Tax Incidence & Elasticity Who actually bears the burden of taxes? Chapter 6 (pages 124-131)

Buyers have higher tax incidence Regardless of who pays the tax directly to the Gov’t => buyers & sellers both share some of the tax incidence (tax burden) Buyers pay more Sellers receive less Tax incidence- is the study of who pays a higher burden of a tax i.e. who pays a higher % of an excise tax Buyers have higher tax incidence If buyers pay $1.50 $2 per unit tax Sellers pay $0.50 22 30

Tax Incidence & Elasticity Tax incidence does not depend on who the tax is “placed on” i.e. who “sends tax” to the Government Tax incidence (tax burden) depends on the relative elasticity of demand versus elasticity of supply Bottom line: Tax incidence is greater on the more inelastic market The Steeper Curve pays more of the tax! 21 31

Shifting Supply or Demand Curves Shifting the demand or supply curve is an “illusion” It only tells you who “paid” the Gov’t => not who “pays more” of tax Draw in the tax wedge first & label all new points Label: Pb, Ps, DWL, Qty sold, CS, PS Shift the curve last! (to either top of tax wedge or bottom) The end result of the tax in terms of DWL, Tax Revenue, Tax Incidence is the same regardless of which curve you shift!

So Demand more inelastic $.50 Cent Tax on Sellers Example #1 Price Last step: tax on sellers Shift supply to the “top” of tax wedge D1 Price buyers pay S2 Tax Wedge = $0.50 S1 $3.30 90 Tax incidence? P1 = 3.00 100 Buyers pay $0.30 Sellers pay $0.20 So Demand more inelastic Equilibrium without tax 2.80 Price sellers receive Quantity

Taxes & Shifting Supply/Demand The end result of a curve shift is identical to a “tax wedge” A tax on sellers shifts supply curve left by amount of tax A tax on buyers shifts the demand curve left by amount of tax If Gov’t taxes Sellers Seller pays Gov’t Supply left to “top of wedge” If Gov’t taxes Buyers Buyer pays Gov’t Demand left (bottom of wedge)

Tax Incidence Worksheet Total Welfare after Tax DWL Price Buyer pays Price Seller Receives