2. Positive Principles of Taxation
Concerns the effects of taxation
General principles that apply to all taxes
Not normative

3. Tax Shifting Unit tax Ad valorem tax
Tax charged per unit of a good exchanged
Example: most cigarette taxes
Ad valorem tax
Tax charged based on the dollar value of goods sold
Example: retail sales tax

4. A Unit Tax on Suppliers

5. A Unit Tax Placed on Demanders

6. A Tax on Suppliers Versus a Tax on Demanders
No difference whether tax is placed on suppliers or demanders
Ultimate burden of a tax depends on relative elasticities of supply and demand
Legal assignment has no impact on tax incidence

7. A Tax on Suppliers Versus a Tax on Demanders

8. Elasticities and Tax Incidence
The more elastic the schedule, the larger the proportion of the tax that will fall on the other side of the market
Elastic demand curve = larger proportion paid by suppliers
Elastic supply curve = larger proportion paid by demanders

9. Elasticities and Tax Incidence

10. Perfectly Elastic or Perfectly Inelastic Supply
A tax placed on demanders; will be shifted entirely to suppliers
Perfectly elastic supply
A tax placed on demanders; will be paid entirely by demanders

11. Perfectly Inelastic Supply

12. Perfectly Elastic Supply

13. Shifts in the Tax Burden
Tax shifting can be illustrated algebraically
Ratio of the slope of the supply curve to the slope of the demand curve

14. The Welfare Cost of Taxation
Also known as:
Excess burden of taxation
Deadweight loss of taxation
Arises because taxpayers alter their behavior in response to a tax
Taxpayers are better off if they paid tax without altering behavior

15. The Welfare Cost of Taxation

16. Excess Burden as a Cost of Taxation
Should be taken into account when calculating total cost of taxation
Tax with minimum excess burden is optimal from an efficiency standpoint
Minimizing social cost = minimizing excess burden

17. Lump Sum Taxes Completely eliminates excess burden of taxation
Example: one-shot head tax
No ability to change behavior
Difficult to apply in the real world
At odds with equity goals

18. Excess Burden and Individual Choice
Excess burden exists because a tax:
Takes the tax away from the taxpayer
Discourages consumption of the taxed good
Better off if tax did not distort relative prices between goods

19. Excess Burden and Individual Choice

20. Inelastic Labor Supply and the Welfare Cost of an Income Tax
Perfectly inelastic supply curve = no excess burden
Inability to substitute out of market is critical
Example: income tax and labor supply
If inelastic supply is because of offsetting income and substitution effects, there is still an excess burden

21. Inelastic Labor Supply and the Welfare Cost of an Income Tax

22. Utility Functions and Excess Burden
For a tax to have not excess burden, there must be no substitution effect
Individuals cannot substitute away from relatively higher price of taxed good

23. Utility Functions and Excess Burden

24. Minimizing the Excess Burden of Taxation
General magnitude of welfare loss
13 to 24 cents of every dollar raised
The Ramsey Rule
Taxes should be placed on good in inverse proportion to elasticity of demand for the goods
Example:

25. The Ramsey Rule

26. The Marginal Cost of Public Spending
The higher government spending is, the greater will be the cost of increased government spending
Excess burden rises with government size
Some potentially beneficial projects not beneficial at current level of government outlays

27. Additional Costs of the Tax System
Compliance Costs
Administrative Costs
Political Costs

28. Earmarked Taxes Revenues are designated to a specific activity
Example: Social Security payroll tax
Most used at local government level
Alternative: general fund financing

29. Advantages and Disadvantages of Earmarking
Lack of Flexibility
Advantages
Better opportunity to receive level of output they find satisfactory
Removes discretion from lawmakers
Make transparent how much taxpayers pay for an activity