资源描述
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8
Chapter 8
APPLICATION: THE COSTS OF TAXATION
of Taxation
WHAT’S NEW IN THE SEVENTH EDITION:
A new In the News box on “The Tax Debate” has been added.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
how taxes reduce consumer and producer surplus.
the meaning and causes of the deadweight loss from a tax.
why some taxes have larger deadweight losses than others.
how tax revenue and deadweight loss vary with the size of a tax.
CONTEXT AND PURPOSE:
Chapter 8 is the second chapter in a three-chapter sequence dealing with welfare economics. In the previous section on supply and demand, Chapter 6 introduced taxes and demonstrated how a tax affects the price and quantity sold in a market. Chapter 6 also described the factors that determine how the burden of the tax is divided between the buyers and sellers in a market. Chapter 7 developed welfare economics—the study of how the allocation of resources affects economic well-being. Chapter 8 combines the lessons learned in Chapters 6 and 7 and addresses the effects of taxation on welfare. Chapter 9 will address the effects of trade restrictions on welfare.
The purpose of Chapter 8 is to apply the lessons learned about welfare economics in Chapter 7 to the issue of taxation that was addressed in Chapter 6. Students will learn that the cost of a tax to buyers and sellers in a market exceeds the revenue collected by the government. Students will also learn about the factors that determine the degree by which the cost of a tax exceeds the revenue collected by the government.
KEY POINTS:
A tax on a good reduces the welfare of buyers and sellers of the good, and the reduction in consumer and producer surplus usually exceeds the revenue raised by the government. The fall in total surplus—the sum of consumer surplus, producer surplus, and tax revenue—is called the deadweight loss of the tax.
Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less, and these changes in behavior shrink the size of the market below the level that maximizes total surplus. Because the elasticities of supply and demand measure how much market participants respond to market conditions, larger elasticities imply larger deadweight losses.
As a tax grows larger, it distorts incentives more, and its deadweight loss grows larger. Because a tax reduces the size of a market, however, tax revenue does not continually increase. It first rises with the size of a tax, but if the tax gets large enough, tax revenue starts to fall.
CHAPTER OUTLINE:
I. The Deadweight Loss of Taxation
A. Remember that it does not matter who a tax is levied on; buyers and sellers will likely share in the burden of the tax.
B. If there is a tax on a product, the price that a buyer pays will be greater than the price the seller receives. Thus, there is a tax wedge between the two prices and the quantity sold will be smaller if there was no tax.
Figure 1
C. How a Tax Affects Market Participants
1. We can measure the effects of a tax on consumers by examining the change in consumer surplus. Similarly, we can measure the effects of the tax on producers by looking at the change in producer surplus.
2. However, there is a third party that is affected by the tax—the government, which gets total tax revenue of T Q. If the tax revenue is used to provide goods and services to the public, then the benefit from the tax revenue must not be ignored.
If you spent enough time covering consumer and producer surplus in Chapter 7, students should have an easy time with this concept.
Figure 2
3. Welfare without a Tax
Figure 3
a. Consumer surplus is equal to: A + B + C.
b. Producer surplus is equal to: D + E + F.
c. Total surplus is equal to: A + B + C + D + E + F.
4. Welfare with a Tax
a. Consumer surplus is equal to: A.
b. Producer surplus is equal to: F.
c. Tax revenue is equal to: B + D.
d. Total surplus is equal to: A + B + D + F.
5. Changes in Welfare
a. Consumer surplus changes by: –(B + C).
b. Producer surplus changes by: –(D + E).
c. Tax revenue changes by: +(B + D).
d. Total surplus changes by: –(C + E).
6. Definition of deadweight loss: the fall in total surplus that results from a market distortion, such as a tax.
D. Deadweight Losses and the Gains from Trade
Figure 4
1. Taxes cause deadweight losses because they prevent buyers and sellers from benefiting from trade.
2. This occurs because the quantity of output declines; trades that would be beneficial to both the buyer and seller will not take place because of the tax.
Show the students that the nature of this deadweight loss stems from the reduction in the quantity of the output exchanged. Stress the idea that goods that are not produced, consumed, or taxed do not generate benefits for anyone.
