Economics Tax

Economics Tax - Economics: Taxation The deadweight loss...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Economics: Taxation The deadweight loss with taxation is determined by changes in quantities when a tax is imposed, since this change captures the number of socially efficient trades that are not being made. Supposed, for example, that the government levied a tax on a particular fast-food restaurant, McGruber’s. This tax would cause a large reduction in demand for McGruber’s meals because individuals would shit their consumption to close substitutes (like Gruber King). This change is inefficient, however, because the fact that individuals were eating at McGruber’s before the tax indicates that McGruber’s meals are their preferred choice. The large deadweight loss occurs because many individuals move away from their preferred choice in response to the tax. The inefficiency of any tax is determined by the extent to which consumers and producers change their behavior to avoid the tax; deadweight loss is caused by individuals and firms making inefficient consumption and production choices in order to avoid taxation. The fact that the marginal deadweight loss rises with the tax rate means that preexisiting distortions in a market, such as externalities, imperfect competition, or existing taxes, are key determinants of the efficiency of a new tax. The fact that the marginal deadweight loss rises with the tax rate implies that governments should not raise and lower taxes as they need money but should instead set a long-run tax rate that will meet their budget needs on average, using deficits and surpluses to smooth out its short-run budget fluctuations. Ramsey Rule: to minimize the deadweight loss of a tax system while raising a fixed amount of revenue, taxes should be set across commodities so that the ratio of the marginal deadweight loss to marginal revenue raised is equal across commodities. If the tax on good A has an MDWL/MR that is higher than the MDWL/MR from taxing good B, taxing good A causes more inefficiency per dollar of revenue raised than does taxing good B. The goal of the government is to raise revenues in a manner that maximizes the nation’s social welfare function, the function that aggregates individual utilities into an overall level of social well-being. Primary earners are the family members who are the main source of labor income for a household, while secondary earners are other workers in the family. The work decisions of primary earners are not very responsive to changes in their wages. For every 10% reduction in after-tax wages, primary earners work about 1% fewer hours, for an elasticity of labor supply with respect to after tax wages of 0.1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Secondary earners are much more responses to wages (and thus taxes) with elasticities of labor supply with respect to after-tax wages typically estimated to range from .5 to 1. Most of the response of secondary earners comes from the decision to work at all, with a
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 05/20/2008 for the course ECN 682 taught by Professor Kubik during the Spring '08 term at Syracuse.

Page1 / 9

Economics Tax - Economics: Taxation The deadweight loss...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online