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Lecture 9

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2 views

Lecture 9

Uploaded by

Charity Kwok
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Government Actions in Markets (Cont.

)
Taxes

Everything you earn and most things you buy are taxed.
Who really pays these taxes?
Income tax and the Social Security tax are deducted from your pay, and state
sales tax is added to the price of the things you buy, so isn’t it obvious that
you pay these taxes?
Isn’t it equally obvious that your employer pays the employer’s contribution
to the Social Security tax?
Taxes

Tax Incidence
Tax incidence is the division of the burden of a tax between buyers and sellers.
When an item is taxed, its price might rise by the full amount of the tax, by a
lesser amount, or not at all.
If the market price rises by the full amount of the tax, buyers pay the tax.
If the market price rises by a lesser amount than the tax, buyers and sellers share
the burden of the tax.
If the market price doesn’t rise at all, sellers pay the tax.
Taxes

Equivalence of a Tax on Buyers and Sellers


The people of Maryland want to discourage cigarette smoking and impose a
tax on cigarettes of $3 pack.
They want to know whether to make producers pay the $3 tax when they
sell cigarettes, or to make smokers pay the $3 tax when they buy cigarettes.
Which one is better?
Taxes

A Tax on Sellers
The figure shows the effects of this tax.
With no tax, the equilibrium price is $6 a
pack.
A tax on sellers of $3 a pack is introduced.
Supply decreases and the curve S + tax
on sellers shows the new supply curve.
Taxes

The market price paid by buyers rises to


$8 a pack and the quantity bought
decreases from 350 million to 325 million
a year.
The price received by the sellers falls to
$5 a pack.
So with the tax of $3 a pack, buyers pay
$2 a pack more and sellers receive $1 a
pack less.
Taxes

A Tax on Buyers
Again, with no tax, the equilibrium price
is $6 a pack.
A tax on buyers of $3 a pack is
introduced.
Demand decreases and the curve D - tax
on buyers shows the new demand curve.
Taxes

The price sellers receive falls to $5 a


pack and the quantity sold decreases
from 350 million to 325 million a year.
The price buyers pay rises to $8 a pack.
Buyers pay $2 of the tax sellers pay $1
of the tax.
Taxes

The $3 tax on buyers in Figure (b) has


the same effects as the $3 tax on
sellers in Figure (a).
Taxes

The Tax as a Wedge


Figure (c) shows that the tax is like a
wedge driven between the price the
buyer pays and the price the seller
receives.
Taxes

With a tax, the equilibrium quantity is


no longer at the intersection of the
demand and supply curves.
The equilibrium quantity is the quantity
where the vertical gap between the
curves equals the size of the tax.
Taxes

Taxes and Efficiency


Except in the extreme cases of perfectly inelastic demand or perfectly
inelastic supply when the quantity remains the same, imposing a tax creates
inefficiency.
The figure on the next slide shows the inefficiency created by a $200 tax on
tablet computers.
Taxes

With no tax, marginal social benefit


equals marginal social cost.
Total surplus (the sum of consumer
surplus and producer surplus) is
maximized.
The market is efficient.
The tax decreases the quantity
bought, raises the buyer’s price, and
lowers the seller’s price.
Taxes

Marginal social benefit exceeds


marginal social cost and the tax is
inefficient.
The tax revenue takes part of the total
surplus.
The decreased quantity creates a
deadweight loss.
Taxes

Tax Incidence of Elasticity of Demand


The division of the tax between buyers and sellers depends on the elasticities
of demand and supply.
To see how, we look at two extreme cases.
• Perfectly inelastic demand: Buyers pay the entire tax.
• Perfectly elastic demand: Sellers pay the entire tax.
The more inelastic the demand, the larger is the buyers’ share of the tax.
Taxes

Perfectly Inelastic Demand


Demand for this good is perfectly
inelastic—the demand curve is vertical.
When a tax is imposed on this good,
buyers pay the entire tax.
Taxes

Perfectly Elastic Demand


The demand for this good is perfectly
elastic—the demand curve is horizontal.
When a tax is imposed on this good,
sellers pay the entire tax.
Taxes

Tax Incidence of Elasticity of Supply


To see the effect of the elasticity of supply on the division of the tax
payment, we again look at two extreme cases.
• Perfectly inelastic supply: Sellers pay the entire tax.
• Perfectly elastic supply: Buyers pay the entire tax.
The more elastic the supply, the larger is the buyers’ share of the tax.
Taxes

