Micro Chapter 8

Fairness and the Big Tradeoff (8.3)

2 conflicting principles of fairness to apply yo a tax system: -The Benefits Principle -The Ability-to-Pay Principle

Progressive Tax (8.2)

A tax whose average rate increases as income increases.

Proportional Tax (8.2)

A tax whose average rate is constant at all income levels.

Average Tax Rate (8.2)

The percentage of income that is paid in tax.

The Benefits Principle (8.3)

The proposition that people should pay taxes equal to the benefits they receive from public goods and services. -is fair because those who benefit the most pay the most -can be used to justify a progressive income tax

Tax Incidence (8.1)

Is the division of the burden of a tax between the buyer and the seller. (a tax on the buyer vs. a tax on the seller)

Excess Burden (8.1)

The amount by which the burden of a tax exceeds the tax revenue received by the gov't--the deadweight loss from a tax. (*Because a tax creates a deadweight loss, the burden of the tax exceeds the tax revenue(aka the excess burden of the tax)

Taxes and Efficiency (8.1)

-(in previous chapters we saw that resources that are used efficiently when marginal benefit = marginal cost, and we've seen that a tax places a wedge between the price the buyer pays and the price the seller receives.) -buyer's price = marginal benefit, and the seller's price = marginal cost. =>so a tax puts a wedge between marginal benefit and marginal cost => The equilibrium quantity is less than the efficient quantity, and a deadweight loss arises. -Assume that the gov't taxes the seller: 1) with no tax, marginal benefit = marginal cost and the market is efficient. 2) with a tax, marginal benefit exceeds marginal cost and consumer surplus and producer surplus shrink. Part of each surplus goes to the gov't as tax revenue, and part of each surplus becomes a deadweight loss. -Because a tax creates a deadweight loss, the burden of the tax exceeds the tax revenue(aka the excess burden of the tax) But because the gov't uses the tax revenue to provide goods and services that people value, only the excess burden measures the inefficiency of the tax.

Incidence, Inefficiency, and Elasticity of Demand (8.1)

-Perfect Inelastic Demand: Buyer Pays and Efficient: The tax leaves the price received by the seller unchanged but raises the price paid by the buyer by the entire tax. The outcome is efficient(there is no deadweight loss) because marginal benefit equals marginal cost. -Perfect Elastic Demand: Seller Pays and Inefficient: The price paid by the buyer is unchanged and the seller pays the entire tax. The outcome is inefficient because marginal benefit exceeds marginal cost and a deadweight loss arises.

Incidence, Inefficiency, and Elasticity of Supply (8.1)

-Perfect Inelastic Supply: Seller Pays and Efficient: The seller pays the entire tax. Because the marginal benefit equals marginal cost, there is no deadweight loss and the outcome is efficient. -Perfect Elastic Supply: Buyer Pays and Inefficient: The buyer pays the entire tax. Because the marginal benefit exceeds marginal cost, a deadweight loss arises and the outcome is inefficient.

Social Security Tax (8.2)

-Social Security taxes fall equally on workers and employers. -Its incidence depends on the elasticities of demand and supply in the labor market. *Social Security Tax on Workers (the effects of Social Security tax when the law says that workers must pay the entire tax) -read example -This division of the burden of the tax arises because the demand for labor is more elastic than the supply of labor. *Social Security Tax on Employers (the effects of Social Security tax on employers) -read example -The tax on employers delivers the same outcome as the tax on workers. Workers recieve the same take-home wage, and firms pay the same total wage. -Congress cannot decide who pays the Social Security tax. When the laws of Congress come into conflict with the laws of economics, econimics wins. (Congres can't repeal the laws of supply and demand)

Incidence, Inefficiency, and Elasticity (8.1)

-The incidence of a tax and its excess burden depend on the elasticities of demand and supply in the following ways: 1) For a given elasticity of supply, the more inelastic the demand for the good, the larger is the share of the tax paid by the buyer. 2) For a given elasticity of demand, the more inelastic the supply of the good, the larger is the share of the tax paid by the seller. 3) The excess burden is smaller, the more inelastic is demand or supply

The Big Tradeoff (8.3)

-The taxes that generate the greatest deadweight loss are those on the income from capital. But most capital is owned by a relatively small number of people who have the greatest ability to pay taxes. -conflict between fairness and efficiency -We want a tax system that is efficient, in the sense that it raises the revenue that the government needs to provide public goods and services, but we want a tax system that shares the burden of providing these goods and services fairly. -Our tax system currently is an evolving compromise that juggles these two goals.

