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Unformatted text preview: PADP 8670 POLICY ANALYSIS I Taxes and Subsidies Angela Fer7g, Ph.D. Overview Taxes Output tax Excise tax Tariff Subsidies Tax deduc6ons/credits Grants Vouchers 1 Ra6onale for Taxes Correct a market failure (nega6ve externali6es); raise efficiency Redistribu7on; raise equity, not efficiency Raise revenue (but we won't focus on this ra6onale) Output tax: Tax on supply side produc6on Ra6onale: nega7ve externali7es which cannot be fixed with a Coasian solu7on A nega6ve externality occurs when the ac6ons of one agent impose costs on others, but the agent does not have to compensate anyone for these costs With a nega6ve externality, compe66ve market exchanges result in too much of the ac6vity that creates the externality The Coase Theorem says that, as long as transac6ons costs are zero, bargaining among the par6es affected by externali6es will result in the efficient quan6ty of the good, regardless of who is ini6ally assigned the property rights! 2 Economic Analysis of Nega6ve Externali6es Consider a nega6ve externality in produc6on (such as pollu6on) Then the marginal social cost of produc6on exceeds the marginal private cost: MSC MEC = marginal external cost P MEC MPC = S Market equilibrium quan6ty (Q*) is greater than socially op6mal quan6ty (Q0) MB = D Q0 Q* Electricity Coasian Solu6on Example Dick owns a dog that barks and disturbs Jane, Dick's neighbor. Dick gets a benefit from owning the dog, but the dog confers a nega6ve externality on Jane. The socially efficient outcome is to compare Dick's benefit to the cost incurred by Jane and if C>B, the dog goes to the pound, and if B>C, then Dick keeps the dog. According to Coase's Theorem, Dick and Jane can always reach the efficient outcome. 3 Example cont. If Dick's benefit=$500, Jane's cost=$800; then Jane pays Dick $600 to get rid of the dog If Dick's benefit=$1000, then Dick keeps the dog. B>C so efficient outcome is reached C>B so efficient outcome is reached What if property rights were reversed? Jane has the right to peace and quiet. Then Dick has to pay Jane to keep the dog and the efficient outcome is s6lled achieved. So, whatever the ini6al distribu6on of rights, the par6es can always reach a bargain that achieves the efficient outcome. The distribu6on of property rights is not irrelevant though: it determines who has to pay whom in the bargain. Why don't we see Coase's Theorem solving more problems? It is rare that the transac6on costs are 0 Par6es can't agree on a payment There are many par6es (not just 2) to organize 4 Policy Solu6on: Output Taxes Suppose the government puts a tax on produc6on equal to the marginal external cost at the socially op6mal quan6ty: P MSC=MPC + t MPC MEC(Qo) Then the market will end up producing the socially op6mal quan6ty MB Qo Q* Electricity Implementa6on is difficult Requires the govt to know a lot of info to choose correct t. What if the MEC varies by the output? And the government chooses the wrong t? P MSC MPC + t MPC Then the market will end up producing less, but s6ll more than the socially op6mal quan6ty MB Qo Qt Q* Electricity 5 Excise Tax: Tax on demand-side consump6on Suppose the government puts a tax on consump6on equal to the marginal external benefit at the socially op6mal quan6ty: P MC MEB(Qo) Then the market will end up consuming the socially op6mal quan6ty MPB MSB=MPB+t Qo Q* Alcohol Price elas6city of demand Elas6city will affect: Consump6on change Inelas6c, price insensi6ve, small change Tax revenue collected Inelas6c, small change in Q , so large tax revenue Consumer burden Inelas6c, firm will pass tax to consumer since won't change consump6on much 6 Elas6city & Q Graph P S Delas6c Dinelas6c Dinelas6c w/tax Qe Qi Qo Delas6c w/tax Alcohol Elas6city & Tax Revenue Graph P S P S Delas6c w/tax Qe Qo Alcohol Qi Qo Delas6c Dinelas6c Dinelas6c w/tax Alcohol Tax revenue is larger when demand is inelas6c. 7 Elas6city & Tax Burden Graph P S P S Delas6c Delas6c w/tax Qe Qo Alcohol Qi Qo