1. Taxes
AP Micro 9/20

2. Warm Up
In general, regarding taxation policy, Republicans advocate lowering taxes as a way to stimulate the economy.
In general, Democrats advocate raising taxes mostly on the wealthy as a way to stimulate the economy.
Discuss with the people around you – how can BOTH policies achieve the goal of economic growth?

3. Tax Basics 2 principles of tax fairness
1. Benefits principle: those who benefit should pay
Examples: those who use a road should pay for it
Any problems with this?
2. Ability to pay principle: those who are able to pay more should
Examples: Poll tax in Britain

4. Equity Vs. Efficiency
A lump-sum tax where everyone pays the same amount (ex: everyone pays $500) vs. tax based on property values (ex: everyone pays 1% of their home’s value)
Which tax is more efficient? (hint: which tax is more likely to distort people’s behavior?
Which tax is more equitable?
There is normally a tradeoff between equity and efficiency

5. Tax Base and Tax Structure
Every tax has 2 pieces:
1. Base: measure that determines how much tax an individual or firm pays
2. Structure: how the tax depends on the tax base.
Ex. Income tax: depends of the income of an individual from their wages
Payroll tax: depends on the earnings an employer pays to an employee
Sales tax: depends on the value of goods sold
Profits tax: depends on a firms profits
Property tax: depends on the value of a property

6. Progressive Vs. Regressive
Progressive Tax: takes a larger share of the income of high-income taxpayers than low-income taxpayers
Regressive: takes a smaller share of the income of high-income taxpayers than of low-income taxpayers
Marginal tax rate: the percentage of an increase in income that is taxed away.

7. Excise Tax
Excise tax: a tax charged on each unit of a good or service that is sold
Ex. “Sin taxes” like on cigarettes
Ex. Luxury taxes of % tax on cars over $30,000 and fur/jewelry over $10,000 and boats over $100,000
What do you think happened? Will more or fewer products be sold? Will the consumers pay more or less for the product than they did before?

8. Supply/Demand for Hotel Room in Potterville
Price of hotel room
$140
120 S
100 E
Equilibrium price 80 60 D 40 20
5,000
10,000
15,000
Quantity of hotel rooms
Equilibrium quantity

9. Excise Tax Imposed on Hotel Owners
Price S
Tax of $40 imposed. Supply curve shifts upwards by the amount of the tax. New equilibrium = 5000 rooms supplied at $100 per room.
Burden of tax shared by hotel and customers (hotel loses $20 per room, customers pay $20 more per room)
$140
Supply curve shifts upward by the amount of half of the tax 2
120 A S
P after tax100 1 E
Excise tax = $40 per room 80
P suppliers receive60 D B 40
Tax creates DEADWEIGHT LOSS 20
5,000
10,000
15,000
Quantity of hotel rooms

10. Tax Revenue The tax revenue collected is:
Price of hotel room
The tax revenue collected is:
Tax revenue = $40 per room × 5,000 rooms = $200,000
$140
120 A S
100 E
Excise tax = $40 per room
Area = tax revenue 80 60 D B
The area of the shaded rectangle is:
Area = Height × Width = $40 per room × 5,000 rooms = $200,000 40 20 6
5,000
10,000
15,000
Quantity of hotel rooms

11. Practice Problem Practice Problem!!
The supply and demand for rental cars is as follows:
Price
Quantity Supplied
Quantity Demanded
$100
1000 90
900
100 80
800
200 70
700
300 60
600
400 50
500 40 30 20 10
Graph it. What is market equilibrium price and quantity?
A tax of $20 per car is imposed on the market. Illustrate this on your graph.
What is the new quantity of cars rented?
What price will consumers now pay?
What price will sellers receive?
What is the TOTAL government revenue generated by this tax?