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Chapter 17
Public Choice
Theory and the
Economics of
Taxation
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
• Conveying economic preferences
through majority voting
• Government failure
• Tax philosophies and the tax
burden
• Tax shifting, tax incidence, and
efficiency losses from taxes
17-2
Majority Voting
• Can result in inefficiency
–Over or underproduction of a
public good
–Individuals think only of
themselves
–Strength of preferences ignored
17-3
Majority Voting
• Interest groups-people band
together to persuade others of
public good merits.
• Logrolling-trading of votes to
secure outcomes. Can turn into
inefficient outcome.
Majority Voting
$700
Adams
$300
Inefficient
Majority “Yes” Vote
Benefit; Tax
Benefit; Tax
Inefficient
Majority “No” Vote
$250
Benson
$350
$350
Benson
Conrad
“YES”
“YES”
$300
$200
$100
Conrad
Adams
“YES”
“NO”
“NO”
0
“NO”
0
“NO” Wins!
Inefficient Since
MSB > MSC
$1,150 > $900
“YES” Wins!
Inefficient Since
MSB < MSC
$800 < $900 17-5
Majority Voting
• Paradox of voting-unable to rank
preferences.
–Paired choice majority voting
–Flawed procedure
–Outcome depends on vote order
• Median voter model
–Politicians appeal to the middle
–Extremes pick the middle
17-6
Government Failure
• Special-interest effect
–Pork-barrel politics-securing a
government project that yields
benefits mainly to a single
district
•
•
•
•
•
Rent-seeking behavior
Clear benefits, hidden costs
Limited and bundled choice
Bureaucracy and inefficiency
Imperfect institutions
17-7
The Tax Burden
• Total cost of taxes imposed on
society
• How should the tax burden be
apportioned?
• Benefits-received principlegoods/services purchased the
same way as other commodities
• Ability-to-pay principleapportioned based upon income
17-8
Tax Burden
• Progressive tax-average rate
increases as income increases.
– Larger % of income as income
increases
• Regressive tax-average rate declines
as income increases
– Smaller % of income as it income
increases
• Proportional tax-remains the same
regardless of income
Types of Taxes
•
•
•
•
•
Personal income tax
Sales tax
Corporate income tax
Payroll tax
Property tax
17-10
Tax Incidence
• Who really pays the tax?
• Excise tax
–Tax burden depends on elasticity
–Inelastic vs. elastic
• Efficiency loss of an excise tax
–Deadweight loss
–Depends on elasticity
–Transfer of surplus to govt.
17-11
Tax Incidence of an Excise Tax
P
St
14
S
Price (Per Bottle)
12
Tax $2
10
8
6
4
D
2
0
5
10
15
20
Quantity
25
(Millions of Bottles Per Month)
Q
17-12
Tax Incidence
• Why impose an excise tax?
–Discourage consumption
–Redistributive goals
–Reduce negative externality
• Burden of the excise tax?
–Depends on elasticity
–Availability of substitutes
17-13
Tax Incidence and Elasticity
Smaller efficiency loss with inelastic demand
P
P
St
Tax
Tax
S
S
a
Pi
Pe
P1
Pa
St
a
b
P1
Pb
De
c
b
c
Di
0
Q2
Q1
Tax Incidence and
Elastic Demand
Q
0
Q2Q1
Q
Tax Incidence and
Inelastic Demand
17-14
Tax Incidence and Elasticity
Smaller efficiency loss with inelastic supply
P
P
Tax
St S
Tax
St
a
Pe
P1
Pa
S
Pi
P1
b
a
b
c
Pb
c
D
0
Q2
Q1
Tax Incidence and
Elastic Supply
D
Q
0
Q2Q1
Q
Tax Incidence and
Inelastic Supply
17-15
Efficiency Loss of a Tax
P
S’
14
Tax Paid by
Consumers
Price (Per Bottle)
12
S
Tax $2
10
8
6
4
2
0
Efficiency
Loss (or
Tax Paid by Deadweight
Loss)
Producers
5
10
15
20
Quantity
D
25
(Millions of Bottles Per Month)
Q
17-16
Incidence of U.S. Taxes
• Workers bear full burden of:
–Social security tax
–Medicare tax
–Income tax
• Burden of corporate income tax:
–Stockholders (short run)
–Workers (long run)
17-17
U.S. Tax Structure
• Federal tax system progressive
• State and local system is
regressive
• Overall tax structure slightly
progressive
17-18
Taxes on General Consumption
• Sales tax, excise tax, value-added tax
Percentage of GDP, 2005
0
2
4
6
8
10
12
14
Iceland
Denmark
Sweden
New Zealand
France
Germany
Italy
Canada
Japan
United States
Source: Organization for Economic Cooperation and Development
17-19
Government Failure
• Examples of pork barrel politics
–Chicago “wilderness” program
–Bison meat, cauliflower, and
pumpkin supports
–Catfish as livestock spending
–9,300 special projects in 2003
–Waste and fraud in Katrina relief
spending
17-20
Key Terms
•
•
•
•
•
•
public choice theory
logrolling
paradox of voting
median-voter model
government failure
special-interest
effect
• earmarks
• rent seeking
• benefits-received
principle
• ability-to-pay
principle
• progressive tax
• regressive tax
• proportional tax
• tax incidence
• efficiency loss of a
tax
17-21
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Antitrust Policy and
Regulation
17-22