ECON0103 Tax Policy

W1 - what is a tax incidence?

determination of who should pay tax

W1 - what is formal/statutory incidence? what is effective/economic incidence?

formal = who is legally paying tax

effective = who is actually bearing the tax burden

W1 - what determines the tax incidence?

Elasticity of demand. The number of alternatives and market conditions determines how much of the tax a business can pass to its customers

W1 - how do taxes affect asset prices? Example: government decides to make a thing tax exempt ?

Taxes distort asset prices as asset prices embed the taxation element

IF for example bonds are made tax exempt, its price would rise. Those who originally held the bond before exemption was announced would ‘gain’

W1 - what makes an income tax progressive?

a progressive income tax is where avg. tax rate rises with income

W1 - what are some costs to taxation?

admin, compliance costs

DWL/economic distortion

W1 - what is the income and substitution effect of tax? What measure of tax rate influences each?

income effect - i am being taxed more, therefore i should work more to increase my income. avg tax rates influence income effect. someone with higher ATR may decide to work more to maintain living

substitution effect - assuming leisure is a normal good, tax means working is no longer so attractive and i may want to consume more leisure. marginal tax rates influence substitution effect. one with higher MTR may substitute labor with leisure

W1 - what was the Window Tax issue and what did it demonstrate?

the issue in the UK whereby tax laws created economic distortions, leading people to board up their windows to pay less tax. The tax was meant to be on the rich but led the poor to cover up windows.

It also showed that many people will stay just below the threshold, e.g. if the law said 8+ windows incurred a tax, people would just report 7 windows.

W1 - who should be taxed according to Mirrlees, J. et al. (2011)?

final consumers. or else there will be economic distortions.

transactions such as exchanging of ownership should not be taxed either (property, for example)

W1 - wwhat are the arguments for and against a uniform taxation?

for: promotes simplicity, promotes equity regardless of goods preference

against: inverse elasticity rule - we could charge goods w inelastic demand more than goods with elastic demand. (But this also creates problems as necessities would be taxed - problem of unfairness)

W1 - what are corrective taxes according to Mirrlees, J. et al. (2011)?

taxes on negative externalities or internalities

→ smoking, alcohol, bad practices like gambling

by the Pigouvian Principle, the tax should equal the marginal damage caused by the externality

W1 - what is input VAT? Output VAT?

input VAT is the output VAT of the supplier you bought from - you can reclaim this as a tax refund

output VAT is the amount of tax you pay HMRC, calculated on the total value of the selling price to customer

W1- A good passes through three VAT-registered businesses. VAT = 25%.

• Seller A produces a good worth $100.

• Seller B purchases it and adds $100 in value.

• Seller C purchases it and adds another $100 before selling to the final consumer.

Calculate for each seller: (i) input VAT, (ii) output VAT, (iii) net VAT remitted, and (iv) VAT-inclusive selling price.

	Seller A	Seller B	Seller C
Pre-VAT selling price	$100	$200	$300
Input VAT	$0	$25	$50
Output VAT (25%)	$25	$50	$75
Net VAT remitted	$25	$25	$25
VAT-inclusive selling price	$125	$250	$375

Total VAT revenue: $25 + $25 + $25 = $75.

Final consumer price: $300 + $75 = $375.

W1 - What is a Retail Sales Tax? problems?

tax on the final retailer. problem is that if they avoid tax, then govt collects zero tax. That is the case for VAT.

W1 - what is a cascade tax?

A variation on VAT whereby businesses cannot reclaim input VAT. Therefore they are necessarily paying tax at every stage with no reclaims. This distorts the economic picture.

W1 - VAT, zero rating versus exempting

Zero-rating means output VAT is exempt, but can still claim input VAT

Exempting means the business does not pay output VAT nor is able to claim input VAT

W1 - what are the arguments for and against a VAT threshold?

Most agree that some VAT threshold is important because

• reduces admin costs, compliance costs for small firms

• encourages small businesses to thrive

However, some argue it should not be too high or should not exist because

• Window Tax issue - lots of firms will choose to deliberately stay below the threshold

• Firms below the threshold and choose not to pay VAT may suffer from incentive issues, because “downstream” firms cannot claim input VAT from them. They may need to lower prices to attract customers.

W1 - what are the ways of VAT fraud?

1. Overreporting input VAT or underreporting output VAT

2. Not reporting at all, or reporting but not paying to HMRC

W1 - how does VAT work on international transactions?

The exporter does not pay VAT, but is instead zero-rated (can claim input VAT) but the importer pays VAT. This makes sense becuase the importer is the consumer of the good.

W1 - what is carousel fraud? illustrate with an example

Carousel fraud is a form of missing trader VAT fraud exploiting zero-rated cross-border supplies and the input VAT credit system.

Example (Germany → France → Germany; 20% VAT assumed):

1. German Firm A sells goods to French Firm B for €1,000, with no VAT charged on the qualifying intra-EU supply.

2. Firm B (missing trader) sells them to French Firm C for €1,200 + €240 VAT, collects €240 but disappears without remitting it.

3. Firm C exports the goods back to Germany, charging 0% VAT, and claims a €240 input VAT refund.

4. The goods may circulate repeatedly, generating further fraudulent claims.

Government loss: €240 refunded/credited without the corresponding VAT having been remitted by B.

W1 - What is excess burden?

Excess burden is the same as DWL - it is equal to R_L - R_s

Where R_L is the lump-sum payment agents would be willing to make to avoid the tax

And R_S is the revenue raised from the tax.

noting for lumpsum taxes there is no DWL

W1 - what is marginal excess burden? (MEB)

The marginal excess burden of taxation is the additional economic loss (or deadweight loss) to society caused by raising one more dollar or unit of tax revenue

W1 - What is the margin value of public funds? MVPF

The additional unit of social benefit brought about by one addtl pound of spending by govt

W1 - Hicks-Kaldor compensation principle

Idea that to maximise social efficiency, you probably need to make one or more parties worse off in order to compensate the ‘poorest’ parties. In turn, this would not be a Pareto outcome

W1 - Production efficiency theorem?

Idea that revenue-raising taxes should NOT affect/distort production. Instead, final consumption shd be taxed