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# lnc5 - Lecture Notes Companion 5 General rule for...

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Unformatted text preview: Lecture Notes Companion 5 General rule for determining the incidence of a tax: The Burden (Incidence) of a Tax The lower the elasticity of 1. The burden of a tax falls on both the buyer and the seller, regardless of which party pays the tax to the state { demand, supply, } the greater the burden of the tax 2. A tax also imposes an excess burden which is a deadweight loss to buyers and sellers, i.e., a loss which is not offset by someone else’s gain borne by the { buyer. seller. } Effect of a tax on waffles (1) Effect of a tax on waffles (2) Let the market for waffles begin in initial equilibrium with P = \$1.00, Q = 1000/wk. Now, let a tax of 30 cents each be placed on waffles, to be paid by the seller. P P This raises the seller's offer, or reservation, price for the 1000th waffle by 30 cents. S S 1.00 } 1.00 tax = 30 cents D D 00 17 00 16 00 15 00 1400 13 00 12 00 11 00 10 0 90 0 80 0 70 0 60 0 50 0 40 0 30 0 20 0 10 00 17 00 16 00 15 00 1400 13 00 12 00 11 00 10 0 90 0 80 0 70 0 60 0 50 0 40 0 30 0 20 0 10 Q Effect of a tax on waffles (4) Effect of a tax on waffles (3) Thus, we have a new supply curve at S + tax. In fact, it raises the offer price for each waffle by 30 cents. P P S + tax S S } 1.00 Q tax = 30 cents } 1.00 tax = 30 cents D D 00 17 00 16 00 15 00 1400 13 00 12 00 11 00 10 0 90 0 80 0 70 0 60 0 50 0 40 0 30 0 20 0 10 00 17 00 16 00 15 00 1400 13 00 12 00 11 00 10 0 90 0 80 0 70 0 60 0 50 0 40 0 30 0 20 0 10 Q Q P P S S + tax S + tax D D "I don't need Bush's tax cut. I have never worked a [bleeping] day in my life." U.S. Rep. Patrick Kennedy (D-RI) (Washington Post, June 27, 2003) Q Q Deadweight loss = ½ x b x h Deadweight loss = ½ x b x h = ½ x \$.30 x 150 = \$22.50 Effect Effect on social welfare of the deadweight loss due to the tax Does the tax make society better off? Tax revenue = 850 x \$.30 = \$255.00 = \$255.00 150 waffles not 150 waffles not sold & consumed sold & consumed { Clearly, it does if it passes our standard test of rational behavior; If the benefits of the tax, i.e., the services the government provides from the revenues, services the government provides from the revenues, exceed the cost of the tax, then the answer is yes. exceed the cost of the tax, then the answer is yes. { { 850 waffles sold & consumed & consumed { However, this turns out to be a tall order. The total cost, i.e., burden, of the tax is defined as total cost, i.e., burden, of the tax is defined as Total tax burden = tax payments to government + excess burden + excess burden In our waffle example, the tax payments come to \$255.00 (850 waffles x 30¢ tax per waffle). The deadweight loss is \$22.50 (see graph for this), giving deadweight loss is \$22.50 (see graph for this), giving a total burden of \$277.50. However, the government has only \$255.00 of revenue to spend on services. so, it has to spend this money as efficiently as the so, it has to spend this money as efficiently as the taxpayers could have spent the whole \$277.50—just to leave society no better off than before. This is not to say that there are no government This is not to say that there are no government services that are worth the cost. Many are, such as defense, police and courts, and public health. Probably most, however, would fail the test. Probably most, however, would fail the test. So why are there so many government services? And so many taxes? Read the article assigned for And so many taxes? Read the article assigned for Special Topic 1 by Robert Russell, "If You're Paying, Special Topic 1 by Robert Russell, "If You're Paying, I'll Have Top Sirloin," for an explanation. "Of course we (Democrats) tax and spend." Tim Robertson, Former New Hampshire legislator (The Union Leader, April 27, 2003) Tax = 30¢ ...
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