TAXATION AND INCOME DISTRIBUTION

14-2 Incidence of Social security (SOC) (COPY)  Who bears the burden? Is SOC direct or indirect tax?  Determinants of incidence (pure PAYGO x FF systems), backward shaped S  Incidence in general equil. models (GEM)

14-3 Vocabulary  Statutory Incidence  Economic Incidence  Tax Shifting  Partial (General) Equilibrium Models  Example: VAT in Czech R. VAT agent – who runs the shop and sells goods (seller, producer) Consumer - me, you if buying something in shop of VAT agent Who is worse off? Me or seller?

14-4 Tax Incidence: General Remarks  Only people can bear taxes Functional distribution of income (capitalists, labourer) (Q (CIT)) Size distribution of income (rich or poor)  Both sources (PRODUCERS – physical!) and uses (CONSUMERS) of income should be considered  Incidence depends on how prices are determined (see later MONOPOL, or time aspects – long or shor run), Labour Union…  Incidence depends on the disposition of tax revenues (what for the taxes are collected) Balanced-budget tax incidence (Net tax/transfer incidence) Differential tax incidence (One tax is replaced by another tax) Lump-sum tax incidence (One tax is replaced by head tax) Absolute tax incidence (only one tax is changing, ceteris paribus – the simplest analyses)

14-5 Tax Progressiveness (YES or NO) Can Be Measured in Several Ways…  Average tax rate versus marginal tax rate  Proportional tax system  Progressive tax system  Regressive tax system Tax Liabilities under a hypothetical tax system IncomeTax Liability Average Tax Rate Marginal Tax Rate $2,000-$ , , ,0001, ,0005,

14-6 … and unfortunately sometimes with different results. HOW Progressive a Tax System is can be measured by: 1/change in ATR if I goes up for 1 OR 2/level of elasticity

14-7 Q: The tax proposal - everyone´s tax liability will increase by 20 %  T = t*TaxBase  T´ = 1,2*T  calculate v1/v1´  calculate v2/v2´  discuss the impact on progressivity

14-8 Measuring How Progressive a Tax System is – A Numerical Example (2 payers, poor 0 and rich 1)

14-9 Measuring of global progressivity - GINI Properties of inequality metrics The Gini coefficient satisfies four important principles:  Anonymity: it does not matter who the high and low earners are (man, woman, children, maried…).  Scale independence: the Gini coefficient does not consider the size of the economy (in dollars or in CZK), the way it is measured, or whether it is a rich or poor country on average (v1 does not meet).  Population independence: it does not matter how large the population of the country is.  Transfer principle: if income (less than the difference), is transferred from a rich person to a poor person the resulting distribution is more equal.

14-10 Gini:  n is number of units  y is income (ascending manner)

14-11 Before TaxAfter Tax Consumers Pay Suppliers Receive $1.40 $1.00 $1.20 D0D0 S0S0 D1D1 S1S1 Partial Equilibrium Models Quantity $

14-12 DXDX S SXSX DX’DX’ Perfectly Inelastic Supply Quantity $

14-13 DXDX S SXSX DX’DX’ Perfectly Elastic Supply Quantity $

14-14 DXDX SXSX DX’DX’ Quantity $ D X ’´ˇ

14-15 Tobacco tax (or green tax reform) paradox  MoF really wants: get some additional money for public budget (but it means no or only small change in consumption). (inelastic d)  On the other side he says to the public to justify - legitimize the new tax: smoking is unhealthy and it is necessary to eliminate this bad habit (it means a large decrease of consumption). (elastic d)  Paradox…

14-16 Absolutely elastic D  Tax T1 on consumers plus absolutely elastic demand  Tax T2 on producer plus absolutely elastic demand  maximum pressure of consumers to producers to preserve effective price unchanged. Tax is shifted on producers. T1 and T2 are equivalent taxes

14-17 Absolutely inelastic D (tobacco)  similar graphic analysis as above  We can sum up: there is a minimum pressure of consumers to produces to preserve effective price unchanged. Tax is shifted on consumers. T1 (consumers) and T2 (producers) are equivalent taxes.

