Tax Incidence & Elasticity Who actually bears the burden of taxes? Chapter 6 (pages 124-131)

Tax Incidence Tax incidence- is the study of who bears the burden of a tax Regardless of who pays the tax directly to the Gov’t => buyers & sellers both bear some of the tax incidence (burden) Buyers pay a higher price Sellers Receive a lower price 22 30

Tax Incidence & Elasticity The degree of tax incidence (tax burden) depends on the relative elasticity of demand versus elasticity of supply Bottom line: Tax incidence is greater on the more inelastic market The Steeper Curve pays more of the tax! 21 31

Taxes & Shifting Supply/Demand A tax on sellers shifts the supply curve left by amount of tax End result is identical to drawing a “tax wedge” A tax on buyers shifts the demand curve left by amount of tax If Gov’t taxes Sellers Seller pays Gov’t Shift supply left If Gov’t taxes Buyers Buyer pays Gov’t Shift demand left

$.50 Cent Tax on Sellers Price of Ice-Cream D1 Price buyers pay Cone Example #1 Price of Ice-Cream D1 A tax on sellers shifts supply left by size of tax ($0.50) Price buyers pay Cone S2 Equilibrium with tax S1 $3.30 90 Tax ($0.50) Price without tax 3.00 100 Equilibrium without tax 2.80 Price sellers receive Quantity of Ice-Cream Cones

Shifting Supply or Demand Curves Tax incidence does not depend on who the tax is “placed on” i.e. who “sends tax” to the Government Shifting the demand or supply curve is an “illusion” It only tells you who “paid” the Gov’t => not who “bears” the burden The end result of the tax in terms of DWL, Tax Revenue, Tax Incidence is the same regardless of which curve you shift!

$.50 Cent Tax on Buyers Price of Ice-Cream Price buyers pay Supply, S1 Cone D1 D2 $3.30 90 Equilibrium without tax Tax ($0.50) Price without tax 3.00 100 A tax on buyers shifts demand curve left by the size of the tax 2.80 New Equilibrium with tax Price sellers receive Buyers pay $0.30 of tax Sellers pay $0.20 of tax Result is the same as When you taxed sellers! Quantity of Ice-Cream Cones

Tax Incidence Worksheet

Inelastic Curves lead to: Tax incidence is higher on curve that is more inelastic Shifting a curve only tells you who “pays” tax Deadweight Loss is smaller for inelastic curves Tax revenue raised is higher Inelastic Curves lead to: Higher tax incidence Lower DWL Higher Tax Revenue D S 30 41