Taxation of Markets Explain 1) the principles relating to tax shifting, 2) tax incidence and 3) the efficiency of losses caused by taxes the principles relating to tax shifting In the event the tax is paid by the seller (e.g. the seller sends the money to the government), the supply curve will shift up vertically by the amount of the tax. In the event the tax is paid by the buyer (e.g. the buyer sends the money to the government), the supply curve will shift down vertically by the amount of the tax. tax incidence The degree to which a tax falls on a particular person or group. The larger share of the burden will fall on the more inelastic side of the market. Taxes do not affect just one side of the market, nor do we expect them to affect them equally. the efficiency of losses caused by taxes Taxes will usually cause some dead weight loss in the market.

Taxes – Excise Taxes Excise Taxes excise tax – a tax levied on the quantity of a product purchased Examples: Fuel & Tobacco

Without the tax in place, equilibrium price is $12.00 The addition of a $3.00 excise tax placed on the sellers will shift the supply curve up by $3.00 – from S1 to S2. The new equilibrium price is now $14.50. Note the equilibrium price did not increase a total $3.00, as you may suspect. With the tax in place, the story is as follows: The consumer pays a total of $14.50 to the seller (this dollar amount includes the tax). This is $2.50 more than without the tax in place. The seller sends $3.00 to the government. After which, he keeps $11.50. This is $0.50 less than he kept without the tax in place. The tax incidence is as follows: Note that the buyers have the more inelastic curve and bear the larger burden of the tax. S2 S1 $1450 $12 $1150 Buyers Sellers $2.50 $0.50 D

Given the following tax incidence: A short-cut exists to determine the tax incidence without shifting the curves – usually called a tax wedge The tax wedge is the vertical distance between the Supply and Demand curves. The height of the wedge is equal to the size of the tax. If the tax is $3.00, then find the Buyers Sellers $2.50 $0.50 S $1450 $12 $1150 D