Taxation Chapter 4c

Effects of Taxation on Economic Welfare How are consumers affected by taxes? How are producers affected by taxes? What tax revenues are generated? Do taxes simply mean a transfer of income between one group of tax payers and another?

Market Equilibrium Quantity Demand Price E Supply E Q P

Welfare Without Taxes dsdf Producer Surplus Consumer Surplus D S E P

The Costs of Taxation A tax places a wedge between the price buyers pay and the price sellers receive. Wedge=P T - P P Tax Qty 0 Price Supply Demand PTPT Pp PEPE

The Costs of Taxation A tax places a wedge between the price buyers pay and the price sellers receive. A tax results in a Deadweight Loss to society and the economy Tax! Qty Supply Demand Loss! S +T

Deadweight Loss of Taxation: Example The current market situation of $0.50 per unit of a product results in 1,000 units being offered for sale and purchased. A twenty cent tax ($0.20) is imposed on the suppliers. Sellers “collect” the tax and send the tax revenue to the government.

Deadweight Loss of Taxation: Graphical $.50 Qty Demand Supply 1000 Price

Deadweight Loss of Taxation: Graphical A $.20 tax is imposed $.50 Qty Demand Price 800 P T =$ P P =$.40 Supply $.10 $1.00 S+Tax

Deadweight Loss of Taxation: Example The twenty cent tax results in new prices to consumers and producers: Consumers pay $0.60 Sellers receive $0.40 The Tax Revenue from the imposed tax is =$160 i.e. [($0.20)*800]

Deadweight Loss of Taxation: Graphical A $.20 tax imposed $.50 Qty Demand Price 800 $ $.40 Supply B D C E F

Deadweight Loss of Taxation: Graphical Without tax: Consumer Suplus = A+B+C Without tax: Producer Surplus = D+E+F Without tax: Total Surplus = A+B+C+D+E+F With tax: Consumer Surplus = A With tax: Producer Surplus = F With tax: Tax Revenue = B+D With tax Total Surplus = A+B+D+F

Debate Over Effect of Income Taxes Income taxes may be a tax on labor. All taxes on wages and salaries result in almost 50% tax on the last dollar earned. Does the income tax distort work decisions? If the tax rate goes up, do people work less?

Income Tax as % of Family Income, Projected 1999 Cash Income IndividualAverageEffectiveTax Rates (Dollars)and familiesPeoplePretaxIndividual All Individual(Millions) IncomeTotalIncome 0 to 10k , k to 20k , k to 30k , k to 40k , k to 50k , k to 75k , k to 100k , k to 200k , k to more , All , Source: Congressional Budget Office:

2015 IRS Tax Rate Schedules 2015 IRS Tax Rate Schedule Tax Rate Single Filers Married and Filing Jointly or Qualifying Widow(er) Married and Filing Separately Head of Household 10%$0 - $9,225$0 - $18,450$0 - $9,225$0 - $13,150 15%$9,226 - $37,450$18,451 - $74,900$9,226 - $37,450$13,151 - $50,200 25%$37,451 - $90,750$74,901 - $151,200 $37,451 - $75,600$50,201 - $129,600 28%$90,751 - $189,300 $151,201 - $230,450 $75,601 - $115,225 $129,601 - $209,850 33%$189,301 - $411,500 $230,451 - $411,500 $115,226 - $205,750 $209,851 - $411,500 35%$411,501 - $413,200 $411,501 - $464,850 $205,751 - $232,425 $411,501 - $439, % $413,201 and above $464,851 and above $232,426 and above $439,001 and above

Debate Over Income Tax Do workers adjust their work habits as wages increase, or decrease as when taxes rise? Estimates of the tax elasticity of supply of labor services: For men 25-60, near zero. For women, large and approaching one.

7. Debate Over Income Tax Workers can adjust by working overtime, by finding second jobs. Families may have second, even third earners. Those other family workers may have more flexibility than the primary earner. The elderly may have more flexibility as a result of Social Security and pensions. The Underground Economy

Debate Over Income Tax Tax on Consumption vs Income Some economists and a number of politicians advocate eliminating the income tax in favor of consumption taxes. Consumption could be the difference between income and amount saved. C=DI- Saving Encourages saving. But saving only postpones taxes; it does not avoid them.

Debate Over Income Tax Is income or consumption tax fairer? In the long-run, the tax burden of a consumption tax may be greater than an income tax. Transition from income to consumption tax is a problem. Relative efficiency of the two depends on elasticity of labor supply and tax elasticity of saving. For debate on Tennessee tax issues see