Dinelas6c Dinelas6c w/tax Alcohol Consumer tax burden is larger when demand is inelas6c. Tariffs: Tax on imported goods Non-efficiency ra6onale: Protect domes6c firms Efficiency ra6onales: Posi6ve externali6es of protec6ng a domes6c "infant industry" Protect domes6c firms because will do bener in the long-run and won't need protec6on, and may be future exporter. Reducing monopsony power 8 Protect domes6c firms P SUS PUSclosed Pworld+t Pworld Gain in PS DUS QS QStariff QDtariff QD Q But larger loss in CS P SUS PUSclosed Pworld+t Pworld Loss in CS DUS QS QStariff QDtariff QD Q 9 Monopsony Power Monopsony power is when there is one large buyer that can affect the price. If US has monopsony power for a foreign good: a tariff raises the price to US consumers thus, lowering the world demand and reducing the world price. As a result, the world (including the US) benefits from a lower price. Ra6onale for subsidies Correct a market failure; raise efficiency: Posi6ve externali6es Public goods Redistribu7on; raise equity, not efficiency 10 Tax Deduc7ons/Credits Allowing individuals or firms to deduct some of their taxable income or receive credits against taxes owed is a common form of subsidy. Supply-side: Can encourage use of inputs with posi6ve externali6es Can reduce costs of producing outputs with posi6ve externali6es Can fund research & development which may be a public good in some circumstances If can't exclude compe6tors from access to findings, then no one has to pay to use it, and everyone benefits from it. Graph of supply-side tax expenditures All other inputs P S D Energy- saving input Fuel-efficient cars 11 Tax Deduc6ons/Credits Demand-side: Can encourage consump6on of goods with posi6ve externali6es Higher-income households are more likely to benefit from tax expenditures because low-income households are less likely to pay any tax Deduc6ons are worse for equity than credits: Demand-side tax expenditure equity concern: Deduc6ons reduce taxable income so people at higher tax brackets (marginal tax rates) benefit more Credits reduce the tax payment so they are worth the same dollar amount to high and lower income households, as long as they owe some tax. Grants Non-matching grants, or block grants, are fixed amounts of funds given to an economic unit to spend on a targeted good They provide a pure income effect All other goods If both goods are normal then ci6zens will want more of each Targeted good 12 Grants Matching grants provide a subsidy to the local community where the federal or state government matches local expenditure on the targeted good Can be open-ended (no cap on total subsidy) or close- ended (cap on total subsidy) Effec6vely changes the price All other goods Close-ended matching grant Open-ended matching grant Targeted good Block vs. Matching grant All other goods At pt A, both grants are of equal size. Community would prefer block grant why? The open-ended matching grant induces greater consump6on of the covered good than an equivalent- subsidy non-matching grant. A Targeted good 13 Maintenance of effort requirement If the goal is to limit increases in spending on the other goods due to the subsidy, a maintenance of effort requirement could be imposed. An MoE means that the recipient community is eligible only for grant funds to supplement its prior spending on the covered good MoE graphically All other goods New budget line is kinked at prior spending (X0) If unrestricted matching grant, choose Xunrest But, if MoE, then must choose XMoE, such that no subsidy goes to targeted good only. X0 Xunrest XMoE Targeted good 14 Vouchers Vouchers are an in-kind subsidy to individuals to purchase a par6cular good from any seller that accepts them. In the case of food stamps & sec6on 8 housing subsidies, the goal is to increase equity; the graph looks like non-matching grant In the case of school vouchers, the goal is to address government failures that results from lack of compe66on 15 ...
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- Fall '10