Taxes (8.1)

-When a good is taxed, it has 2 prices: a price that excludes the tax and a price that includes the tax. -Buyers respond only to the price that includes the tax because that is the price they pay. -Sellers respond only to the price that excludes the tax because it is the price they receive. -If the gov't taxes the buyer, the tax doesn't change the buyer's willingness and ability to pay. -Market equilibrium occurs when the tax curve intersects the supply curve. -If the gov't taxes the seller, the tax acts like an increase in the suppliers' cost, so supply decreases and the supply curve shifts up. This curve tells us what sellers are willing to accept, given that they must pay the gov't (a small price) on each item sold. -Market equilibrium occurs when the tax curve intersects the demand curve. -The argument about making the buyer or seller pay is futile. The buyer pays the same price, the seller receives the same price and the gov't receives the same tax revenue on the same quantity regardless of whether the gov't taxes the buyer or the seller. (in this example the buyer and seller share the tax burden equally, but in most cases the burden is shared unequally and might even fall on one side of the market.)

Marriage Tax Problem (8.3)

-When two individuals get married they are treated as one taxpayer(instead of two different taxpayers.) -This problem arises from the progressive tax(look at example on page 208.) It would not arise if taxes were proportional. Because horizontal equity confilcts with progressive taxes, some people say that only proportional taxes are fair.

Effects of the Income Tax (8.2)

-income tax is a tax on sellers of the services of labor, capital, and land -the incidence and inefficiency of a tax depend on the elasticities of demand and supply(but because these elasticities are different for each factor of production, we must examine the effects of the income tax on each factor separately) *Tax on Labor Income: -Firms can substitutes machines for labor in many tasks, so the demand for labor is elastic. -But, most people have few good options other than to work for their income, so the supply of labor is inelastic. -because the demand for labor is elastic and the supply of labor is inelastic, the tax creates a deadweight loss *Tax on Captial Income: -Capital income in the form of interest on bonds and bank deposits is taxed at the normal income tax rate. (but capital income in the forms of dividends on stocks is taxed twice, it is taxed as a dividend and as corporate profit at the corporation income tax rate) -Because many tasks can be done by machines or labor, the demand for capital is elastic. -Capital is internationally mobile, and its supply is highly elastic. -Firms pay the entire capital income tax, and lenders receive the same after-tax interest rate as they receive in the absence of a capital income tax. The tax creates a deadweight loss. *Tax on the Income from Land and Other Unique Resources: -Each plot of land and reserve of mineral or other natural resource is unique, so its supply is perfectly inelastic, A fixed amount of the resource is supplied regardless of the rest offered for its use. The equilibrium quantity of land is determined purely by supply and the equilibrium rent is determined by the demand for land. -Tax is efficient when the equilibrium quantity of land used is the same with the tax as without it. The tax generates no deadweight loss(excess burden) and is ideal from the perspective of efficiency. -The principle that applies to a tax on income from land also applies to the income from any unique resource that has a perfectly inelastic supply.

Regressive Tax (8.2)

A tax whose average rate decreases as income increases.

Marginal Tax Rate (8.2)

The percentage of an addtional dollar of income that is paid in tax.

The Ability-to-Pay Principle (8.3)

The proposition n that people should pay taxes according to how easily they can bear the burden. -A rich person can more easily bear the burden of providing public goods than a poor person can, so the rich should pay higher taxes than the poor. -The ability-to-pay principle involves comparing people along 2 dimensions: horizontally and vertically: *Horizontal Equity: The requirement that taxpayers with the same ability to pay should pay the same taxes. *Vertical Equity: The requirement that taxpayers with a greater ability to pay should bear a greater share of the taxes.

Taxable Income (8.2)

Total income minus a personal exemption and a standard deduction(or other allowable deductions.) *the amount of income tax a person pays depends on his/her taxable income. *the tax rate depends on the income level, the tax rate for a single person increases with income.