KW_Macro_Ch_04_Sec_04_Taxes

KW_Macro_Ch_04_Sec_04_Taxes - chapter 4 > The Market...

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>> The Market Strikes Back Section 4: A Surprise Parallel: Taxes chapter 4 To provide the services we want, from national defense to public parks, governments must collect taxes. But taxes impose costs on the economy. Among the most impor- tant roles of economics is tax analysis: figuring out the economic costs of taxation, determining who bears those costs, and suggesting ways to change the tax system that will reduce the costs it imposes. It turns out that the same analysis we have just used to understand quotas can be used, with hardly any modification, to make a prelimi- nary analysis of taxes, too. Why Is a Tax Like a Quota? Suppose that the supply and demand curves for New York taxis were exactly as shown in Figure 4-5 in “Section 3: Controlling Quantities.” This means that in the absence of government action, the equilibrium price of a taxi ride will be $5 and 10 million rides will be bought and sold.
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Now suppose that instead of imposing a quota on the quantity of rides, the city imposes an excise tax —a tax on sales. Specifically, it charges taxi drivers $2 for each ride they provide. What is the effect of the tax? From the point of view of a taxi driver, the tax means that he or she doesn’t get to keep all of the fare: if a passenger pays $5, $2 is collected as a tax, so the driver gets only $3. For any given quantity of rides supplied, the post-tax supply price is higher than the pre-tax supply price. For example, drivers will now require a price of $6 to supply as many rides as they would have been willing to supply at a price of $4 in the absence of the $2 tax. 2 CHAPTER 4 SECTION 4: A SURPRISE PARALLEL: TAXES An excise tax is a tax on sales of a good or service. Figure 4-7 S 1 S 2 A B 6 0 8 10 12 14 $7.00 6.00 5.00 4.00 3.00 Quantity of rides (millions per year) Fare (per ride) D E Supply curve shifts upward by the amount of the tax. Excise tax = $2 per ride Effect of an Excise Tax Levied on Sales of Taxi Rides S 1 is the supply curve before the tax. After the city requires drivers to pay a tax of $2 for every ride they give, the supply curve shifts upward by $2, to the new supply curve S 2 . This means that the price drivers receive net of tax is $4, repre- sented by point B on the old supply curve S 1 . And the price paid by riders is $6, rep- resented by point A on the new supply curve S 2 . The tax drives a wedge between the demand price, $6, and the original supply price, $4.
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So the tax on sales shifts the supply curve upward, by the amount of the tax. This is shown in Figure 4-7, where S 1 is the supply curve before the tax is imposed and S 2 is the supply curve after the tax is imposed. The market equilibrium moves from E , where the price is $5 per ride and 10 million rides are bought and sold, to
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This note was uploaded on 04/10/2008 for the course ECONOMICS 103 taught by Professor Sheflin during the Spring '08 term at Rutgers.

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KW_Macro_Ch_04_Sec_04_Taxes - chapter 4 > The Market...

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