Week 4: Tax Incidence

Fairness in taxation

- AVERAGE TAX RATES: percentage of total income that is paid in taxes. (amount paid in taxes divided by total income) - MARGINAL TAX RATES: percentage that is paid in taxes of the next dollar earned. - VERTICAL EQUITY: groups with more resources should pay higher taxes than groups with fewer resources. * Better off/ more well off tax payers should pay more in taxes. (CEE) * basis for progressive taxation * "normative" - HORIZONTAL EQUITY: similar individuals who make similar economic choices should be treated similarly by the tax system. * Equally situated tax payers should pay equal taxes (CEE) * "basic fundamental idea of fairness" -professor ** CEE: Concise Encyclopedia of Economics

Match the following conditions to their tax incidence.

Inelastic Supply: Bears tax burden Elastic Supply: Avoids tax burden Inelastic Demand: Bears tax burden Elastic Demand: Avoids tax burden

Taxes on Earnings

PAYROLL TAX: tax levied on income earned at one's job. - mainly goes to social insurance

Which of the following is NOT true? a. For state and local governments, property taxes are the biggest source of revenue. b. For the federal government, payroll taxes are a bigger source of revenue than corporate income tax. c. The biggest source of federal government revenue is individual income tax. true d. state and local governments rely more on property tax than sales tax.

a. For state and local governments, property taxes are the biggest source of revenue.

A fixed amount a taxpayer can subtract from adjusted gross income for each dependent member of the household, the taxpayer and spouse is...

an exemption

Property tax is collected

annually based on how the value is estimated - In Texas this process is done by the county - May change yearly as the value of property changes

Parties with more inelastic supply or demand (less sensitive to price) Parties with a more elastic supply or demand (more sensitive)

bear the taxes avoid taxes

General equilibrium

considers the effects on related markets of a tax imposed on one market. -follow the tax burden

Partial Equilibrium Analysis

considers the impact of a tax on a market in isolation

What determines how burdens get broken down?

elasticity or inelasticity of the supply and demand.

The total of an individual's income sources is...

gross income

According to the lectures, which notion of fairness is most important?

horizontal equity

In economics what is important in decision making is what happens on the

margin

Fairness in taxes is

not as easy as it appears. - Difficulty in how to judge whether two tax payers are equally situated - income vs wealth

Tax incidences is about ________, not _______.

prices, quantities Because in equilibrium, the marginal consumer is indifferent between buying and not.

Higher income tax payers pay more and pay proportionately more in taxes under which tax system?

progressive taxation

A tax system in which effective average tax rates do not change with income so that taxpayers pay the same proportion of their income in taxes is....

proportional taxation

Flat taxes are an example of...

proportional taxation

Paying the same proportional amount in taxes at all income levels is....

proportional taxation

Tax on producers will ______. Tax on consumers will ______.

reduce supply reduce demand

Tax Incidence

Assessing which party, consumers / buyers or producers / sellers, bears the true burden of tax. - not merely who sends the government a check. - markets respond to taxation

How much more should better off taxpayers pay? 3 Answers/ approaches to this:

- PROGRESSIVE TAXATION: tax system where effective average tax rates rise with income. * Higher taxpayers pay more and pay more proportionately. "rate goes up" * Example: US income taxes, which are graduated marginal rates; therefore the more income you make, the higher the bracket, which you pay higher marginal rates on taxes. * higher bracket raises the average tax rate - PROPORTIONAL TAXATION: tax system in which effective average tax rates do NOT change with income *ALL taxpayers pay the same proportion of their income in taxes. * "flat taxes": same proportion of taxable income from everyone. - REGRESSIVE TAXES: tax system in which effective average tax rates fall with income. *people who are less well off / situated, pay more as a proportion of their income.

3 Rules of Tax Incidence

1. The statutory burden of a tax does NOT describe who really bears the tax burden. - STATUTORY INCIDENCE: The burden of a tax born by the party that sends the check to the government. * vendor collects the statutory tax 2. Individuals with relatively elastic demand (or supply) of a taxed good tend to escape the burden of tax imposed on that good - ECONOMIC INCIDENCE: The burden of taxation measured by the change in resources available to an economic agent as a result of that taxation. "who actually bears the burden" 3. The side of the market on which the tax is imposed is irrelevant to the distribution of the tax burdens. "Doesn't matter whether you put it on consumers or producers" **The theory of tax incidence - who bears the burden of a given tax structure - begins with three basic principles: (i) the burden of all taxes must be traced back to individuals; (ii) individuals with relatively elastic demand (or supply) of a taxed good tend to escape the burden of tax imposed on that good; and (iii) in the long run the incidence of a tax levy does not depend on which side of the market bears the legal responsibility for remitting the tax to the government.

