Tax Incidence

Categories of Taxes Regressive Taxes: tax the poor more than the rich, in terms of percentage of income (e.g., sales tax) Progressive taxes: tax the rich more than the poor, in terms of percentage of income (e.g., a graduated income tax) Proportional tax: taxes the same percentage, regardless of income (“flat tax”) Received benefit taxes: tax only those people who benefit from the service (e.g., road tax charged to car owners for vehicle licenses) Taxes to address market failure or discourage purchase of demerit goods

Types of Taxes Personal Income Taxes Property Taxes Sales Taxes Tax on calculated income Taxable income calculated sources of income and deductions In US, most sources of income mail annual statements to citizens (W2, 1099 forms etc.) Marginal rates increase with income Property Taxes Typically local taxes levied on assessed value Typically seen as progressive, because most poor do not own property Sales Taxes Fixed percentage on sales. In US, local and state. Regressive because poor pay large percentage of income. Excise Taxes Imposed on specific items, often to discourage consumption Payroll taxes fund Social Security and Medicare

Tax Incidence For sales and excise tax, key question: when tax is applied, who will pay it? If producers pass entire tax on to consumers, consumers may stop buying product If producers pay all tax, producers may stop producing product Elasticity of S & D shows us the compromise

Tax Incidence Analysis Elasticity of S & D determine tax incidence Determine tax incidence by Placing vertical line equal to tax amount as wedge into S&D Noting resulting change in P If ΔP > half of tax, the most of tax falls on consumer If ΔP < half of tax, the most of tax falls on supplier Elastic S places greater incidence on consumer Elastic D places greater incidence on seller