivity increase supply but they result in lower prices.

18. Long-Run Problems of Price Controls
In the long run, supply and demand tend to be much more elastic than in the short run.
Therefore, price controls will cause large shortages or surpluses in the long run.

19. Long-Run and Short-Run Effects of Price Controls
Quantity
Price
Short run supply D0 D1
Long run supply P1 Q1 P2 Q2 P0 Q0
Price ceiling Q3
Shortage