3. The deadweight loss is equal to areas C and E (the drop in total surplus).
4. Note that output levels between the equilibrium quantity without the tax and the quantity with the tax will not be produced, yet the value of these units to consumers (represented by the demand curve) is larger than the cost of these units to producers (represented by the supply curve).
II. The Determinants of the Deadweight Loss
Figure 5
A. The price elasticities of supply and demand will determine the size of the deadweight loss that occurs from a tax.
1. Given a stable demand curve, the deadweight loss is larger when supply is relatively elastic.
2. Given a stable supply curve, the deadweight loss is larger when demand is relatively elastic.
B. Case Study: The Deadweight Loss Debate
1. Social Security tax and federal income tax are taxes on labor earnings. A labor tax places a tax wedge between the wage the firm pays and the wage that workers receive.
2. There is considerable debate among economists concerning the size of the deadweight loss from this wage tax.
3. The size of the deadweight loss depends on the elasticity of labor supply and demand, and there is disagreement about the magnitude of the elasticity of supply.
a. Economists who argue that labor taxes do not greatly distort market outcomes believe that labor supply is fairly inelastic.
b. Economists who argue that labor taxes lead to large deadweight losses believe that labor supply is more elastic.
Activity 1—Labor Taxes
Type: In-class discussion
Topics: Deadweight loss, taxation
Materials needed: None
Time: 10 minutes
Class limitations: Works in any size class
Purpose
Most students have not spent a great deal of time considering the effects of taxation on labor supply. This in-class exercise gives them the opportunity to consider the effects of proposed tax rates on their own willingness to supply labor.
Instructions
Ask students to assume that they are full-time workers earning $10 per hour, $80 per day, $400 per week, $20,000 per year.
Ask them if they would quit their jobs or keep working if the tax rate was 10%, 20%, 30%,
… (up to 100%).
Keep a tally as they show hands indicating that they are leaving the labor force.
Ask students what they think the “best” tax rate is.
Points for Discussion
Many students have no idea that current marginal tax rates are greater than 30% for many taxpayers.
Students will likely say that a tax rate of zero would be best, but remind them that there would be no roads, libraries, parks, or national defense without at least some revenue raised by the government.
III. Deadweight Loss and Tax Revenue as Taxes Vary
Figure 6
A. As taxes increase, the deadweight loss from the tax increases.
B. In fact, as taxes increase, the deadweight loss rises more quickly than the size of the tax.
1. The deadweight loss is the area of a triangle and the area of a triangle depends on the square of its size.
2. If we double the size of a tax, the base and height of the triangle both double so the area of the triangle (the deadweight loss) rises by a factor of four.
C. As the tax increases, the level of tax revenue will eventually fall.
D. Case Study: The Laffer Curve and Supply-Side Economics
1. The relationship between the size of a tax and the level of tax revenues is called a Laffer curve.
2. Supply-side economists in the 1980s used the Laffer curve to support their belief that a drop in tax rates could lead to an increase in tax revenue for the government.
3. Economists continue to debate Laffer’s argument.
a. Many believe that the 1980s refuted Laffer’s theory.
b. Others believe that the events of the 1980s tell a more favorable supply-side story.
c. Some economists believe that, while an overall cut in taxes normally decreases revenue, some taxpayers may find themselves on the wrong side of the Laffer curve.
ALTERNATIVE CLASSROOM EXAMPLE:
Draw a graph showing the demand and supply of paper clips. (Draw each curve as a 45-degree line so that buyers and sellers will share any tax equally.) Mark the equilibrium price as $0.50 (per box) and the equilibrium quantity as 1,000 boxes. Show students the areas of producer and consumer surplus.
Impose a $0.20 tax on each box. Assume that sellers are required to “pay” the tax to the government. Show students that:
the price buyers pay will rise to $0.60.
the price sellers receive will fall to $0.40.
the quantity of paper clips purchased will fall (assume to 800 units).
tax revenue would be equal to $160 ($0.20 800).
Have students calculate the area of deadweight loss. (You may have to remind students how to calculate the area of a triangle.)
Show students that as the tax increases (to $0.40, $0.60, and $0.80), tax revenue rises and then falls, and the deadweight loss increases.
