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Chapter 16: Public Finance: Expenditures and Taxes

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Meggie Gresham

on 22 January 2014

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Transcript of Chapter 16: Public Finance: Expenditures and Taxes

Results: VAT
Value Added Tax
Difference between the value of a firms sales and the value of its purchases from other firms.
Controversial
...
Encourages savings and investment by penalizing consumption
Discourages savings and investment as much as do income and profit taxes
Public Finance: Expenditures and Taxes
Sources of Conflict
Should we be able to obtain government goods and services without paying for them?
Do governments levy too big a variety of taxes?
Do taxes do more harm than good?
Classifications of Taxes: Progressive, Proportional, and Regressive
Progressive
As income increases, the average rate of a tax increases
Regressive

As income increases, the average rate of a tax declines
Proportional
Average tax rate does not change regardless of the size of income

Personal Income Tax
Progressive
BUT....
Rules allow individuals to deduct from income interest on home mortgages and property taxes
Exempts interest on state and local bonds from taxation.
Tax less progressive than suggested
Sales Tax
Foundation: Appointing the Tax Burden
1
.
Purposes of taxes
Provide wages and salaries of government workers
Fund government-provided goods and services
2
.
Two philosophies of the tax burden
Benefits-Received Principle
Ability-to-Pay Principle
3
.
The three classifications of taxes
Classified based on the relationship between average tax rates and taxpayer incomes

Benefits-Received Principle
- Beneficiaries of government supplied goods and services should pay the necessary tax to finance them
- Households should purchase government goods and services the same way other commodities are bought

Ability-to-Pay Principle
- The tax burden should be appropriated according to taxpayers income and wealth.
- Therefore... A dollar taken through taxes from a poor person yields a greater utility sacrifice than a dollar taken through taxes from a wealthy person

- Why? Each additional dollar of income received yields smaller marginal utility when spent
Foundation: Tax Incidence and Efficiency Loss
1.
Tax incidence
Degree to which a tax falls on a particular person or group
2.
Elasticity and Tax Incidence
Division of Burden
Elasticities
3.
Efficiency Loss of a Tax
Tax Revenues
Efficiency Loss
Role of Elasticities
Qualifications

Regressive with respect to income
Larger portion of a low-income is exposed to tax
Smaller portion of a high-income is exposed to tax
Property Tax
Property owners add the tax to the rents that tenants are charged
Property taxes are higher for low-income housing families than for high-income families because a larger proportion of income is spent on housing
Incidence of an Excise Tax: Division of Burden
The excise tax shifts the supply curve up by the amount of the tax per unit
Higher price for consumers
Lower after-tax price for producers
Elasticities of Demand
Elastic Demand
Most of the tax borne on producers
Small portion on consumers
Larger decline in equilibrium quantity
Inelastic Demand
Most tax on consumers
Small amount paid by producers
Smaller decline in equilibrium quantity
Elasticities of Supply
Elastic supply
Consumers bear most of the tax
Producers bear small portion
Equilibrium quantity declines more than inelastic supply
Inelastic supply
Consumers bear small portion
Producers bear large portion
Equilibrium quantity declines less than elastic supply
Demand Elasticity and Incidence of an Excise Tax
Supply Elasticity and the Incidence of an Excise Tax
Efficiency Loss of a Tax
1. Tax causes the product price to increase
2. Equilibrium quantity reduces
3. Tax revenue to the government represented
4. Efficiency loss from the decline in output and is represented by the triangle

Smaller efficiency loss
Greater efficiency loss
Qualifications: Other Goals Besides Minimizing Efficiency Losses
Redistributive goals
Impose progressive taxes to redistribute income
Luxury tax unsuccessful
Reducing negative externalities
Implement it on purpose to reduce output
"Sin taxes" on cigarettes and alcohol
To Summarize...
Benefits-Received Principle:
Beneficiaries from government services ought to pay the necessary taxes to finance them
Ability-to-Pay Principle:
Taxes should depend on income and wealth
Progressive tax
Higher income, higher tax
Regressive tax
Lower income, lower tax
Proportional tax
Higher income, tax does not change
Taxes raise equilibrium price, reduce equilibrium output, and usually generate efficiency loss
Fixed demand:
More elastic supply puts tax burdens on consumers
Fixed supply:
more elastic demand puts tax burdens on producers
Full transcript