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TAXATION AND INCOME DISTRIBUTION
Chapter 14
Vocabulary
Statutory Incidence
Economic Incidence
Tax Shifting
Partial Equilibrium Models
0
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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
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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 0 0 0.2
5,000 400 0.08 0.2
10,000 1,400 0.14 0.2
30,000 5,400 0.18 0.2
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Measuring How Progressive a Tax System Is
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Measuring How Progressive a Tax System is – A Numerical Example
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Partial Equilibrium Models
Models that study only one market and ignore possible spillover effects on other markets
Economic incidence depends on:
Elasticities of Supply and Demand
Tax Salience: the extent to which a tax rate is made prominent to a taxpayer
Economic incidence does not depend on whether it is levied on Consumers or Producers.
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Before Tax After Tax
Consumers Pay
Suppliers Receive
$1.40
$1.00
$1.20
$1.20
0
D0
S0
D1
S1
Quantity
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Unit Tax on Commodities
0
DX
S
SX
DX’
Perfectly Inelastic Supply
Quantity
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0
DX
S
SX
DX’
Perfectly Elastic Supply
Quantity
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Ad Valorem Taxes
Pounds of food per year
Price per Pound of food
Df
Sf
Q0
Qm
Qr
P0
Pm
Pr
Df’
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Taxes on Factors
Statutory vs. Economic Incidence
The Payroll Tax
Tax on labor that finances Social Security
Tax on Capital in a Global Economy
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The Payroll Tax
Hours per year
Wage rate per hour
DL
SL
L0 = L1
wg = w0
Pr
DL’
wn
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Commodity Taxation without Competition
Monopoly
Despite market power a monopolist is generally made worse off
QD does down
Price paid by consumers goes up
Price received by the monopolist goes down
Profits go down
Oligopoly
Can result in higher or lower profits
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Monopoly
X per year
$
DX
MRX
ATCX
MXX
X0
P0
ATC0
a
b
c
d
DX’
MRX’
Pn
i
g
f
h
X1
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Economic Profits
Economic Profits after unit tax
Profits Taxes
Economic profit
Perfect competition
Monopoly
Measuring economic profit
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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: A stream of tax liabilities becomes incorporated into the price of an asset
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General Equilibrium Models
Show how various markets are interrelated
Consider a 2-commodity, 2-factor economy resulting in the following 9 possible ad valorem taxes
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
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Tax Equivalence Relations
Partial factor tax: tax levied on an input in only some of its uses.
tKF, tLF, tKM, tLM
Tax Equivalence: any two sets of taxes that generate the same changes in relative prices.
tKF and tLF are equivalent to tF
and and and
tKM and tLM are equivalent to tM
are are are
equivalent equivalent equivalent
to to to
tK and tL are equivalent to t
Source: McLure [1971].
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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
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Analysis of Various Taxes
Commodity tax (tF)
Income tax (t)
General tax on labor (tL)
Partial factor tax (tKM)
Output effect
Factor substitution effect
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Some Qualifications
Differences in individuals’ tastes
Immobile factors
Variable factor supplies
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An Applied Incidence Study
Average Federal Tax Rates and Share of Federal Taxes
by Income Quintile (2009)
Income Category Average Federal Tax Rate Share of Federal Taxes
Lowest Quintile 1.0% 0.3%
Second Quintile 6.8% 3.8%
Third Quintile 11.1% 9.4%
Fourth Quintile 15.1% 18.3%
Highest Quintile 23.2% 67.9%
All Quintiles 17.4% 100.0%
Top 1% 28.9% 22.3%
Source: Congressional Budget Office (2012a)
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Chapter 14 Summary
Who bears the burden of a tax It depends on price changes, which, in turn, depend on:
Time frame
Disposition of tax revenue
Market structure
Elasticities of supply and demand
Mobility of factors of production
Tax salience
Partial equilibrium incidence and general equilibrium incidence analyses are used to determine burdens of unit and ad-valorem taxes
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