Taxes and Subsidies

Lesson 08: Taxes and Subsidies

Introduction

  • Quote by Benjamin Franklin:

    • "[I]n this world, nothing is certain except death and taxes."

    • This signifies the inevitability of taxation in society.

Types of Taxes

  • Ad Valorem Tax:

    • Definition: A tax that is a certain percentage of the price of a good.

    • Example: Sales tax of 6%.

  • Per Unit Tax:

    • Definition: A tax that is a certain dollar amount per unit of the good.

    • Example: Gasoline tax of $0.48 per gallon.

Hamburgers and Tax Implications

  • Businesses, specifically hamburger producers, are expected to contribute fairly to government revenues.

  • Implementation of a Hamburger Tax:

    • A $3 per unit tax is imposed on hamburger suppliers.

  • Effect of Tax:

    • "Levy on" Definition: Refers to the group that sends payment to the government.

    • Hamburger suppliers owe $3 multiplied by the number of hamburgers sold to the government, treating the tax as an additional cost.

    • Comparison of Costs:

    • Bun cost: $0.10 per hamburger.

    • Patty cost: $1.00 per hamburger.

    • Government tax: $3.00 per hamburger sold.

    • Supply Curve Shift:

    • The supply curve reflects the marginal costs and will shift upward by the dollar amount of the tax.

Graphs of Supply Adjustment Due to Tax

  • Equilibrium without Tax:

    • Price per Hamburger increases as demand adjusts to reach market-clearing price.

    • Graph Visuals:

    • Price at equilibrium ($8), Quantity (600 burgers per week).

  • Graph: Shift in Supply due to Tax:

    • Supply curve shifts upward by $3, illustrating that at each price point, the cost to suppliers increases.

    • Example: Original curve at $2; New with tax at $5.

  • Graph: Contraction of Supply and Price Changes:

    • Result of tax affects equilibrium, leading to a higher price per burger and lower equilibrium quantity post-tax.

    • New price at $10 for consumers (up from $8).

  • Graph: Price Rises by Less than the Tax:

    • New price for demanders cannot simply equal the old price plus tax.

    • New equilibrium price lower than expected (below $11).

  • Graph: Tax Pass Through Impacts on Consumers and Suppliers:

    • Demanders who paid $8 now pay $10; suppliers only receive $7 after tax.

    • Creates a wedge between prices demanders pay (PD) and what suppliers keep (PS).

Tax Revenue Calculation

  • Definition of Tax Revenue:

    • Total amount of money the government receives from a tax.

    • Tax Revenue Formula:

    • Tax Revenue = $ Amount of Tax * QTAX

    • Example Calculation:

    • For a tax of $3 and quantity (QTAX) of 500:

    • Tax Revenue = $3 * 500 = $1,500.

Effects on Surpluses

  • Consumer Surplus without Tax:

    • Calculated as:

    • Area of a triangle = 1/2 * Base * Height

    • Base = 600 units, Height = $20 - $8 = $12

    • Area = 1/2 * 600 * $12 = $3,600.

  • Consumer Surplus with Tax:

    • New area calculated with price demanders (PD) dropping to $10.

    • New area = 1/2 * 500 units * ($20 - $10) = $2,500.

  • Producer Surplus without Tax:

    • Calculated similarly:

    • Area = 1/2 * 600 units * ($8 - $2) = $1,800.

  • Producer Surplus with Tax:

    • New PS calculated as:

    • Area = 1/2 * 500 units * ($7 - $2) = $1,250.

Gains from Trade and Tax Revenue

  • Definition of Gains from Trade with Tax:

    - Total includes consumer surplus, producer surplus, and tax revenue.

    Consumption of Surplus:

    • My consumer surplus now rises while the producer surplus decreases post-tax, impacting overall economic welfare.

  • Graphical representation showcases the shifts and the areas of surplus along with deadweight loss from taxation.

Tax Burden Overview

  • Definition of Tax Burden:

    • Represents percentage of tax paid by demanders versus suppliers (also known as tax incidence).

    • Tools for visualizing tax burdens and comparing adjustments stemming from elasticities of demand and supply.

  • Graphical Visualizations of Tax Burden:

    • Shows demanders and suppliers' reactions to tax changes indicating the distribution of burden based on price alterations.

Effect of Tax Elasticity

  • Elasticity Impacts:

    • When demand is inelastic, more tax burden falls on consumers; when supply is inelastic, more burden falls on producers.

  • Graphs: Various Tax Framing:

    • Illustrations demonstrating identical outcomes regardless of whether taxes are levied on suppliers or consumers.

Payroll Tax Example

  • Definition:

    • A payroll tax is levied on employee wages, affecting the calculated net wages of workers and overall labor costs for employers.

Deadweight Loss Considerations

  • Implications of Deadweight Loss:

    • Explains that most taxes introduce some form of deadweight loss which increases progressively with higher tax rates.

    • Graphs:

    • Representing how deadweight loss grows and influences market efficiency.

Laffer Curve Discussion

  • Definition of Laffer Curve:

    • Describes the relationship between tax rates and tax revenue, indicating that while increasing tax adds revenue, extreme rates will ultimately reduce it.

  • Graphical Representation of Laffer Curve:

    • Demonstrates tax revenues at various rates and highlights the tipping points for revenue changes across differing tax rates.

Subsidy Overview

  • Subsidy History:

    • Historical context of subsidies affecting agricultural prices post-1920’s, leading to government buy-ups and eventual subsidy programs.

Effects of Subsidies on Markets

  • Subsidy Graphs:

    • Adjustment of supply curves showing how subsidies shift the equilibrium price and quantity, effectively creating price differences between what consumers pay and what suppliers keep.

  • Definition of Subsidy Expenditures:

    • Total government money spent on subsidies calculated as:

    • Subsidy Expenditure = $ Amount of Subsidy * QSUB

Analysis of Consumer and Producer Surplus with Subsidies

  • Changes in consumer surplus due to lower prices and producer surplus due to higher effective prices they receive.

  • Graphs illustrate how subsidy expenditures do not fully convert to surplus for both producers and consumers, referring to potential deadweight loss due to inefficiencies created by price distortion.

Case Studies on Subsidies

  • Current Agricultural Crop Subsidies and Their Dynamics:

    • The effects of subsidies on production, price stability, and long-term economic implications of continued governmental assistance versus market-driven price adjustments.

  • Case of Cash for Clunkers:

    • A government program that incentivized new car purchases during economic downturns, analyzed for effectiveness and actual impact versus expectations.

  • Potential Concerns of Subsidies:

    • Mention of fertilizer runoff and its environmental impact, demonstrating the interconnected implications of such economic policies.

Conclusion

  • Overall insights into the complex dynamics of taxation and subsidies provide a critical lens through which to view economic policy and market behavior, emphasizing the importance of assessing both immediate and long-term impacts on all stakeholders involved.