1. Public Choice Theory and the Economics of Taxation Chapter 17 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. The Tax Burden How should the tax burden be apportioned? Benefits-received principle Ability-to-pay principle Progressive tax Regressive tax Proportional tax 17-2

3. Types of Taxes Personal income tax –progressive Sales tax –regressive Corporate income tax –proportional (35%) Payroll tax –regressive (S.S. cap) Property tax –Regressive (low property value, higher tax) 17-3

4. Tax Incidence Who really pays the tax? Excise tax –Tax burden depends on elasticity –Inelastic vs. elastic Efficiency loss of an excise tax –Deadweight loss –Depends on elasticity –Transfer of surplus to govt. 17-4

5. Tax Incidence of an Excise Tax 0 2 4 6 8 10 12 14 510152025 Q P Price (Per Bottle) Quantity (Millions of Bottles Per Month) S D StSt Tax $2 17-5

6. Efficiency Loss of a Tax 0 2 4 6 8 10 12 14 510152025 Q P Price (Per Bottle) Quantity (Millions of Bottles Per Month) S D S’ Tax $2 Tax Paid by Consumers Tax Paid by Producers Efficiency Loss (or Deadweight Loss) 17-6

7. Tax Incidence Why impose an excise tax? –Discourage consumption –Redistributive goals –Reduce negative externality Burden of the excise tax? –Depends on elasticity –Availability of substitutes 17-7

8. Tax Incidence and Elasticity 0 P QQ P 0 Tax Incidence and Elastic Demand Tax Incidence and Inelastic Demand Smaller efficiency loss with inelastic demand DeDe DiDi Tax StSt S StSt S Q2Q2 P1P1 PePe PaPa P1P1 PiPi PbPb Q1Q1 Q2Q2 Q1Q1 a a b b c c 17-8

9. Tax Incidence and Elasticity 0 P QQ P 0 Tax Incidence and Elastic Supply Tax Incidence and Inelastic Supply Smaller efficiency loss with inelastic supply D D S SStSt StSt P1P1 PaPa PePe P1P1 PbPb PiPi Q1Q1 Q2Q2 Q1Q1 Q2Q2 Tax a a b b c c 17-9

10. Incidence of U.S. Taxes Workers bear full burden of: –Social security tax –Medicare tax –Income tax Burden of corporate income tax: –Stockholders (short run) –Workers (long run) 17-10

11. U.S. Tax Structure Federal tax system progressive State and local system is regressive Overall tax structure slightly progressive 17-11