5 types/categories of taxes

1. taxes on earnings 2. taxes on individual income 3. taxes on corporate income 4. taxes on wealth 5. taxes on consumption

Property taxes are...

A wealth tax

T/F It is generally considered an easy task to assess whether two payers are equally situated in the context of resources.

FALSE **NOT an easy task

Statutory vs Economic Incidence

CONSUMER INCIDENCE: (post-tax price you pay minus the pre-tax price) plus any per-unit tax payments (post-tax - pre-tax) + per-unit tax "How much did the price of the product change plus your statutory incidence) * taxation will change total effective cost for a producer. (supply curve / effective marginal cost will shift up / be higher) PRODUCER INCIDENCE: (pre-tax price minus post-tax price) plus per-unit tax payments (pre-tax - post-tax) + per-unit tax

Income Tax Structure

Calculate the Tax Base: Adjust your gross income. - GROSS INCOME: total of an individuals income sources. - ADJUSTED GROSS INCOME: Gross income less/minus deductions. Deduction Examples: retirement, alimony, health insurance premium, payroll taxes by self employment. - EXEMPTION: fixed amount a taxpayer can subtract from their adjusted gross income for each dependent member of the household, as well as for the taxpayer and the spouse.

Taxes on Corporate Income

Corporate income tax: Tax levied on the earnings of corporations.

Tax Wedge

Difference between what consumers pay and what producers receive. (net of tax) from a transaction.

T/F Tax incidence is which party sends the government a check.

FALSE

T/F Tax incidence is about prices, not quantities, because producers do not care about quantities.

FALSE **1st half is true, second half is false.

T/F Statutory incidence describes who really bears the burden of a tax.

FALSE **Economic Incidence

Taxes on Individual Income

IDIVIDUAL INCOME TAX: A tax paid on individual income accrued during the year. (what you think of when you think of "income tax") -Different than payroll tax because Individual Income Tax covers: * broader range of sources * family income EX: Capital gains: Earnings from selling capital assets, such as stocks, paintings, and houses.

What's the difference between income tax and payroll taxes?

Income taxes cover a broader range of sources of income.

Payroll taxes are used for...

Social Security

T/F Itemized deductions are an alternative to standard deductions.

TRUE

T/F Tax incidence is which party bears the burden of the tax.

TRUE

Taxes on Consumption

Tax paid on individual or household consumption of goods and services. - SALES TAX: Taxes paid by consumers and collected by vendors at the point of sale. * tax on goods and services that goes to your state or local government. * used by states as a source of their income, and each state sets its own tax rate. - EXCISE TAX: a tax paid on the sale of goods. (specific application) *"luxury tax" "sin tax" * This is used by both the state and federal government. * Taxes on items such as gasoline, beer, liquor, cigarettes, and airplane tickets are excise taxes.

Marginal Cost (MC)

The additional cost incurred from the consumption of the next unit of a good or service Actual cost without the taxes or production costs

Benefit Principle

Those who benefit more from government operations should pay more in taxes. the idea that people should pay taxes based on the benefits they receive from government services * vertical equity often contradicts the benefit principle.

Taxes on Wealth

Wealth taxes: Taxes paid on the value of assets. - Examples: * Property tax based on real-estate value * Estate tax based on value of the estate left behind when someone dies. * State inheritance taxes

spillover between markets

When a tax is levied on one market and it spills over into other markets - Income effect: lower income causes consumers to purchase fewer units of a good. - substitution effect: consumers will select alternative options. - complementary effect: similar items will be effected in gain or loss of consumption

Types of Deductions

standard and itemized - STANDARD DEDUCTION (main type): fixed amount that a taxpayer can deduct from taxpayers income. - ITEMIZED DEDUCTION (alternative to standard deduction): taxpayer deducts the total amount of money spent on various expenses (gifts to charity, interest on home/ mortgage) can NOT have both Most people stick with standardized. Those who make a lot of money and often donate to charity go with the itemized option.

Tax incidence is NOT mere who sends the government a check because...

the market responds to taxes

Groups with more resources paying more in taxes is which notion of fairness in taxation?

vertical equity

Full Shifting

when one party bears the full tax burden