Lecture 9: Taxation Flashcards
Income Tax
Tax classification: A tax system is said to be
Progressive: if the average tax rate increases as the income increases
Proportional: If the average tax rate remains constant as the income increases
Regressive: If the average tax rate decreases as the income increases
Income Tax
Tax deductions and credits
Not only to generate a progressive tax system
Provide incentive to individuals to spend money on some specific goods or services (like education, insurance)
Also used to discriminate among types of consumers (e.g. health expenditure is deductible to redistribute resources towards people who are more likely to suffer loss from health issues and thus may be less able to earn)
Commodity tax
For example sugar tax
Commodity tax on Producers implies
The price that the buyer pays will be greater than the price the seller Receiver
The quantity Sold will be smaller wrt the case with no tax
The change in total welfare includes:
The change in consumer surplus
The change in producer surplus
The change in tax revenue
The losses to buyers and sellers exceed the revenue raised by the government
This fall in total surplus is called deadweight loss
Commodity tax in perfect competition
A commodity tax formally paid by the producers is equivalent to a tax formally paid by the consumers: The equilibrium price and the equilibrium total price paid by the consumers will be the same
Determinants of the deadweight loss
The magnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price
That, in turn, depends on the price elasticities of supply and demand
If there is perfectly inelastic demand or perfectly elastic supply, the price increases by t, the tax burden is completely paid by the consumers. Complete tax shifting
If there is perfectly elastic demand or perfectly inelastic supply, the price does not increase, the tax burden is completely paid by the producers. No tax shifting
The greater the price elasticities of demand and supply…
The larger will be the decline in equilibrium quantity
The greater will be the deadweight loss of a tax
With each increase in the tax rate, the deadweight loss of the tax rises even more rapidly than the size of the tax
How does the tax Revenue react to an increasing tax rate?
For the small tax, tax revenue is small
As the size of the tax rises, tax revenue grows
But as the size of the tax continues to rise, tax revenue falls because the higher tax reduces the size of the market
Taxes and efficiency
One tax system is more efficient than another, if it raises the same amount of revenue at a lower cost (lower deadweight loss) to taxpayers
The income tax may also lead to deadweight loss due to the distortionary effect of taxation
