Market Intervention: Taxes

Mr. BarnettUniversity HighAP Economics

Taxes Why does the government

tax goods & services like cigarettes, alcohol and gambling? “Sin taxes” ▪ Health drawbacks from alcohol

and cigarettes are paid for by all members of society (users and non-users)

▪ Thus, seems fair to tax individuals using products

Addictive – so demand is inelastic and a tax would raise a lot of money

Taxes

Tax incidence – the manner in which the burden of a tax is shared among participants in a market

How taxes affect market outcomes Unit taxes (Government requires buyers or

sellers to pay a certain dollar amount for each unit of a good sold)▪ Will ______ supply, Will ______demand▪ The supply/demand curve will decrease (shift

left) by the amount of the tax

Taxes How taxes affect market outcomes cont.

The quantity of the good sold will decline Buyers and sellers share the burden of the tax▪ Do buyers and sellers like taxes? Why not?

▪ Buyers pay more for the good (b/c of added tax)▪ Sellers receive less for the good

Taxes discourage market activity Tax can be on buyers or sellers (thus, can affect supply

or demand curve) ▪ Supply curve shifted by taxes on suppliers▪ Demand curve shifted by taxes on consumers

Tax!, Tax!, Tax!, Tax!, Tax!, Tax! Partner 1: You are “Big Brother”

Choose a good you want, who you are taxing & why you are taxing that good

Tell your partner what the original price was and the amount of the tax

Partner 2: You are the supplier or consumer Show the shift in the supply or demand curve Show Prices▪ Price without tax▪ Price that buyers will now pay▪ Price that sellers will now receive

Partner 1: Show the resulting graph and prices if you switch who (buyer or supplier) got taxed

Tax

When a tax is imposed on good with inelastic demand (like cigarettes) producers are able to pass along most of it to consumers

Tax

If the supply is more inelastic than demand, then the producer will bear a greater burden of the tax

Vroom…Vroom! What is the tax burden on consumers and producers if the government

passed an excise tax on new fuel-inefficient cars that did not get 35 miles per gallon?

A new Aston Martin DB9 costs around $200,000 Averages 13 MPG

The elasticity of demand for a new Aston Martin DB9 is 4.0 and the elasticity of supply is 0.5

Aston Martin Lagonda Limited is taxed by the government $3,000 per unit (car).

Will consumers or producers bear more of the burden from the tax? The shift in the _______curve to the _____is equal to $_______ The consumers’ share of the tax burden is $_____ Producers share of the tax burden is $______ The new price consumers pay is $_______ The new price suppliers receive is $_________ Graph it!

Let’s Graph it!

Taxes Three criteria for all taxes

Is it equitable/fair▪ Taxes should be impartial and fair▪ Need to avoid possible loopholes that create inequality

Is it objective?▪ Need to avoid possible loopholes that create inequality▪ Is it easy to understand?▪ Individual income tax – difficult to understand and do on your own▪ Sales tax – easier to understand and straightforward

Is it efficient? ▪ Easy to administer ▪ Reasonably successful at generating revenue – worthwhile

Economic Impact of Taxes

Resource Allocation: factors of production affected when taxes are levied May raise costs of production, product price

Behavior Adjustment: some taxes encourage/discourage behavior Ex: Sin Tax = relatively high tax designed to raise

revenue, discourage consumption of socially undesirable product

Ex: Homeowners use interest paid on mortgage as tax deduction … encourages people to buy a home

Economic Impact of Taxes

Productivity & Growth - Taxes can

change incentives to save, invest, and work

Why work more if you’ll be taxed more?

Economic Impact of Taxes Incidence of Tax, or final burden of

the tax = who actually “pays” it? Ex: City wants to tax local utility co…

utility co. raises rates = consumer bears burden of the tax

Is the tax fair/equitable?

Payroll Tax

1. FICA (Social Security) taxes2. How elastic are these curves?3. Designed so workers and firms share burden of the tax4. How does the tax affect labor suppliers & labor demanders

Elasticity & Tax Incidence Let’s recap

A tax burden falls more heavily on the side of the market (suppliers or consumers) that is _______ elastic

A small elasticity of demand means that buyers do not have good alternatives ▪ No good substitute (opportunity cost)

A small elasticity of supply means that sellers do not have a good alternative to produce▪ No good plan B (opportunity cost)

Back to smoking ….

Back to smoking ….

Back to smoking ….

Back to smoking ….

Quiz Prep Go through your notes for this week and

come up with 2 quiz questions

Write down your quiz questions on scrap paper

Exchange questions with a partner and answer each other’s questions

Discuss answers!

Closure

An ideal tax has what characteristics? Do consumers or producers benefit

from a government tax?