The cost of taxes Lecture 7 – academic year 2015/16 Introduction to Economics Dimitri Paolini.

Slides:



Advertisements
Similar presentations
Equilibrium. Market Equilibrium  A market is in equilibrium when total quantity demanded by buyers equals total quantity supplied by sellers.  An equilibrium.
Advertisements

8 Application: The Costs of Taxation. CHAPTER 8 APPLICATION: THE COSTS OF TAXATION 2 The Effects of Taxation We saw in Chapter 6 how taxesChapter 6 –reduce.
Economic Policies and Efficiency: Exercises and Applications Lecture 6 – academic year 2014/15 Introduction to Economics Fabio Landini.
Demand, Supply and Economic Policy Lecture 4 – academic year 2014/15 Introduction to Economics Fabio Landini.
Copyright©2004 South-Western 8 Application: The Costs of Taxation.
LECTURE #7: MICROECONOMICS CHAPTER 8
Chapter Application: The Costs of Taxation 8. The Deadweight Loss of Taxation Tax on a good – Levied on buyers Demand curve shifts downward by the size.
Elasticity and Government Excise Tax Revenue Activity 21.
Application: The Costs of Taxation
Application: The Costs of Taxation Chapter 8 Copyright © 2004 by South-Western,a division of Thomson Learning.
Applications: The Costs of Taxation & International Trade
Application: The Costs of Taxation Chapter 8 Figure 1 The Effects of a Tax Copyright © 2004 South-Western Size of tax Quantity 0 Price Price buyers pay.
The Effects of a Tax... Supply Demand Price Size of tax per unit
© 2007 Thomson South-Western. Application: The Costs of Taxation Welfare economics is the study of how the allocation of resources affects economic well-
Copyright©2004 South-Western 8 Application: The Costs of Taxation.
Application: The Costs of Taxation
Equilibrium Introduce supply Equilibrium The effect of taxes Who really “pays” a tax? The deadweight loss of a tax Pareto efficiency.
Application: The Costs of Taxation
Market Interventions chapter 15
Consumer and Producer Surplus: Effects of Taxation
Principles of Micro Chapter 8: “Application: The Cost of Taxation” by Tanya Molodtsova, Fall 2005.
THE COSTS OF TAXATION MR. BARNETT UNIVERSITY HIGH AP MICROECONOMICS.
Market Equilibrium in Perfect Competition What do buyers and sellers get out of the market? And Why do economists think this is efficient?
Copyright©2004 South-Western 8 Application: The Costs of Taxation.
The cost of taxes Lecture 7 – academic year 2014/15 Introduction to Economics Fabio Landini.
Application: The Costs of Taxation Chapter 8 Copyright © 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part.
Chapter 8 notes.
Chapter 8 The Costs of Taxation Ratna K. Shrestha.
Application: The Cost of Taxation
A PPLICATIONS : D EADWEIGHT L OSS ETP Economics 101.
Copyright©2004 South-Western 8 Application: The Costs of Taxation.
Chapter 8 The Costs of Taxation. Objectives 1. Understand how taxes reduce consumer and producer surplus 2. Learn the causes and significance of the deadweight.
Lecture PowerPoint® Slides to accompany 1. Chapter 8 Application: the Costs of Taxation 2 Copyright © 2011 Nelson Education Limited.
MACROECONOMICS Application: The Costs of Taxation CHAPTER EIGHT 1.
Copyright © 2004 South-Western/Thomson Learning Happy Tuesday Take out your homework and please write the number of any question(s) that you would to go.
Econ 201 Ch. 6 & 8 Government Policy & Economic Welfare.
Supply, Demand & Government Policies Chapter 6. In a free market system, market forces establish equilibrium prices and exchange quantities. One of the.
Excise Tax And Allocative Efficiency. Effect of a $.15 Excise Tax QuantitySupply Price Before Tax Supply Price After Tax.
The Analysis of Competitive Markets
TAXATION The Effect of Taxation on Economic Welfare.
A PPLICATIONS : D EADWEIGHT L OSS ETP Economics 101.
APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION
Demand, Supply and Economic Policy Lecture 4 – academic year 2015/16 Introduction to Economics Dimitri Paolini.
Copyright © 2004 South-Western/Thomson Learning Application: The Costs of Taxation Welfare economicsWelfare economics is the study of how the allocation.
IB Economics HL Topics Indirect Taxes, Subsidies and Price Controls.
Copyright © 2006 Nelson, a division of Thomson Canada Ltd. 8 Application: The Costs of Taxation.
Copyright © 2004 South-Western/Thomson Learning Application: The Costs of Taxation Recall that welfare economicsRecall that welfare economics is the study.
Oct The Analysis of Competitive Markets.
Econ 201 Ch. 8 Government Policy & Economic Welfare.
© 2009 South-Western, a part of Cengage Learning, all rights reserved C H A P T E R Consumers, Producers, and the Efficiency of Markets E conomics P R.
The Analysis of Competitive Markets. Chapter 9Slide 2 Topics to be Discussed Evaluating the Gains and Losses from Government Policies--Consumer and Producer.
The costs of taxation. Tax Usually taxes are collected because government wants to run the country. Some people believe that all taxation creates market.
Copyright © 2006 Thomson Learning 8 Application: The Costs of Taxation.
Copyright © 2002 by Thomson Learning, Inc. to accompany Exploring Economics 3rd Edition by Robert L. Sexton Copyright © 2005 Thomson Learning, Inc. Thomson.
Economic Analysis for Business Session X: Consumer Surplus, Producer Surplus and Market Efficiency-2 Instructor Sandeep Basnyat
8 Application: The Costs of Taxation. Welfare economics Welfare economics is the study of how the allocation of resources affects economic well- being.
Application: The Costs of Taxation
Application: The Costs of Taxation
Application: The Costs of Taxation
APPLICATION: THE COSTS OF TAXATION
Application: The Costs of Taxation
APPLICATION: THE COSTS OF TAXATION
Application: The Costs of Taxation
Application: The Costs of Taxation
Application: The Costs of Taxation
Application: The Costs of Taxation
Applications of Welfare
Application: The Costs of Taxation
© 2007 Thomson South-Western
Application: The Costs of Taxation
Presentation transcript:

