1. Taxation and Income Distribution
CHAPTER 14
Taxation and Income Distribution
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2. Vocabulary Statutory Incidence Economic Incidence Tax Shifting
Statutory Incidence
Economic Incidence
Tax Shifting
Partial Equilibrium Models
Tax Analysis – use of economic theory to analyze impact of taxes
Equity and Efficiency – how do taxes affect the distribution of income, how do taxes affect economic efficiency
Statutory Incidence - who is legally responsible for tax (who writes the check)
Economic Incidence – whose purchasing power is reduced by the tax
Tax Shifting – extent that statutory and economic incidence differ
Partial Equilibrium Models- look at a single market, appropriate when market for commodity is small relative to economy

3. Tax Incidence: General Remarks
Only people can bear taxes
Functional distribution of income
Size distribution of income
Both sources and uses of income should be considered
Incidence depends on how prices are determined
Incidence depends on the disposition of tax revenues
Balanced-Budget tax incidence
Differential tax incidence
Lump-sum tax
Absolute tax incidence

4. Tax Progressiveness Can Be Measured in Several Ways
Average tax rate versus marginal tax rate
Proportional tax system
Progressive tax system
Regressive tax system
Tax Liabilities under a hypothetical tax system
Income
Tax Liability
Average Tax Rate
Marginal Tax Rate
$2,000
-$200
-0.10
0.2
3,000
5,000
400
0.08
10,000
1,400
0.14
30,000
5,400
0.18
Tax scheme depicted – Tax = 0.20*(Income - $3,000)

5. Measuring How Progressive a Tax System Is

6. Measuring How Progressive a Tax System is – A Numerical Example

7. Partial Equilibrium Models$
Partial Equilibrium Models
Before Tax
After Tax
Consumers Pay
Suppliers Receive
$1.20
$1.40
$1.20
$1.00 S1 S0
Unit Tax on Commodities
Consumer Pays $1.20
Producer receives $1.20
Tax on Consumers of $.40 per gallon
D curve shifts down – D curve perceived by supplier-amount of money the supplier will receive
Tax wedge – tax induced spread between price paid by consumer and price received by producer
Tax on Producers of $.40/gal
Draw new supply curve
Consumer Pays $1.40
Producer receives $1.40
Economic incidence independent of statutory incidence D0
Quantity
14-7 D1

8. Perfectly Inelastic Supply$ SX S
Perfectly Inelastic Supply
DX’ DX
Quantity
14-8

9. Perfectly Elastic Supply$ S
Perfectly Elastic Supply SX
DX’ DX
Quantity
14-9

10. Ad Valorem Taxes Sf Price per Pound of food Pr P0 Pm Df Df’ Qr Q0 Qm
Pounds of food per year

11. Taxes on Factors
The Payroll Tax
Capital Taxation in a Global Economy

12. The Payroll Tax SL Wage rate per hour Pr wg = w0 wn DL DL’ L0 = L1
Hours per year

13. Commodity Taxation without Competition
Monopoly
Oligopoly

14. Monopoly $ MXX Economic Profits Economic Profits after unit tax c a P0
ATCX Pn i f d h g b
ATC0 DX
MRX
DX’
X per year X1 X0
MRX’

15. Profits Taxes Economic profit Perfect competition Monopoly
Measuring economic profit

16. Tax Incidence and Capitalization
PR = $R0 + $R1/(1 + r) + $R2/(1 + r)2 + … + $RT/(1 + r)T
PR’ = $(R0 – u0) + $(R1 – u1)/(1 + r) + $(R2 – u2)/(1 + r)2 + … + $(RT – uT)/(1 + r)
u0 + u1/(1 + r) + u2/(1 + r)2 + … + uT/(1 + r)T
Capitalization

17. General Equilibrium Models
Partial equilibrium
General equilibrium

18. Tax Equivalence Relations
tKF = a tax on capital used in the production of food
tKM = a tax on capital used in the production of manufactures
tLF = a tax on labor used in the production of food
tLM = a tax on labor used in the production of manufactures
tF = a tax on the consumption of food
tM = a tax on consumption of manufactures
tK = a tax on capital in both sectors
tL = a tax on labor in both sectors
t = a general income tax

19. Tax Equivalence Relations
Partial factor taxes
tKF
and
tLF
are equivalent to tF
tKM
tLM tM
are
equivalent to tK tL t
Source: McLure [1971].

20. The Harberger Model Assumptions Technology Elasticity of substitution
Capital intensive
Labor intensive
Behavior of factor suppliers
Market structure
Total factor supplies
Consumer preferences
Tax incidence framework

21. Analysis of Various Taxes
Commodity tax (tF)
Income tax (t)
General tax on labor (tL)
Partial factor tax (tKM)
Output effect
Factor substitution effect

22. Some Qualifications Differences in individuals’ tastes
Immobile factors
Variable factor supplies

23. An Applied Incidence Study