McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. WEEK 8 TAXES ON CONSUMPTION AND WEALTH

21-2 Types of Consumption Taxes  Unit Tax: is a given amount for each unit produced  Ad Valorem Tax: Computed as a percentage of the value of the purchase  The value-added tax (VAT) is popular in Europe but is not used in the United States. The VAT is levied on the difference between sales revenue and cost of purchased commodity inputs The value-added tax (VAT) is popular in Europe but is not used in the United States. The VAT is levied on the difference between sales revenue and cost of purchased commodity inputs

21-3 Efficiency and Equity of Personal Consumption Taxes  Opponents of consumption taxes point out difficult transition problems, argue that income better measures ability to pay, feel that they are administratively burdensome, and argue that in the absence of appropriate taxes on gifts and bequests, they would lead to excessive concentration of wealth.  Consumption taxes are typically viewed as regressive (Rich people spend a lower proportion of their income). However, this view is based on calculations involving annual rather than lifetime income, and assumes that the incidence of the tax lies with the purchaser.

21-4 Efficiency and Equity of Personal Consumption Taxes  Efficiency issues An income tax and saving and labor supply decisions A consumption tax and saving and labor supply decisions Remember the previous chapter: Indirect taxes (taxes on consumption) are non-distortionary

21-5 Wealth Taxes  Proponents of wealth taxes believe that they permit the taxation of unrealized capital gains that escape the income tax, reduce the concentration of wealth, and compensate for benefits received by wealth holders. Some also argue that wealth is a good index of ability to pay and should, therefore, be subject to tax.  Estate and gift taxes are levied on the value of wealth transfers, either from a decedent or from another living individual. Neither is a major revenue source at any level of government. Little is known about the incentive effects or incidence of estate and gift taxes.

21-6 What is the advantage of taxing estate  Immobile– it cannot run away!  Helps with the deficit

21-7 How Big is the Deficit?

21-8 How Big is the Debt?

21-9 Definitions  Borrowing is an important method of government finance. The deficit during a period of time is the excess of spending over revenues; the surplus is the excess of revenues over spending; the debt as of a given point in time is the algebraic sum of past deficits and surpluses.

21-10 Fiscal Federalism  In a federal system, different governments provide different services to overlapping jurisdictions.  The club model of community formation indicates that community size and quantity of public goods depend on tastes for public goods, costs of providing public services, and the costs of crowding.

21-11 Background  Federal system  Fiscal federalism  Centralization Centralization ratio = Central government expenditures Total government expenditures

21-12 Disadvantages of Federalism  Disadvantages of decentralization are intercommunity externalities, forgone scale economies in the provision of public goods, inefficient taxation, and lack of ability to redistribute income.

21-13 Property Taxes in the Context of Fiscal Federalism  Property taxes are an important revenue source for state and local governments. The "traditional view" of the property tax is that it is an excise tax on land and structures. The "new view" is that the property tax is a general tax on all capital with rates that vary across jurisdictions and different types of capital. The "user-fee view" regards property taxes as payment for local public services.  The property tax is very unpopular. Perhaps its main advantage in the context of a federal system is that it can be administered locally.

21-14 Panel Probit Models  Panel Probit Random Effects:  Xtprobit y x  Panel probit fixed effects:  Probit y x (country dummies)  one way fixed effecys  Probit y x (country dummies) (time dummies)  two way fixed effects