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Taxes 8 CHECKPOINTS

Click on the button to go to the problem © 2013 Pearson Problem 1 Problem 2 Problem 3 Problem 1 Problem 2 Problem 1 Clicker version Clicker version Problem 3 Checkpoint 8.1Checkpoint 8.2Checkpoint 8.3 Clicker version Clicker version Problem 1 In the News

© 2013 Pearson Practice Problem 1 The figure shows the market for basketballs in which basketballs are not taxed. If buyers are now taxed $6 a ball, what price does the buyer pay and how many basketballs are bought? What is the tax revenue from the sale of basketballs? CHECKPOINT 8.1

© 2013 Pearson Solution With a $6 tax on buyers, the demand curve shifts downward by $6 a ball. The price that the buyer pays is $16 a basketball and 8 million basketballs a week are bought. The tax revenue is $6 x 8 million, which is $48 million a week (the purple rectangle). CHECKPOINT 8.1

© 2013 Pearson Practice Problem 2 The figure shows the market for basketballs in which basketballs are not taxed. If sellers are now taxed $6 a ball, what price does the seller receive and how many basketballs are sold? What is the tax revenue from the sale of basketballs? CHECKPOINT 8.1

© 2013 Pearson Solution With a $6 tax on sellers, the supply curve shifts upward by $6 a ball. The price that the seller receives is $10 a basketball and 8 million basketballs a week are bought. The tax revenue is $6 x 8 million, which is $48 million a week (the purple rectangle). CHECKPOINT 8.1

© 2013 Pearson Practice Problem 3 The figure shows the market for basketballs in which basketballs are not taxed. Now basketballs are taxed $6 a ball. What is the excess burden of the tax on basketballs? Is the demand for, or the supply of, basketballs more inelastic? Explain your answer. CHECKPOINT 8.1

© 2013 Pearson Solution The excess burden of the tax is measured by the deadweight loss it creates. The deadweight loss is the area of the gray triangle in the figure, which is ½ of (4 million balls x $6 a ball). Excess burden is $12 million. CHECKPOINT 8.1

© 2013 Pearson The $6 tax increases the price paid by buyers by $1 and lowers the price received by sellers by $5. Because the seller pays the larger share of the tax, the supply of basketballs is more inelastic than the demand for basketballs. CHECKPOINT 8.1

© 2013 Pearson In the news Biggest U.S. tax hike on tobacco takes effect The federal government has raised the tax on cigarettes from 39¢ to $1.01 a pack—an increase of 62¢. Before the tax hike, cigarettes were $5 a pack. Analysts say that in the past a price increase of 10 percent cut cigarette consumption by 4 percent. With this new tax, at least 1 million of the 45 million smokers are expected to quit. Source: USA Today, April 3, 2009 Is the demand for cigarettes elastic or inelastic? Will the price rise to $5.62 a pack? Who pays most of the tax increase—smokers or tobacco companies? CHECKPOINT 8.1

© 2013 Pearson Solution If a 10 percent price increase decreases consumption by 4 percent, the price elasticity of demand for cigarettes is 4/10, or 0.4. The demand for cigarettes is inelastic. With the demand for cigarettes inelastic, the 62¢ tax increase will not increase the price to $5.62. The price would rise to $5.62 only if the demand were perfectly inelastic. The tax will be shared between buyers and sellers. Because demand is inelastic, buyers (smokers) will pay more of the 62¢ tax than the sellers (tobacco companies). CHECKPOINT 8.1

© 2013 Pearson Practice Problem 1 Florida levies the following taxes: 5.5 percent corporate income tax; 6 percent sales tax; 4 cent a gallon tax on gasoline, 33.9 cents for a pack of cigarettes, $0.48 a gallon on beer, and $2.25 a gallon on wine; property taxes vary across the counties and range from 1.4 percent to 2.0 percent of property values. Classify Florida’s taxes into progressive, proportional, and regressive taxes. CHECKPOINT 8.2