14-18 Inelastic supply (agricultural production, land property activities)  The aim or result – to punish producers  We can sum up: there is a minimum pressure of producers to consumers. Tax is shifted on producers. T1 and T2 are equivalent taxes.

14-19 Elastic supply  The aim or result – discourage the activity, production…  We can sum up: there is a maximum pressure of producers to consumers. Tax is shifted on consumers. T1 and T2 are equivalent taxes

14-20 Ad Valorem Taxes Pounds of food per year Price per Pound of food DfDf SfSf Q0Q0 QmQm QrQr P0P0 PmPm PrPr Df’Df’

14-21 Taxes on Factors  The Payroll Tax (see ad valorem tax above) The Payroll Tax  Capital Taxation in OPEN Economy (Large X small) CLOSED Economy (Large X small)

Commodity Taxation without Competition  Monopoly Monopoly  Oligopoly (a few sellers) they are able to obtain cartel solution (similar to monopol) or not because of cheating (similar to perfect competition)

14-23 Monopoly maximizing profit (MR=MC) X0 to X1 X per year $ DXDX MR X ATC X MX X X0X0 P0P0 ATC 0 a b c d Economic Profits DX’DX’ MR X ’ PnPn i g f h X1X1 Economic Profits after unit tax X 01 X 00 (MRx=0) PgPg

14-24 ALTERNATIVE - Unit tax on MONOPOLY (supply side, linear demand) MC before and after the tax ATC before and after the tax ½ T on producer, ½ T on consumer Profit (decrese of ½ tax) unit tax

14-25 Monopoly maximizing sales (MR=0) UNIT TAX X per year $ DXDX MR X ATC X MX X X0X0 P0P0 ATC 0 a b c d after tax DX’DX’ MR X ’ PnPn i g f h X1X1 before tax X 01 X 00 (MRx=0)

14-26 Monopoly maximizing sales (MR=0) AD VALOREM TAX X per year $ DXDX MR X ATC X MX X X0X0 P0P0 ATC 0 a b c d DX’DX’ MR X ’ PnPn i g f h X1X1 MR= 0 X00 = X01 X 00 = X01 (MRx=0)

14-27 Profits Taxes (Tax baze)  Economic profit (Long X short period) Perfect competition Monopoly  Measuring economic profit (as rate of return, BUT original costs OR costs of replacing shoud be used?)  Taxation of profit: long period (perfect competion and Profit = 0 so T = 0) short period (perfect competion and Profit > 0 so T > 0) long period + monopoly (Profit > 0 so T > 0)

14-28 Q3 profit tax Q0r max sales Q1r max sales under minimal profit constr. Qpi max profit Q0r>Q1r>Qπ ad valorem tax Q0 max sales (no change) Q1 max sales under minimal profit constr. Q3 max profit (Q is before tax) (TRgross, TRnet) Q

14-29 Profits Taxes (Incidence)  Profit Tax and firm maximizing profit No change, tax is borne by producer  Profit Tax and firm maximizing sales No change, if non binding profit constraints (profit after tax is still higher then minimal demanded profit by owner) Possible change, if profit constraints becomes operative (profit is less then minimal demanded by owner), it is not sustainable to maximize sales

14-30 Tax Incidence and Capitalization P R = $R 0 + $R 1 /(1 + r) + $R 2 /(1 + r) 2 + … + $R T /(1 + r) T P R ’ = $(R 0 – u 0 ) + $(R 1 – u 1 )/(1 + r) + $(R 2 – u 2 )/(1 + r) 2 + … + $(R T – u T )/(1 + r) u 0 + u 1 /(1 + r) + u 2 /(1 + r) 2 + … + u T /(1 + r) T Capitalization P R ’ = P R minus all future tax liabilities The today‘s owner bears the all future taxes

14-31 Incidence of Social security (SOC) (COPY)  Who bears the burden? Is SOC direct or indirect tax?  Determinants of incidence (pure PAYGO x FF systems), backward shaped S  Incidence in general equil. models (GEM)

