1. 1 In this experiment, three people are assigned to a single role. Find your teammates and sit together. Remember: You are competing against the other teams.

2. 2 The Players and the Goals In this experiment, each team controls a firm that sells to a group of consumers. FIRMS select what price to charge.  Lower price means consumers purchase more units.  Higher price means consumers purchase fewer units.

3. 3 The Players and the Goals Goal: make the most profit possible. Profit = Revenue – Cost (Price per unit) (Units sold) (Tax per unit) (Units Sold) ($1) (Units sold)

4. 4 Example You will see a demand schedule like the one to the right. The chart shows the number of units you will sell depending on what price you decide to charge. For example, if you charge $0.50, you will sell 940 units. You must choose what price to charge for your product so as to maximize your profit.

5. 5 Example Suppose you charge $10.00 per unit. How many units will you sell? 750 What is your revenue? ($10.00) (750) = $7,500 What is your cost? ($1.00) (750) = $750 What is your profit? $7,500 – $750 = $6,750

6. 6 Example Suppose you charge $20.00 per unit. How many units will you sell? 550 What is your revenue? ($20.00) (550) = $11,000 What is your cost? ($1.00) (550) = $550 What is your profit? $11,000 – $550 = $10,450

7. 7 Example Suppose you charge $30.00 per unit. How many units will you sell? 350 What is your revenue? ($30.00) (350) = $10,500 What is your cost? ($1.00) (350) = $350 What is your profit? $11,000 – $550 = $10,150

8. 8 Example Suppose you charge $10.00 per unit. Profit = $6,750 Suppose you charge $20.00 per unit. Profit = $10,450 Suppose you charge $30.00 per unit. Profit = $10,150 Of these three prices, $20.00 is the best price to charge.

9. 9 Round 1 Choose the price you will charge for your product. Every unit you sell costs you $1 to produce. There is no tax.

10. 10 Round 1

11. 11 Statutory vs. Economic Tax Burden (or tax incidence) Statutory tax burden is the amount of tax collected from a person. Economic tax burden is the amount of tax paid by a person. Example: With no taxes, the price of gas is $3.00 per gallon. The government imposes a 50 cent per gallon tax on gasoline. The tax is collected from the producer. In response to the tax, the producer raises the price of gas to $3.50. Who bears the statutory and economic burdens of the tax?  Statutory burden is on the producer, but economic burden is on the consumer.

12. 12 Statutory vs. Economic Tax Burden (or tax incidence) Statutory tax burden is the amount of tax collected from a person. Economic tax burden is the amount of tax paid by a person. Example: With no taxes, the price of gas is $3.00 per gallon. The government imposes a 50 cent per gallon tax on gasoline. The tax is collected from the producer. In response to the tax, the producer does not change the price of gas. Who bears the statutory and economic burdens of the tax?  Statutory burden is on the producer and economic burden is on the producer.

13. 13 Statutory vs. Economic Tax Burden (or tax incidence) Statutory tax burden is the amount of tax collected from a person. Economic tax burden is the amount of tax paid by a person. Example: With no taxes, a person earns $50,000 per year. The government imposes a $10,000 income tax. The tax is collected from the worker. In response to the tax, the employer gives the worker a $5,000 raise. Who bears the statutory and economic burdens of the tax?  Statutory burden is on the worker, but economic burden is shared between the worker and the employer.

14. 14 Statutory vs. Economic Tax Burden (or tax incidence) Statutory tax burden is the amount of tax collected from a person. Economic tax burden is the amount of tax paid by a person. Example: With no taxes, a person earns $50,000 per year. The government imposes a $10,000 Social Security tax. $5,000 of the tax is withheld from the worker’s pay check. The employer is required to pay the other $5,000. In response to the tax, the employer cuts the worker’s salary by $5,000. Who bears the statutory and economic burdens of the tax?  Statutory burden is shared by the worker and employer, but economic burden is on the worker only.

15. 15 Sales/Excise Tax When the government imposes a tax, the price the consumer pays is no longer the same as the price the producer receives. Example: $10 per unit tax.  The consumer pays $35 per unit, but the producer receives only $25 per unit. We call the $35 the “consumer price” or the “price including tax” and the $25 the “producer price” or the “price excluding tax.”

16. 16 Round 2: Statutory Tax Burden is on Consumers In this round, consumers will pay an additional $5 per unit tax. The price consumers pay is the price you charge (the producer price) plus $5.  The statutory tax burden is on the consumer.

17. 17 Round 2 In this round, consumers will pay an additional $5 per unit tax. The consumer price is the price you charge plus the $5 tax. If you charge, $7, how many units will consumers buy? 77 What is your profit? ($7)(77) – ($1)(77) = $532

18. 18 Round 2 Choose the price you will charge for your product (the price excluding tax). The consumer price is the price you charge plus $5. Every unit you sell costs you $1 to produce.

19. 19 Round 2

20. 20 Round 2

21. 21 Round 3: Statutory Tax Burden is on Producers In this round, producers will pay a $5 per unit tax for every unit they sell. The price consumers pay is the price you charge.  The statutory tax burden is on the producer.

22. 22 Round 3 In this round, producers will pay a $5 per unit tax. Your cost per unit is now $6 ($1 per unit to produce plus $5 per unit tax). If you charge, $7, how many units will consumers buy? 101 What is your profit? ($7)(101) – ($6)(77) = $245

23. 23 Round 3 Choose the price you will charge for your product. The consumer price is the price you charge. Every unit you sell costs you $6.

