Taxes and Subsidies - Chapter 6 Review

Flashcards covering key vocabulary related to taxes, subsidies, tax incidence, deadweight loss, and elasticity from Chapter 6 of the University of Missouri lecture notes.

Chapter 6 Topic

The lecture chapter focuses on Taxes and Subsidies.

Tax Wedge

A gap created by taxes between the price paid by buyers and the price received by sellers, which also applies to subsidies.

Tax Incidence

Refers to who ultimately pays a tax, which is determined by the elasticity of supply and demand, not by tax laws.

Elasticity Equals Escape

A principle indicating that the side of the market with the relatively more elastic curve will pay less of a tax.

Deadweight Loss

The reduction in total surplus (consumer and producer surplus) that results from a market distortion like a tax or subsidy, meaning the revenue raised is less than the welfare loss. Often referred to as 'The bucket leaks.'

Sales Taxes

Taxes usually levied as a percentage of the price of a good.

Per-Unit Taxes

Taxes levied as a specific dollar amount per unit traded, such as on gasoline, cigarettes, or alcohol.

Property Tax

A major type of tax not directly tied to a transaction, based on the value of a house.

Payroll Tax (Social Security/FICA)

A tax on labor income.

Perfectly Elastic Demand (Tax Burden)

When demand is perfectly elastic, the seller pays the entire tax.

Perfectly Elastic Supply (Tax Burden)

When supply is perfectly elastic, the buyer pays the entire tax.

Perfectly Inelastic Demand (Tax Burden)

When demand is perfectly inelastic, the buyer pays the entire tax ('no escape').

Perfectly Inelastic Supply (Tax Burden)

When supply is perfectly inelastic, the seller pays the entire tax ('no escape').

Subsidies

A reverse tax where the government gives money to consumers or producers, increasing quantity traded inefficiently and creating deadweight loss.

Deadweight Loss from Subsidies

Subsidies also create deadweight loss because they lead to inefficient increases in trade, costing taxpayers more than the benefits gained by consumers and producers.

Conditions for No Deadweight Loss (Taxes)

A tax will not cause a deadweight loss if either supply or demand is perfectly inelastic, as there's no reduction in the quantity traded.

Tax Revenue vs. Deadweight Loss Relationship

A tax can raise no revenue (e.g., if trade ceases completely) but still produce a deadweight loss.

Economic Reasons for Taxes/Subsidies

Governments implement taxes or subsidies primarily due to public goods, externalities, and other 'market failures'.

Economic Myth Regarding Taxes

The misconception that businesses simply 'pass on' taxes to their customers entirely; in reality, the tax burden is almost always shared between consumers and businesses based on their relative elasticities.

Tax Wedge

A gap created by taxes between the price paid by buyers and the price received by sellers, which also applies to subsidies.

Tax Incidence

Refers to who ultimately pays a tax, which is determined by the elasticity of supply and demand, not by tax laws.

Elasticity Equals Escape

A principle indicating that the side of the market with the relatively more elastic curve will pay less of a tax.

Deadweight Loss

The reduction in total surplus (consumer and producer surplus) that results from a market distortion like a tax or subsidy, meaning the revenue raised is less than the welfare loss. Often referred to as 'The bucket leaks.'

Sales Taxes

Taxes usually levied as a percentage of the price of a good.

Per-Unit Taxes

Taxes levied as a specific dollar amount per unit traded, such as on gasoline, cigarettes, or alcohol.

Property Tax

A major type of tax not directly tied to a transaction, based on the value of a house.

Payroll Tax (Social Security/FICA)

A tax on labor income.

Perfectly Elastic Demand (Tax Burden)

When demand is perfectly elastic, the seller pays the entire tax.

Perfectly Elastic Supply (Tax Burden)

When supply is perfectly elastic, the buyer pays the entire tax.

Perfectly Inelastic Demand (Tax Burden)

When demand is perfectly inelastic, the buyer pays the entire tax ('no escape').

Perfectly Inelastic Supply (Tax Burden)

When supply is perfectly inelastic, the seller pays the entire tax ('no escape').

Subsidies

A reverse tax where the government gives money to consumers or producers, increasing quantity traded inefficiently and creating deadweight loss.

Deadweight Loss from Subsidies

Subsidies also create deadweight loss because they lead to inefficient increases in trade, costing taxpayers more than the benefits gained by consumers and producers.

Conditions for No Deadweight Loss (Taxes)

A tax will not cause a deadweight loss if either supply or demand is perfectly inelastic, as there's no reduction in the quantity traded.

Tax Revenue vs. Deadweight Loss Relationship

A tax can raise no revenue (e.g., if trade ceases completely) but still produce a deadweight loss.

Economic Reasons for Taxes/Subsidies

Governments implement taxes or subsidies primarily due to public goods, externalities, and other 'market failures'.

Economic Myth Regarding Taxes

The misconception that businesses simply 'pass on' taxes to their customers entirely; in reality, the tax burden is almost always shared between consumers and businesses based on their relative elasticities.

What is the primary implication of the 'Elasticity Equals Escape' principle?

It implies that the side of the market with the relatively more elastic curve will pay less of a tax, as they can more easily 'escape' the tax burden.

Other than sales and per-unit taxes, what are two other major types of taxes mentioned?

Property Tax (based on asset value) and Payroll Tax (on labor income).

When does a tax result in a deadweight loss?

A tax results in deadweight loss when it reduces the quantity traded in the market, meaning neither supply nor demand is perfectly inelastic.

What economic issues do taxes and subsidies aim to address?

They are primarily used to address public goods, externalities, and other 'market failures'.

What does the phrase 'The bucket leaks' refer to in the context of taxes?

It refers to deadweight loss, indicating that the revenue raised by a tax is