Public Finance, Foldvary

Anderson, public finance, 2nd ed

Chapter 13 - Equity aspects of taxes and spending

Effect of a unit tax - a fixed money amount based on the quantity of a good bought.

E.g. 24c per pack of 20 small cigarettes or tax per gallon of wine.

P. 402.

Tax incidence falls on seller and buyer depending on elasticity or responsiveness of

relative quantity to price.

The unresponsive agent bears most of the burden.

If demand is elastic, the tax is shifted to sellers

If demand is inelastic, the tax is shifted to buyers.

If supply is elastic, the tax is shifted to buyers.

If supply is inelastic, the tax is shifted to sellers.

If supply is totally inelastic, vertical, the total incidence is with the seller or agent renting

out the property.

Price does not increase by the full tax unless demand is infinitely elastic (horizontal).

The incidence of a unit tax is independent on which agent is nominally taxed, or has the

statutory incidence.

Excess burden the triangle.

Difference between the gross-of-tax and net-of-tax prices is a tax wedge. Also for wages.

Tax wedge on land rent?

Same principle for ad valorem tax, based on the value.

The curve is raised by the same proportion at each quantity, not parallel. P. 343.

Taxes on factors of production.

A payroll tax is a tax on wages.

Social security a payroll tax.

The statutory distinction between employer and employee, with the tax split, is

economically irrelevant.

It is a legal fiction that the employer pays half.

The incidence is determined by the total amount of tax.

Labor bears most of the tax.

The portion borne by employers gets partly passed on to consumers, of which labor is the


Taxes on capital goods:

Closed economy: owners bear some of the burden. Reduces the after-tax return on

investment. Less investment, so the long-term

burden also on labor, with lower wages than would be.

Open economy, with fully elastic capital: suppliers bear no burden. Tax fully passed

onto consumers.

Monopoly firm: unit tax reduces Q and increases P; reduces profit, but makes outcome

less efficient.

But a tax on the economic profit leaves MC and MR the same, so the entire tax is borne

by the monopolist.

Need to be careful - high nominal profit can be from risk.

Capitalization: when land is taxed, price decreases; tax is capitalized negatively.

Price equals the present value of future after-tax rents.

The burden is only during the transtion to higher land taxes.

General equilibrium analysis.

A tax on one good can have effects on other goods.

Depends if they are substitutes or complements.

A tax on coffee induces more purchases of tea.

A tax on software reduces the demand for hardware.

General equilibrium analysis studies the full effects.

Taxes on one type of asset or income affects the price of other assets and incomes,

because rates of return to assets tend to equalize, relative to risk.

High taxes on corporate profits will reduce returns to all enterprise.

Investment shifts away from corporations, increasing their returns, and lowering other returns.

Taxes on sales are equivalent to taxes on income.

Both reduce a consumer's budget.

Taxes on income discourage saving and taxes on sales discourage borrowing. Borrowing

equals savings.

Not clear why one side should be favored.

All income is eventually consumed.

If must tax income or sales, do 50% on each.

A tax on output reduces the price of its inputs.

Effects of taxing land rent

More efficient use of land.

Removes disincentive from production.

More investment, capital accumulation.

Lower interest rates.

Main point: the social cost of taxation is not the money turned over the the government.

That's a personal cost.

The cost is the loss of social welfare.

The reason there is a loss is that when supply and demand curves slope diagonally,

government forces a quantity change different from what consumers and producers would

voluntarily choose. The forced changes in quantity are welfare losses.

An example is a sales tax that makes you buy less of that item - e.g. a car. You can't

afford the property and sales taxes, so you don't buy the card. You were willing to pay the

economic cost, but government artificially raises the cost, so it is higher than the marginal

economic cost.

You are worse off because you buy a bundle of goods that gives you less utility, is less

preferred, than without the tax.

This distortion of economic decisions is called the excess burden. Also a welfare cost or

deadweight loss.

Taxes on income and consumption affect labor/leisure.

With a lump-sum tax, there is no excess burden.

But a head tax is forced labor.

was used by colonial powers in Africa.

In UK Thatcher replaced property tax with a head tax.

Very unpopular, felt it was unjust. Led to her downfall.

This is what happens when you don't study public choice.

Land rent is like a lump sum tax in that the owner gets a fixed bill for the year and no

extra marginal cost on his effort.

But unlike head taxes, you can avoid a land tax by not owning land. If you rent, it comes

out of your rent.

So taxes on productive effort and on consumption are generally inefficient in lowering

utility by more than needed for revenue.

Does a subsidy have an excess burden (besides the tax for it).

A subsidy is a tax with an opposite sign.

Mathematically and economically equivalent. p. 316

Excess burden by making price less than marginal cost.

Lump sum money subsidy has not excess burden.

Gift is different. Not just giving an object, but love.

(Can be an insult to give money).

The cost of the subsidy can be greater than the benefit.

Resources are used too much, inefficient.

Empirical study: $20/hr, 40% tax, $640 burden, 4%.

Hired labor is taxed, but home production not:

Too much housework and not enough market work.

Excess burden needs to be included as a cost of government.

Capital (K) same percentages. Q: incidence consumption tax.

A corporation is a legal person.

Hence, setting one up is a privilege.

The federal corporation tax is tax on the privilege of operating as a corporation,

measured by the amount of income.

The proportion of taxation of corporations has fallen;

it is now about 10%.

Corportion income tax 35% after $10 million.

Interest payments are expenses, but dividends not.

Hence, double taxation of dividends, first by corporation, then by individuals.

Hence, more debt and fewer dividends than without taxation.

Excess burden of corportate income taxes have been estimated as high as 45%.

There are also state income taxes on corporations, and

US tax treaties with foreign countries to complicate even more.

Equity concepts

The equity criterion requires that people with equal income should receive equal treatment (horizontal equity) and people with different incomes receive different treatment (vertical equity).

Horizontal Equity

Ability to pay is generally taken simplistically to relate to income.

However, for a tax to be truly equitable the total economic situation of the individual should be considered.

Great effort is made to ensure that income tax is equitable as regards real income but significant anomalies still exist.

Income tax disregards notional income.

The owner-occupier of a house has a notional income in addition to any actual income, he does not pay explicit rent.

The tenant on the other hand must first pay the landlord before being able to assess disposable income.

Furthermore, those on subsidised rents have a notional income equal to the difference between the economic rent and the rent charged.

Fringe benefits and working conditions are also largely untaxed notional incomes.

A salex tax violates horizontal equity because people with equal income can consume unequally.

Horizontal equity is also violated with different tax rates for married and single payers.

Vertical Equity

There is no single tax treatment that actually constitutes vertical equity.

Flat and progressive scales could all be claimed to meet the vertical equity criterion.

Only a tax in which the wealthy pay the same or less than the poor cannot be claimed to be vertically equitable (i.e. not just a smaller proportion of income but actually less).

It is generally acknowledged that it is easier for some to reduce their income tax liability.

These people are more likely to have high incomes, consequentially there is a reduction in the effective progressivity of the income tax scale.

Land value taxation at a State level imposes the same rating scale on all sites and therefore tends to be progressive.

It is reasonable to assume that the wealthier own more valuable properties and the concentration of land ownership in terms of value bears this out.

P. 353: US taxes reduce inequality, but not by much.

Incidence of expenditure programs

The federal government does not study the incidence of its spending.

Cash transfers benefit the poor.

Farm and industrial subsidies benefit the wealthy.

Educational subsidies benefit the middle class.

Financial aid for education benefits lower-income folks.

The biggest income transfer is implicit: land rent.