2. Y = C + I + G

3. The Government levies taxes on many goods & services to raise revenue to pay for national defense, public schools, etc. The Government can make buyers or sellers pay the tax. The tax can be a % of a good’s price, or a specific amount for each unit sold.

4. Causes of Increased Inequality Taxes on Stocks versus Taxes on Flows Taxes on Economic “Flows” Most taxes are levied on measurable economic flows. For example, a profits, or net income, tax is levied on the annual profits earned by corporations.

5. S1S1 D1D1 $10.00 500 430 A tax on buyers shifts the D curve down by the amount of the tax. P Q D2D2 $11.00 P B = $9.50 P S = Tax Effects of a $1.50 per unit tax on buyers The price buyers pay rises, the price sellers receive falls, equilibrium Q falls.

6. S1S1 A tax on sellers shifts the S curve up by the amount of the tax. P Q D1D1 $10.00 500 S2S2 430 $11.00 P B = $9.50 P S = Tax Effects of a $1.50 per unit tax on sellers The price buyers pay rises, the price sellers receive falls, equilibrium Q falls.

7. S1S1 What matters is this: A tax drives a wedge between the price buyers pay and the price sellers receive. P Q D1D1 $10.00 500 430 $9.50 $11.00 P B = P S = Tax The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers!

8. Suppose the market for cigarettes is in equilibrium. Suppose the State of Florida, decides to impose a tax of $1 per pack on the sale of cigarettes. How does the tax affect the market for cigarettes?

9. This kind of tax can be analyzed as if it were an input price increase. The tax is similar to having to pay a higher price for some input (government services?). The tax will raise the supply curve by the amount of the tax per unit.

10. pEpE QEQE S D Q price S + tax CIGARETTE MARKET This distance is exactly $1.

11. The reason the supply curve shifts up by exactly the amount of the tax is that price would have to rise by the full amount of the tax to induce cigarette suppliers to supply the amount they supplied before the tax.

13. D S $/Q D S S+Tax Exactly $1. New price

14. pE’pE’ QEQE S D Q P S + tax QE’QE’ CIGARETTE MARKET total tax collections

15. The tax burden on consumers is the part of the tax paid by consumers in terms of higher prices. The tax burden on sellers is the part of the tax paid by firms in terms of lower receipts.

16. S+Tax D S P Q Tax per unit Go to hidden slide

17. S+Tax D S P Q Buyer's burden Seller's burden So the total tax revenue of the state is born by the buyers and sellers.

18. Tax burden on each is determined by the elasticities of supply and demand.

19. Given the demand curve, more elastic (flatter) supply means greater tax burden for consumers. Given the supply curve, more elastic (flatter) demand means greater tax burden for sellers. [Hint: Don't try to memorize these statements. Instead, make sure you can figure out each case.]

20. For example: 1)The more inelastic is the demand curve, the greater will be the state’s tax revenue. 2)The more inelastic is the supply curve, the greater will be the state’s tax revenue.

21. The next (hidden) slide shows these principles for different elasticities of demand. When demand is more elastic: - Price rises less. - There's relatively more burden on sellers. - The state takes in less revenue.

22. S D elast D inelast S Q Q $/Q Equal Pretax Sales S+Tax

23. tax base The measure or value upon which a tax is levied. tax rate structure The percentage of a tax base that must be paid in taxes—25 percent of income, for example. proportional tax A tax whose burden is the same proportion of income for all households. progressive tax A tax whose burden, expressed as a percentage of income, increases as income increases. regressive tax A tax whose burden, expressed as a percentage of income, falls as income increases.

24. average tax rate Total amount of tax paid divided by total income. marginal tax rate The tax rate paid on any additional income earned.

25. The Economics of Taxation Causes of Increased Inequality Marginal versus Average Tax Rates TABLE 19.3 Individual Income Tax Rates, 2007 Married Couples Filing Jointly Taxable IncomeTax Rate $0 – 15,65010% $15,651 – 63,70015% $63,701 – 128,50025% $128,501 – 195,85028% $195,851 – 349,70033% More than $349,70035% Single Taxpayers Taxable IncomeTax Rate $0 – 7,82510% $7,826 – 31,85015% $31,851 – 77,10025% $77,101 – 160,85028% $160,851 – 349,70033% More than $349,70035% Source: The Internal Revenue Service.

26. The Economics of Taxation Causes of Increased Inequality Marginal versus Average Tax Rates TABLE 19.4 Tax Calculations for a Single Taxpayer Who Earned $100,000 in 2007 Total income$ 100,000  Personal exemption 3,400  Standard deduction 5,350 = Taxable income$ 91,250 Tax Calculation 0 - $7,825 taxed at 10% = $7,825 X.10 =$782.50 $7,825 - $31,850 taxed at 15% ($31,850 – $7,825) X.15 = $24,025 X.15 =$ 3,603.75 $31,850 - $77,100 taxed at 25% = ($77,100 – $31,850) X.25 = $45,250 X.25 =$11,312.50 Income above $77,100 taxed at 28% = ($91,250 - $77,100) X.28 = $14,150 X.28 =$ 3,962 Total tax$19,660.75 Average tax rate19.7% Marginal tax rate28%