24. 24 Round 3

25. 25 Round 3

26. 26 Round 3

27. 27 Luxury versus Necessity Consumption of luxury goods is more sensitive to price changes. Consumption of necessity goods is less sensitive to price changes. Example: At a price of $10 per ticket, Howie will see 10 movies per year. If the price rises to $12, Howie will cut back to 5 movies per year.  20% rise in price results in a 50% reduction in consumption  Howie’s consumption is highly sensitive to price changes.  For Howie, movies are a luxury good.

28. 28 Luxury versus Necessity Consumption of luxury goods is more sensitive to price changes. Consumption of necessity goods is less sensitive to price changes. Example: At a price of $10 per ticket, Rob will see 10 movies per year. If the price rises to $12, Rob will cut back to 9 movies per year.  20% rise in price results in a 10% reduction in consumption  Rob’s consumption is less sensitive to price changes.  For Rob, movies are a necessity good.

29. 29 Round 4 Choose the price you will charge for your product. The consumer price is the price you charge. Every unit you sell costs you $6.

30. 30 Round 4

31. 31 Round 4

32. 32 Round 4

33. 33 How to increase tax revenue In an attempt to increase tax revenue, the government increases the tax from $5 per unit to $15 per unit.

34. 34 Round 5 Choose the price you will charge for your product. The consumer price is the price you charge. Every unit you sell costs you $16.

35. 35 Round 5

36. 36 Round 5

37. 37 Round 5

38. 38 Round 5

39. 39 How to increase tax revenue In an attempt to increase tax revenue even further, the government increases the tax from $15 per unit to $25 per unit.

40. 40 Round 6 Choose the price you will charge for your product. The consumer price is the price you charge. Every unit you sell costs you $26.

41. 41 Round 6

42. 42 Round 6

43. 43 Round 6

44. 44 Round 6

45. 45 Does it work this way in the real world?

46. 46 Who bears the economic burden of the Social Security tax?

47. 47 Source:Social Security Administration and the U.S. Bureau of Labor Statistics.

48. 48 Average annual wage growth when SS tax increases = 1.0% Average annual wage growth when SS tax does not change = 1.3% Source:Social Security Administration and the U.S. Bureau of Labor Statistics.

49. 49 Average annual wage growth when SS tax increases = 1.0% Average annual wage growth when SS tax does not change = 1.3% Increasing SS tax slows average wage growth by 0.3%. When SS tax rate increases, it increases (on average) by 0.3% Employer passes on employer’s half of SS tax increases to the worker in the form of lower wages.

50. 50 Does increasing Social Security tax increase Social Security tax revenues?

51. 51 Source:U.S. Bureau of Labor Statistics.

52. 52 Source:U.S. Bureau of Labor Statistics.

53. 53 Does increasing the capital gains tax rate increase tax revenues?

54. 54 Source:Gwartney, J.D. and R.G. Holcombe, 1997. Optimal Capital Gains Tax Policy. Report to the Joint Economic Committee of the United States Congress.

55. 55 Source:Gwartney, J.D. and R.G. Holcombe, 1997. Optimal Capital Gains Tax Policy. Report to the Joint Economic Committee of the United States Congress.

56. 56 Two possible goals for tax policy: 1. Raise revenue. 2. Redistribute income.

57. 57 Can we tax the rich by taxing things that rich people buy?

58. 58 1990 Deficit Reduction Law: The “Luxury Tax” Goal: Raise tax revenue by raising taxes on “the rich.” Means:10% excise tax on recreational planes. Result:80 fewer planes sold $130 million lost sales 480 lost jobs Estimated tax revenue:$6 million. Actual tax revenue: $530,000.  Economic burden of the tax fell almost entirely on “the poor.”  Government gained $1,100 for every job a worker lost. Source: Joint Committee on Taxation, “Methodology and Issues in the Revenue Estimating Proecess” (JCX-2-95), January 23, 1995.

59. 59 Can we get more money from the rich by taxing their income at a higher rate?

60. 60 In early 1920’s, the top income tax rate was decreased from 73% to 24%.

61. 61 Top Income Tax Rate Cut from 73% to 24% in Early 1920’s

62. 62 In early 1960’s, the top income tax rate was decreased from 90% to 70%.

63. 63 Top Income Tax Rate Cut from 90% to 70% in Early 1960’s

64. 64 In early 1980’s, the top income tax rate was decreased from 50% to 28%. Lower bracket income taxes were also decreased.

65. 65 Top Income Tax Rate Cut from 50% to 28% in Early 1980’s

66. 66 What to do? The rich are getting richer while the poor are getting poorer.

67. 67 Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2006, Table 673. Income Distribution for 1980 (in 2003$)

68. 68 Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2006, Table 673. Income Distribution for 2003 (in 2003$)

69. 69 Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2008, Table 675. In 1980, the lower 80% of households earned 56% of all income. By 2003, the lower 80% of households earned only 50% of all income.

70. 70 In which world would each person rather live? (prices are the same in the two worlds) In world #1, Person 10 earns 11% of all income. In world #2, Person 10 earns 15% of all income.

71. 71 In World #1, the lower 80% of households earned 80% of all income. In World #2, the lower 80% of households earned only 70% of all income.

72. 72 In which world would each person rather live? (prices are the same in the two worlds) World #3’s income distribution is the same as World #1’s.

73. 73

74. 74

75. 75

76. 76

77. 77 Compiled from data published in 2003 Statistical Abstract of the United States, U.S. Bureau of the Census, and provided by the Social Security Administration Expected annual Social Security tax payments Expected annual Social Security benefits Expected Tax and Benefits for Median Worker

78. 78 Compiled from data published in 2003 Statistical Abstract of the United States, U.S. Bureau of the Census, and provided by the Social Security Administration Expected annual Social Security tax payments Expected annual benefits from privatized account This chart assumes that 100% of the worker’s current Social Security taxes are diverted to a private investment account yielding an 8% annual return.