Professional Documents
Culture Documents
Tax Incidence: Also Known As, Who Bears The Burden of Taxation?
Tax Incidence: Also Known As, Who Bears The Burden of Taxation?
Federal personal income taxes are just part of the federal tax system.
How do we assign burdens of…
– Federal corporate income taxes
– Payroll taxes
– Excise taxes
– Estate and gift taxes
– Other taxes (e.g., tariffs)
The payroll tax is particularly problematic, since subsequent benefits
are tied to tax payments. Not clear whether it should be included.
One way of doing this: assign tax burdens based on arbitrary
assumptions (corporate tax paid by owners of capital, payroll tax paid
by workers, excise taxes paid by consumers, estate tax paid by
decedents). This assignment produces:
6
7
8
Might anything be wrong here?
10
Who cares who pays?
Think about there being a “tax jar” at the counter. In one regime, the customer
pays for the good, then puts taxes in the jar. Alternatively, the seller can collect
the tax, then the seller puts the tax in the jar. The difference between the
customer paying the tax, or the seller, is clearly unimportant.
This relies on the idea that prices are determined by supply and demand.
In a competitive market economy, such as that in the United States, this is how
prices are determined.
Occasionally prices are set some other way, perhaps by government regulation
(e.g., as with a fixed minimum wage, or with regulated prices for utilities or
other services), in which case it may well matter who remits the taxes.
And as a practical issue it may well make more sense to have certain parties
remit taxes rather than others, since they can do so at lower cost, or can be
audited with greater ease.
But note that even these administrative considerations are largely about
remittance, not attribution. The social security tax, for example, could be “paid”
75% by employers and 25% by employees without affecting who remits and
12 who keeps records.
What happens when a tax is imposed?
13
The burden of the
(a) (b)
Price per tax is split Price per
gallon (P) between gallon (P)
consumers and A 50 cent tax S2
Initially, producers shifts the effective
S1 supply curve. S1
equilibrium entails
a price of $1.50 B
and a quantity of $2.00
100 units. C
P2 = $1.80 Consumer burden = $0.30
P1 = $1.50 A P1 = $1.50
A
D D
P2 = $1.30 C
B
$1.00
$0.50
D2 D1
Quantity in billions
Q2 = 90 Q1 = 100 of gallons (Q)
15
OK, so it works.
16
Principle #2: People pay taxes.
18
Price per
gallon (P) D S2
S1
P2 = $2.00
With perfectly inelastic demand,
Consumer burden
consumers bear the full burden.
P1 = $1.50
$0.50
Quantity in billions
Q1 = 100 of gallons (Q)
19
Price per
gallon (P) S2
S1
$0.50
Supplier burden
$1.00
Quantity in billions
Q2 = 90 Q1 = 100 of gallons (Q)
20
Why does it work this way?
With inelastic demand, the total quantity does not change after
the tax is imposed. Since you have to pay the suppliers a
certain amount to get them to sell you this quantity, there is no
scope for shifting the burden onto sellers. Hence the burden
falls on buyers.
With perfectly elastic demand, the price that consumers face
cannot change, since they will simply purchase other
substitutes, hence consumers do not bear the burden of the
tax.
A similar logic applies to sellers: inelastic supply implies that
sellers bear the tax burden, elastic supply that buyers bear the
tax burden.
21
Supply curve does not change
Price per when it shifts up.
gallon (P) S
P1 = $1.50
Hence the price to consumers
does not change.
Quantity in billions
Q1 = 100 of gallons (Q)
22
More inelastic supply, smaller
More consumer
elastic supply, larger
burden.
consumer burden.
(a) Tax on steel producer (b) Tax on street vendor
P P
S2
S1
Tax
S2
B
B P2
P2 Tax
Consumer burden Consumer burden S1
P1 A
A
P1
D D
Q2 Q1 Q Q2 Q1 Q
23
How should one think about these
burdens?
26
Business tax in Rhode Island.
Make the following stylized assumptions:
– Rhode Island is very small (good assumption!)
– All output is produced by a combination of labor and capital.
– Labor is immobile: people live their whole lives in the states in
which they are born.
– The total amount of capital in the United States is fixed, but capital
is freely mobile between states.
Then what happens when we tax businesses in Rhode Island?
The after-tax rate of return to investing in businesses in Rhode
Island CANNOT FALL, since if it did, capital owners would just
invest in California, Florida, New York, or Texas instead.
Hence the owners of Rhode Island businesses DO NOT bear
the burden of the Rhode Island tax.
27
How does that work?
In order to keep capital in Rhode Island, it must be the case
that the pre-tax rate of return to investing there rises when the
tax is imposed.
This happens because capital FLEES RHODE ISLAND – and
with less capital, the stuff that is left earns higher rates of
return.
So who bears the burden of the Rhode Island tax? Workers in
Rhode Island! Why?
– Since capital does not bear the burden, workers are what’s left
(and workers can’t leave, by assumption).
– With less capital in Rhode Island, labor becomes less productive,
and wages fall to reflect that.
– By the way, this is what really happens!
28
What about the rest of the country?
29
Small things can be big!
31
General equilibrium reasoning.
34
Who bears burdens of environmental
and other corrective taxes?
36
Over what period of time should family
income be measured?
37
Does it matter how we measure
income?
Recall that there are two primary reasons why annual income differs
from lifetime resources (as reflected in annual expenditures):
– Annual income fluctuates due to transitory shocks including unemployment, planned
leave from the labor force for education, care of the elderly or very young, income
from selling long-held capital assets, bonuses, windfalls, and other sources.
– Incomes fluctuate over the life cycle, with the young and retirees having lower income
levels.
Poterba offers evidence that the first of these sources , the annual
fluctuations from transitory shocks, is the more important of the two by
looking at how expenditure shares on gasoline, alcohol and tobacco
vary by age.
– Expenditure shares vary somewhat by age, with those under 25 showing the highest
expenditure shares and those over 75 the lowest.
– But these variations are much less pronounced than the expenditure/income ratios in
different quintiles, suggesting that age differences alone probably account for a
relatively small fraction of the variation.
43 – Note, too that expenditure/income varies over the life cycle.
44
Lessons from this study.
48
Why tax specific items with excise
taxes?
50
Excise tax revenues, as % of
national income, 2002
Australia 4.5 %
Canada 3.2
France 3.6
Germany 3.6
Japan 2.1
United Kingdom 4.3
Europe Average 4.0
51
Excise tax revenues as % of total
tax revenues, 2002
Australia 14.3 %
Canada 9.5
France 8.1
Germany 10.1
Japan 8.2
United Kingdom 12.0
Europe Average 9.9
52
Other externalities.
Various bad habits that people have.
– Smoking.
Accounts for more than 400,000 deaths/year.
Externalities from:
– Second-hand smoke.
– Reduced workplace productivity.
– Causing fires.
– Health costs paid by others (out of $75b of annual health costs).
Large positive externalities from reduced retirement benefits.
Net external cost (47 cents a pack) is small compared to the cost that smokers
impose on themselves ($35 a pack).
– Drinking alcohol
Main external problem is drunk driving ($120b a year in cost).
Also creates problems for drinkers, but these are estimated to be smaller.
– Overeating, lack of exercise.
Is there a role for public policy in regulating or taxing unwise individual
behavior? Should we think of that as an externality?
53
Why tax consumption instead of
income?
55
The lump sum nature of transiting
to a consumption tax.