The cost of taxes Lecture 7 – academic year 2015/16 Introduction to Economics Dimitri Paolini

2 The cost of taxes Past classes: a tax on a good affects its price and quantity exchanged. Moreover: buyers and sellers share in the tax burden in different ways. The objective of this lecture is to answer the following question: what are the effects of a tax on the welfare of market participants?

3 Market equilibrium and allocative efficiency A free market produces the quantity of goods that maximizes the total welfare(= consumer surplus + producer surplus). When an allocation of resources maximizes the total welfare, we say that such allocation is economically efficient.

4 The costs of imposing taxes When the government imposes a tax on a particular good, the equilibrium quantity of that good diminishes and its price increases. The size of the market for that particular good decreases. Therefore: in a perfectly competitive market, taxes have a cost in terms of diminished welfare experienced by individuals.

5 Market equilibrium in presence of a tax Tax levy ( T x Q ) Q.ty with the tax Demand Supply Q.ty without the tax Quantity 0 Price Value of the tax (T) Consumer Price Quantity sold ( Q ) Producer price

6 The tax introduces a mark-up between the price paid by the consumer and the price earned by the producer. The cost of the tax for consumers and producers exceeds the tax levy (earned by the government), generating a net loss. The net loss is the reduction in total welfare caused by the introduction of a tax. The costs of imposing taxes

7 A F B D C E Demand Supply Q1Q1 Price without tax = P 1 Q2Q2 Price paid by consumer = P B Price earned by producer = P S 0Quantity Price Consumer surplus: from A+B+C to A Producer surplus: from D+E+F to F Tax levy: from none to B+D Total surplus (social welfare): from A+B+C+D+E+F to A+B+D+F Net loss of social welfare: C+E

8 Net loss: an example At the current price of 0.50 € per unit, the quantity sold is units.

9 Quantity 0 Price demand Supply Net loss: an example

10 The government introduces a tax of 0.20 € on the production of each unit of the good. The producers “collect” the tax and then they pay it back to the government. Let’s assume the tax burden is shared equally –Consumers and producers pay 0.10 € each. – Remember: taxes are not necessarily paid only by those who are supposed to pay the government (previous lessons). The higher price for consumers and the smaller price for producers translates into a smaller quantity that is exchanged in the market. Net loss: an example

