Download Burden of Tax

The Benefits of Taxation
• The benefits of taxation are the goods and services
that government provides.
Burden of Tax
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Provides a stable set of institutions and rules
Promotes effective and workable competition
Corrects for externalities
Creates an environment that fosters stability and growth
Provides public goods
Adjusts for undesirable market results
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Two Principles of Taxation
Who Bears the Burden of a Tax?
• The benefits principle – the individuals who
receive the benefit of the good or service
should pay the tax necessary to supply the
good.
• The ability-to-pay principle – individuals who
are most able to bear the burden of the tax
should pay.
• The supply and demand framework gives the
answer to this question.
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Burden Depends on Relative
Elasticity
• The person who physically pays the tax is
not necessarily the person who bears the
burden of the tax.
• The burden of the tax is rarely shared equally
since elasticities are rarely equal.
Burden Depends on Relative
Elasticity
• The more inelastic one’s relative supply and
demand, the larger the tax burden one will
bear.
Who Bears the
Burden of a Tax?
• If demand is more inelastic than supply,
consumers will pay the higher share.
• If supply is more inelastic than demand,
suppliers will pay the higher share.
Supplier Pays Tax
S1
Price of luxury boats
Burden Depends on Relative
Elasticity
$70,000
60,000
50,000
40,000
30,000
20,000
10,000
S0
Supplier pays
Demand
510
200
McGraw-Hill/Irwin
tax
Consumer pays
400
600 Quantity of luxury boats
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
2
Who Bears the
Burden of a Tax?
Who Bears the
Burden of a Tax?
Demand is inelastic
S1
S0
Demand
590
400
600 Quantity of luxury boats
tax S
0
60
50
40
0
510 600
Quantity of luxury boats
$70
S1
D
S0
60
50
40
590
0
D0
D1
510
400
600 Quantity of luxury boats
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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Quantity of luxury boats
Quantity
of
luxury
boats
w
Supplier pays the taxSupply shifts
500 600
Quantity of luxury boats
Consumer pays the taxDemand shifts
1
Price of luxury boats
S1
D
tax
Who Bears the Tax Burden?
Demand is inelastic
Larger consumer burden
Price of luxury boats
Price of luxury boats
$70
Supplier pays
McGraw-Hill/Irwin
Who Bears the Tax Burden?
Demand is elastic
Equal burden
S0
Consumer pays
200
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw-Hill/Irwin
$70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
Price of luxury boats
200
tax
Price of luxury boats
Price of luxury boats
$70,000
Consumer pays
60,000
50,000
Supplier pays
40,000
30,000
20,000
10,000
Consumer Pays Tax
0
1
3
Who Pays Versus Who Bears the
Burden of a Tax
Tax Incidence and Current Policy
Debates
Social Security Taxes
Social Security Taxes
• Both employer and employee contribute the
same percentage of before-tax wages to the
Social Security fund.
• The fact that both the employer and
employee contribute the same percentage
does not mean they share the burden
equally.
• The burden of a tax is independent of who
physically pays the tax.
• The analysis of tax incidence is helpful when
discussing current policy debates.
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Social Security Taxes
Sales Taxes
• On average, labor supply tends to be less
elastic than labor demand, so the Social
Security tax burden is primarily on
employees.
• Sales taxes are those paid by retailers on the
basis of their sales revenue.
• Since sales taxes are broadly defined,
consumers find it hard to substitute.
• Demand is inelastic so consumers bear the
greater burden of the tax.
Sales Taxes
• As consumers increase purchases on the
internet where sales are not taxed, retail
stores will bear a greater burden of the sales
tax.
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