© 2013 Pearson Solution If counties with the higher rates are those with high property values, then Florida’s property taxes are progressive. The corporate income tax does not vary with income, so this tax is a proportional tax. Saving increases with income, so expenditure as a fraction of income decreases as income increases. So the taxes on sales, gasoline, cigarettes, beer, and wine are regressive taxes. CHECKPOINT 8.2

© 2013 Pearson Practice Problem 2 Explain why Tiger Woods pays his own Social Security tax and the PGA (the Professional Golf Association) pays none of it. CHECKPOINT 8.2

© 2013 Pearson Solution Tiger Woods pays his Social Security tax and the PGA pays none of it because the supply of Tiger Woods’ services is (most likely) perfectly inelastic. The elasticities of demand and supply determine who pays the tax. CHECKPOINT 8.2

© 2013 Pearson Practice Problem 3 Which tax is more efficient: a tax on land rent or a tax on capital income? Explain. CHECKPOINT 8.2

© 2013 Pearson Solution A tax on capital income is more efficient than a tax on land rent. A tax on capital income has the larger effect on the quantity of factors of production employed than does a tax on land rent because the supply of land is perfectly inelastic whereas the supply of capital is highly elastic. The larger the decrease in the quantity, the larger the deadweight loss created by the tax (the excess burden of the tax) and the more inefficient is the tax. CHECKPOINT 8.2

© 2013 Pearson Study Plan Problem A tax on the rent from a block of land _______ a tax on capital income because the supply of land is ______ and the supply of capital is _______. CHECKPOINT 8.2 A.can be more efficient or less efficient than; elastic; more elastic than the supply of capital B.is more efficient than; inelastic; elastic C.is less efficient than; elastic; inelastic D.is more inefficient than; inelastic; elastic E.is as efficient as; inelastic; inelastic

© 2013 Pearson Practice Problem 4 Illinois Governor proposes broad array of tax increases Faced with a huge budget deficit, Illinois Governor Patrick Quinn has proposed a 50 percent increase in the personal income tax rate. Source: The Wall Street Journal, March 20, 2009 Explain the effects of the tax hike on labor income. Will workers or employers pay most of the tax increase ? CHECKPOINT 8.2

© 2013 Pearson Solution A tax on labor income will not change the demand for labor, but it will decrease the quantity of labor employed. The wage rate paid by employers will rise, the wage rate received by workers will fall, and the deadweight loss will increase. Because the demand for labor is elastic and the supply of labor is inelastic, most of the increase in the tax will be paid by the worker. CHECKPOINT 8.2

© 2013 Pearson Practice Problem 1 In Hong Kong, the marginal income tax rates range from 2 percent to 20 percent. Does Hong Kong place greater weight on the ability-to-pay principle than does the United States? Does Hong Kong place a greater weight on efficiency and a smaller weight on fairness than does the United States? CHECKPOINT 8.3

© 2013 Pearson Solution Income tax rates are lower in Hong Kong than in the United States, so Hong Kong places less weight on the ability-to- pay principle than does the United States. With income tax rates in Hong Kong lower than in the United States, Hong Kong places a greater weight on efficiency and a smaller weight on fairness than the United States does. CHECKPOINT 8.3

© 2013 Pearson Study Plan Problem In Hong Kong, the marginal income tax rates range from 2 percent to 20 percent. Hong Kong places a______ weight on the ability-to-pay principle, a ______ weight on efficiency and a _____ weight on fairness than does the United States. CHECKPOINT 8.3 A.smaller; greater; smaller B.smaller; smaller; greater C.greater; smaller; greater D.greater; greater; smaller E.smaller; smaller; smaller

© 2013 Pearson In the News Michael Nutter of Philadelphia is pushing the 2-cents-per- ounce tax on soda to help prevent cuts in the city’s cash- strapped school system. Source: The Wall Street Journal, June 14, 2011 Which principle of fairness will the mayor use to justify a tax on soda ? CHECKPOINT 8.3

© 2013 Pearson Solution Two principles of fairness are the benefits principle and the ability-to-pay principle. The mayor will justify the tax on the ability-to-pay principle and use the tax revenue raised to help finance the city’s school system. CHECKPOINT 8.3