Public 2: Commodity Taxes Flashcards
What is tax incidence?
Formal incidence is the party who has to pay the tax. For example, income tax is formally incident on employees.
Economic incidence is the party who ‘bears the burden’ of the tax - the extent to which consumer or producer surplus is reduced by the tax. Unless employers are perfectly elastic in their demand for labour, they will bear some of the economic incidence of income tax.
Why does the more inelastic factor bear most of the burden of a sales tax?
Intuitively, the party more able to walk away from the transaction bears less of the tax.
What is Marshallian demand? What is Hicksian demand?
Marshallian demand takes prices, income and preferences as an input, and outputs a demand vector that maximises utility by constrained optimisation.
Hicksian demand takes prices, preferences and a given utility level as an input, and outputs a demand vector that minimises the cost of reaching that utility level.
What is the Slutsky matrix?
The derivates of Hicksian demand. Entry s_{i,j} measures the change in compensated demand for good i from changes to price j. This is a symmetric matrix.
In simple partial equilibrium analysis, why is deadweight loss proportional to the square of the tax rate?
If we have linear supply and demand curves, DWL = 0.5∆Qt. ∆Q is a linear function of t, so DWL is proportional to t^2.
What is the social marginal utility of income?
The derivative of social welfare with respect to an income change. This decomposes into the welfare effect of increased spending power, and the welfare effect of increased tax revenue.
What is the social value of government revenue?
The welfare effect of “£1 found down the back of the Treasury sofa”
Why do optimal taxation problems impose an exogenous public revenue requirement R? What is it used for?
Spending on public goods, Pigouvian subsidies, etc. Importantly, this is not for providing benefits, which is endogenous in the tax-and-benefit system.
What is the setup of the Ramsey commodity taxation problem?
The government needs to raise R and can only set commodity taxes. We have an economy of a single (or a representative) consumer who optimises consumption choices by maximising utility. Lump-sum taxes are not possible.
What is the Ramsey rule? Provide some intuition.
The proportional change on compensated demand for good k of the entire tax system should be constant between goods; if it were not, it would be a Pareto improvement to move towards equality.
This implies that we should tax substitutes of goods similarly to reduce the overall distortion.
What is the inverse elasticity rule? Under what conditions does it hold?
The inverse elasticity rule states that goods should be taxed in inverse proportion to their elasticities of demand.
This is a special case of the Ramsey rule under the condition that there are no cross-price effects.
What is the Corlett-Hague result?
The Corlett-Hague result (1953) states that goods with higher complementarity of leisure should be taxed more highly. Uniform commodity taxation acts like an income tax and distorts the labour market. Therefore, this can be corrected for by taxing the complements of leisure.
What is the setup of the Diamond-Mirrlees (1971) model? How does it relate to Ramsey’s problem?
Diamond-Mirrlees (1971) generalise the Ramsey problem to the many-household case. It assumes, again, that consumption patterns are observable to the government, but that incomes are not. A set amount of government revenue R is to be raised whilst minimising distortions to social welfare.
Suppose income-based transfers are not possible. Is it desirable to set zero tax rates on necessities, in order to help the poor?
Yes. The many-person Ramsey rule suggests that we can create a progressive tax system by setting lower commodity tax rates on necessities and inferior goods.
Suppose income-based transfers are possible. Is it desirable to set zero tax rates on necessities, in order to help the poor?
No. It is more efficient to tax necessities at the standard rate and give the money directly to low-income people, since by subsidising necessities we will still be giving more to higher-income people in absolute terms.