Perfectly Inelastic Supply


The supply of this good is perfectly
inelastic—the supply curve is vertical.
When a tax is imposed on this good,
sellers pay the entire tax.
Taxes

Perfectly Elastic Supply


The supply of this good is perfectly
elastic—the supply curve is horizontal.
When a tax is imposed on this good,
buyers pay the entire tax.
Taxes

Taxes and Fairness


Economists propose two conflicting principles of fairness to apply to a tax
system:
• The benefit principle: people should pay taxes equal to the benefits they receive from
the services provided by government.
• High fuel taxes to pay for freeways; high taxes on alcoholic beverages and tobacco products to
pay for public healthcare services; high rates of income tax on high incomes to pay for law-
and-order
• The ability-to-pay principle: people should pay taxes according to how easily they
can bear the burden of the tax.
• High rates of income tax on high incomes; tax on capital gains
Taxes

Taxes in Practice: Why We Need Tax?


Taxes lead to inefficiency. Why do we still need taxes?
• In addition to the deadweight loss, taxation also incurs compliance costs.
• Even in Hong Kong, one of the most free economy, we still have taxes.
Taxes serve two purposes:
• To fund government spending and public expenditures
• Social security, healthcare, public education, infrastructure, national defense, etc.
• To correct negative externalities (“Pigouvian taxes”)
Taxes

Taxes in Practice: Taxes and Elasticity


Taxes usually are levied on goods and
services with an inelastic demand or an
inelastic supply.
Alcohol, tobacco, and gasoline have
inelastic demand, so the buyers of these
items pay most of the tax on them.
Labor has a low elasticity of supply, so the
seller—the worker—pays most of the
income tax and most of the Social Security
tax.
Taxes
Taxes in Practice: Global Minimum Corporate Tax
The largest companies in the world are all
multinationals.
However, the multinationals do not pay as much tax
as they should.
• The reason: “Race to the bottom on corporate taxes”
(Jenet Yellen)
For example, Apple uses its subsidiaries in Ireland
to shift profits and evade taxes
• “Tax Havens”: Ireland, Cayman Islands, British Virgin
Islands, Hong Kong…
• As a result, corporate income tax only accounts for 6.6%
of total federal revenue in 2019.
Taxes
Taxes in Practice: Global Minimum Corporate Tax
Solution: A Global minimum corporate tax
• In July, 2021, Finance ministers of G20 agreed
to set a minimum global corporate tax rate of at
least 15%.
• It was then agreed by 132 countries.
• 32 countries have a top corporate tax rate below
15%.

• If the policy is implemented, multinationals


will have to pay tax everywhere – not just
where they have their headquarters.
• It will potentially affect Hong Kong, the 8 th Tax
Haven in the world.
Subsidies

Subsidies
A subsidy is a payment made by the
government to a
producer/consumer.
With no subsidy, the price is $40 a
ton and 40 million tons a year are
produced.
With a subsidy of $20 a ton, marginal
cost minus subsidy lowers the cost of
production and the new supply curve
is S – subsidy.
Subsidies

The market price falls to $30 a ton


and farmers increase the quantity to
60 million tons a year.
But farmers’ marginal cost of the 60th
ton increases to $50.
With the subsidy, farmers receive
more on each ton sold—the price of
$30 a ton plus the subsidy of $20 a
ton, which is $50 a ton.
Subsidies

Inefficient Overproduction
At the quantity produced:
• Marginal social benefit equals the market
price, which has fallen.
• Marginal social cost (on the supply curve)
has increased.
• Marginal social cost exceeds marginal
social benefit.
• What is the deadweight loss?
Subsidies

Subsidies in Practice: Agricultural Subsidies


Agricultural production are heavily subsidizes in many countries.
• For example, the United States and the European Union pay the biggest subsidies to
their farmers, which create inefficient overproduction.
• It also makes it more difficult for famers in the underdeveloped countries to compete in
the global markets.
Countries such as Australia and New Zealand have stopped subsidizing
farmers.
• They see efficiency improvement of farming, and remain competitive in the global
markets.
Subsidies

Subsidies in Practice: Industrial Policies


Subsidy is an important component in industrial
policies, which is now common in both
developing and developed countries.
• Forms of subsidies in IPs
• Production subsidies
• R&D subsidies
• Export subsidies
• …
• Rationales: externalities, coordination failures, activity-
specific public inputs, …
• Critique: information shortcomings, rent-seeking, …

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