11 Quantity0 Price Demand Supply Net loss: an example

12 The tax impair both consumers and producers, so that the quantity exchanged diminishes of 200 units(= ). The area of the triangle included between the demand curve and the supply curve and delimited by the quantity exchanged is a measure of the net loss. Example: = (0.10 x 200)/2 + (0.10 x 200)/2 = 20 €. Tax levy= ( ) x 800 = 160 Net loss: an example

13 Quantity0 Price Demand Supply Tax levy = 160 Decrease in quantity = 200 Net loss of social welfare = 20 Net loss: an example

14 Effects of taxes Taxes -> loss of welfare – They induce the market participants (producers and consumers) to change their behaviour. Prices (P D, P S ) change makes some some exchanges not profitable any more. – Higher price induces consumers to purchase less. – Lower price induces producers to produce less. The size of the market reduces and becomes smaller than the optimal level.

15 Price without tax Q1Q1 Demand Supply P B Q2Q2 P S Value for consumer Cost of supplier Value of the tax Loss of exchange benefits Decrease in quantity due to the tax Quantity 0 Price

16 Why the net loss? Even if the tax levy is redistributed entirely to producers and consumers, the fiscal revenue is not sufficient to compensate for the reduction in the volume of exchange due to the tax.

17 How big is the net loss? Theory The size of the net loss depends on Q* caused by T. At the same time: Q* depends on the price elasticity of demand and supply. –If price elasticity, then net loss.

18 Effects of taxes and elasticity of supply (a) Inelastic supply(b) Elastic supply Price 0Quantity Price 0Quantity Demand Supply If the supply is inelastic, the net loss is small. If the supply is elastic, the net loss is large Value of the tax Value of the tax

19 Demand Supply (c) Inelastic demand(d) Elastic demand 0Quantity0 Value of the tax Demand Supply If the demand is elastic, the net loss is large If the demand is inelastic, the net loss is small Price Value of the tax Price Effects of taxes and elasticity of supply

20 State and the economy The debate on the net loss is not (only) an academic discussion. Different opinions on the elasticity and its effects often derive from different visions concerning the role of the State in the economy The tax on labour represent a large part of the tax levy in advanced countries. When people talk bout reducing such taxes, the question is: –Do we want to reduce taxes and public services? –Or do we want higher taxes and more public services? The answer depend on how we think the role of the State in the allocation of resources.

21 Net loss and fiscal revenue Following an increase in taxes, the fiscal revenue rapidly increases up to a maximum and, then, it diminishes.

22 PBPB Quantity Q2Q2 0 Price Q1Q1 Demand Supply Net loss Fiscal revenue PSPS Small tax Net loss and fiscal revenue

23 Demand Supply Fiscal revenue PBPB Quantity Q2Q2 0 Price Q1Q1 Net loss PSPS Medium tax Net loss and fiscal revenue

24 Fiscal revenue PBPB Quantity Q2Q2 0 Price Q1Q1 Demand Supply Large tax Net loss PSPS Net loss and fiscal revenue

25 (a) Net loss Net loss 0 Value of the tax (b) Revenue (Laffer’s curve) Fiscal revenue 0 Value of the tax

26 The theory of Laffer’s curve … Main idea: when taxes are too high they discourage production. In the case of labour: if the tax on income is too high, it discourage the supply of work. Smaller taxes create incentives to work more, increasing social welfare and fiscal revenue. Hence: it is better to reduce taxes!

27 The debate… But then why there are countries with high tax rates and countries with low tax rates? It depends on how one evaluates the elasticity of some economic curves. In reality it is really complex to determine the real value of elasticity, and this creates a lack of consensus on this issues. Much depends on the preferences of citizens/voters…

28 In some countries ( northern Europe ), high tax rates are accepted because they create more resources to be redistributed through public services. This, in their view, compensate parts of the net loss. In other countries ( USA ), low tax rates and little redistribution are preferred because it is generally believed that poverty is not the result of unlucky events but rather the consequence of individual actions. Therefore the social expenditure is unfair (beyond a certain limit) and it does not compensate the net loss. The debate…

29 Conclusion The reduction in the consumer surplus and producer surplus caused by taxes exceeds the the increase in fiscal revenue obtained by the public administration. Therefore, taxes produce a net loss. The higher the tax rate, the higher the net loss. The fiscal revenue first increase with the value of the tax; then, as the tax rate increases, the fiscal revenue starts to diminish following the reduction in the size of the market. When the tax rate is very high, this can justify a tax cut so as to reduce the net loss.