14-32 General Equilibrium Models  Partial equilibrium (One Market, One Product, tax remains on this market)  General equilibrium (tax can escape its market to other market/s) 2 Markets, 2 Producers (sectors) 2 Products (food X, manufactures Y) 2 production factors – L and K

14-33 Tax Equivalence Relations t KF = a tax on capital used in the production of food t KM = a tax on capital used in the production of manufactures t LF = a tax on labor used in the production of food t LM = a tax on labor used in the production of manufactures t F = a tax on the consumption of food t M = a tax on consumption of manufactures t K = a tax on capital in both sectors t L = a tax on labor in both sectors t = a general income tax

14-34 Tax Equivalence Relations  Partial factor taxes (C = I, I = TC = Wages + Interest) t KF Andt LF are equivalent to (TC = W+Int) tFtF and t KM andt LM are equivalent totMtM are equivalent (it can move between sectors) Equivalent ( budget constr. down) Toto tKtK andtLtL are equivalent to (I = W+Interest)t

14-35 The Harberger Model (F + M sectors)  Assumptions Behavior of factor suppliers (perfect mobility, wf=wm) Market structure (competitive markets, MR=P=MC, full employment) Total factor supplies (Kf+Km = K, is const.) Consumer preferences (we focus only on source (I) side (capitalists x labourer), the uses side is same for all subjects) Tax incidence framework (differential tax incidence, I is const.)

14-36 Assumptions II  Technology (Cobb-Douglas prod. f.) Elasticity of substitution K for L Capital / Labor intensive sector  aFL = number of person-hours needed to produce one piece of food)  aFK = amount of capital needed to … Line of constant profit, see graph later… Pf=aFL*w + aFK*r, do same for M if aFL/aFK > aML/aMK so F is labour intensive industry

14-37

14-38 Analysis of Various Taxes  General tax on labor (t L ) (no escape to other, non taxed sector, no shift)  Income tax (t) (equivalent to tfk+tfl and all is employed, so again no escape, no shift)  Commodity tax (t F ) ?escape? Pf increase, Subst. Effect, Q of F decrease (how big? - ) factors move to other sector if F is K intensive, too many K and too less L (how much) for M industry, r must go down, W goes up, capitalists are worst off if F is L intensive, … laborer are worst off

14-39 Commodity tax (t F ) or some tax exclusively introduced in only one sector… ?escape? Pf increase, Subst. Effect, Q of F decrease (how big? – Part. Eq.) factors move to other sector due to decrese of production if F is K intensive, there will be too many K and too less L (how much?) asking for utilitization in M industry, SO r must go down, W must goes up, capitalists are worst off BUT if F is L intensive, … laborer are worst off

14-40 Partial factor tax (t KM )  Output effect (similar Commodity tax) – ambiguous with respect to who is worst off  Factor substitution effect r*gross goes up – SE, less K and more L is demanded  Total effect = OE + SE clear ambiguous (for tkm if m is L intensive, OE decreases w, increases r, SE decreases r and increases w)

14-41 Some Qualifications (releasing of assumption)  Differences in individuals’ tastes (impact on uses side) PIT – first impact on capitalist (progressive tax), but later through the increase of Px also on consumers (regressive impact)  Immobile factors all burden on L or K, can not excape)  Variable factor supplies tk in long run decrease Q K, but it mieans also decrese of productivity of L)

14-42 An Applied Incidence Study Income Category Average Federal Tax Rate T/BAZE Share of Federal Taxes T/SUMT Lowest Quintile5.6%1.1% Second Quintile Third Quintile Fourth Quintile Highest Quintile All Quintiles Top 1% Source: Congressional Budget Office [2004]. These figures are based on projections that rely on assumptions about inflation and income growth. They include all tax law as of Table 14.3Average federal tax rates and share of federal taxes by income quintile (2006)

14-43 The Payroll Tax Hours per year Wage rate per hour DLDL SLSL L 0 = L 1 w g = w 0 PrPr DL’DL’ wnwn