E. In the News: The Tax Debate
1. Recently, policymakers have debated the effects of increasing the tax rate, particularly on higher-income taxpayers.
2. These two opinion pieces from The Wall Street Journal present both sides of the issue.
Activity 2—Tax Alternatives
Type: In-class assignment
Topics: Taxes and deadweight loss
Materials needed: None
Time: 20 minutes
Class limitations: Works in any size class
Purpose
The market impact of taxes can be a new concept to many students. This exercise helps them think about the effects of taxes on different goods. Taxes that may be appealing for equity reasons can be distortionary from a market perspective.
Instructions
Tell the class, “The state has decided to increase funding for public education. They are considering four alternative taxes to finance these expenditures. All four taxes would raise the same amount of revenue.” List these options on the board:
1. A sales tax on food.
2. A tax on families with school-age children.
3. A property tax on vacation homes.
4. A sales tax on jewelry.
Ask the students to answer the following questions. Give them time to write an answer, and then discuss their answers before moving to the next question:
A. Taxes change incentives. How might individuals change their behavior because of each of these taxes?
B. Rank these taxes from smallest deadweight loss to largest deadweight loss. Explain.
C. Is deadweight loss the only thing to consider when designing a tax system?
Common Answers and Points for Discussion
A. Taxes change incentives. How might individuals change their behavior because of each of these taxes?
1. A sales tax on food: At the margin, some consumers will purchase less food. Overall food purchases will not decrease substantially because the tax will be spread over a large number of consumers and demand is relatively inelastic.
2. A tax on families with school-age children: No families would put their children up for adoption to avoid taxes. A large tax could have implications for family planning; couples may choose not to have children, or to have fewer children, over time. A more realistic concern would be relocation to other states by mobile families to avoid the tax.
3. A property tax on vacation homes: This tax would be concentrated on fewer households. A large tax would discourage people from buying vacation homes. Developers would build fewer vacation homes in the long run. In many areas, people could choose an out-of-state vacation home to avoid the tax.
4. A sales tax on jewelry: This tax would also be relatively concentrated. People would buy less jewelry, or they would buy jewelry in other states with lower taxes.
SOLUTIONS TO TEXT PROBLEMS:
B. Rank these taxes from smallest deadweight loss to largest deadweight loss.
Lowest deadweight loss—tax on children, very inelastic
Then—tax on food. Demand is inelastic; supply is elastic.
Third—tax on vacation homes Demand is elastic; short-run supply is inelastic.
Most deadweight loss—tax on jewelryDemand is elastic; supply is elastic.
C. Is deadweight loss the only thing to consider when designing a tax system?
No. This can generate a lively discussion. There are a variety of equity or fairness concerns. The taxes on children and on food would be regressive. Each of the taxes would tax certain households at much higher rates than other households with similar incomes.
Quick Quizzes
1. Figure 1 shows the supply and demand curves for cookies, with equilibrium quantity Q1 and equilibrium price P1. When the government imposes a tax on cookies, the price to buyers rises to PB, the price received by sellers declines to PS, and the equilibrium quantity falls to Q2. The deadweight loss is the triangular area below the demand curve and above the supply curve between quantities Q1 and Q2. The deadweight loss shows the fall in total surplus that results from the tax.
Figure 1
2. The deadweight loss of a tax is greater the greater is the elasticity of demand. Therefore, a tax on beer would have a larger deadweight loss than a tax on milk because the demand for beer is more elastic than the demand for milk.
3. If the government doubles the tax on gasoline, the revenue from the gasoline tax could rise or fall depending on whether the size of the tax is on the upward or downward sloping portion of the Laffer curve. However, if the government doubles the tax on gasoline, you can be sure that the deadweight loss of the tax rises because deadweight loss always rises as the tax rate rises.
Questions for Review
1. When the sale of a good is taxed, both consumer surplus and producer surplus decline. The decline in consumer surplus and producer surplus exceeds the amount of government revenue that is raised, so societys total surplus declines. The tax distorts the incentives of both buyers and sellers, so resources are allocated inefficiently.
2. Figure 2 illustrates the deadweight loss and tax revenue from a tax on the sale of a go
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