Topic 6: Tax Incidence

Question 1

Tax base

Answer 1

The aggregate value of the financial streams or assets on which tax can be imposed (e.g. property for property tax)

Question 2

Tax equity

Answer 2

1. Vertical equity: people with more money should pay more taxes (redistribution of income using progressive taxes)
2. Horizontal equity: people in the same income group should pay the same level of tax (e.g. poll tax in the UK)

Question 3

Three rules of tax incidence

Answer 3

1. Statutory incidence is not equal to the economic incidence
2. Irrelevance of statutory incidence
3. More inelastic factor bears more of the tax

Question 4

Statutory incidence

Answer 4

The burden of a tax borne by the party who sends the cheque (remitter) to the government

Question 5

Economic incidence

Answer 5

The burden of the tax measured by the change in resources available to any economic agent as a result of the taxation

Question 6

Irrelevance of statutory incidence

Answer 6

Equilibrium prices, quantities, and tax revenue are independent of whether the buyer or seller is the remitter

Question 7

Gross price

Answer 7

Price paid by or received by the party not paying the tax to the government (i.e. the market price)

Question 8

After-tax price

Answer 8

Price paid by or received by the party paying the tax to the government

Question 9

Assumptions underpinning irrelevance of statutory incidence

Answer 9

1. No tax avoidance or evasion by the remitter of the tax
2. Full tax salience: the buyers and sellers fully ‘understand’ and pay attention to the tax (or tax changes)

Question 10

dp/dt=
(elasticity)

Answer 10

εd/(εs-εd)

Question 11

εd=

Answer 11

(q/D(q)) * (dD/dq)

where q=P+t and D(q) is quantity

Question 12

εs=

Answer 12

(p/S(p)) * (dS/dp)

Question 13

dp/dt=
(supply and demand)

Answer 13

D’(p)/(S’(p)-D’(p))

Question 14

dq/dt=

Answer 14

1+(dp/dt)

Question 15

When do consumers bear the entire burden of the tax?

Answer 15

1. dp/dt=0 (perfectly elastic supply: εs=infinite)
2. dq/dt=1 (perfectly inelastic demand: εd=0)

Question 16

When do producers bear the entire burden of the tax?

Answer 16

1. dp/dt=-1 (perfectly inelastic supply: εs=0)
2. dq/dt=0 (perfectly elastic demand: εd=-infinity)

Question 17

VAT

Answer 17

1. Levied on the value at each stage of the processing of a raw material or the production and distribution of a commodity
2. Ultimately final consumer pays the entire burden of the tax as can reclaim at each production stage (sale)

Question 18

DWB=
(elasticities)

Answer 18

1/2 ((εs*εd)/(εs-εd)) Q/p (dt)^2

Question 19

DWB of tax increases with…

Answer 19

1. Absolute size of elasticities (more efficient to tax relatively inelastic goods)
2. The square of the tax rate (small taxes have relatively small efficiency costs so more efficient to spread taxes across all goods to keep each tax rate low)
3. Presence of pre-existing distortions (move from triangle to trapezoid)

Question 20

Optimal commodity taxes

Answer 20

1. Best to use lump-sum taxes which do not distort behaviour (zero DWL) but these may not exist (no behavioural effect because no impact on price of product)
2. Best to tax goods with more inelastic demand

Question 21

Ramsey tax rule

Answer 21

Optimal tax rates are such that the marginal DWB for last dollar of tax collected is the same across all goods

Question 22

Inverse elasticity rule assumption

Answer 22

Cross effects are zero

Question 23

Inverse elasticity rule

Answer 23

Optimal taxes are inversely proportional to elasticities

Question 24

Inverse elasticity rule formula

Answer 24

t/(P+t) = - ((λ-α)/λ) 1/εd

Question 25

If λ>α (Lagrange multiplier for government is bigger than that for individuals)

Answer 25

1. As long as λ>α, government values its revenue more highly than individual than individual values its expenditures (taxes are distortionary as affects government more than individual)
2. (t/(P+t)) > 0 - proportional tax should be higher for goods with a lower elasticity of demand

Question 26

Corlett and Hague (1953)

Answer 26

1. Assume homogeneity of degree zero of compensated demands
2. Goods that are complementary with leisure should be taxed at a higher rate

Question 27

Ramsey model of optimal tax assumptions

Answer 27

1. No administration and compliance costs
2. No effect of commodity taxes on distribution of real income
3. No goods that are additive and/or have negative effects on health

Question 28

General equilibrium tax incidence of soda tax in Berkeley

Answer 28

SHORT TERM
1. Soda demand perfectly elastic then sellers bear full burden
2. But companies are just a technology for combining capital and labour so ultimately these two factors must bear loss in profits (incidence shifted backwards to capital and labour)
3. Since labour supply perfectly elastic, capital bears tax because completely inelastic in short run
LONG TERM
4. Capital is highly elastic in the long-run so land (inelastic factor) bears tax in long-run
5. When both labour and capital can avoid the tax, the only way soda sellers will remain in Berkley is if they pay a lower rent on their land