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10

CHAPTER

Positive Principles of

Taxation

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy

Randall Holco!e

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Randall Holco!e 10-2

Positive Principles of TaxationPositive Principles of Taxation

Concerns t"e effects of taxationConcerns t"e effects of taxation

#eneral principles t"at appl$ to all taxes#eneral principles t"at appl$ to all taxes

Not norativeNot norative

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Tax ShiftingTax Shifting

Unit taxUnit tax Tax c"ar%ed per &nit of a %ood exc"an%edTax c"ar%ed per &nit of a %ood exc"an%ed

Example:Example: ost ci%arette taxesost ci%arette taxes

'd valore tax'd valore tax Tax c"ar%ed !ased on t"e dollar val&e ofTax c"ar%ed !ased on t"e dollar val&e of

%oods sold%oods sold

Example:Example: retail sales taxretail sales tax

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A Unit Tax on SuppliersA Unit Tax on Suppliers

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A Unit Tax Placed onA Unit Tax Placed on

DemandersDemanders

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A Tax on Suppliers ersus aA Tax on Suppliers ersus a

Tax on DemandersTax on Demanders No difference ("et"er tax is placed onNo difference ("et"er tax is placed on

s&ppliers or deanderss&ppliers or deanders

Ultiate !&rden of a tax depends onUltiate !&rden of a tax depends onrelative elasticities of s&ppl$ and deandrelative elasticities of s&ppl$ and deand

Le%al assi%nent "as no ipact on taxLe%al assi%nent "as no ipact on tax

incidenceincidence

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A Tax on Suppliers ersus aA Tax on Suppliers ersus a

Tax on DemandersTax on Demanders

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Elasticities and Tax !ncidenceElasticities and Tax !ncidence

T"e ore elastic t"e sc"ed&le) t"e lar%erT"e ore elastic t"e sc"ed&le) t"e lar%er

t"e proportion of t"e tax t"at (ill fall ont"e proportion of t"e tax t"at (ill fall on

t"e ot"er side of t"e ar*ett"e ot"er side of t"e ar*et Elastic deand c&rve + lar%er proportionElastic deand c&rve + lar%er proportion

paid !$ s&pplierspaid !$ s&ppliers

Elastic s&ppl$ c&rve + lar%er proportion paidElastic s&ppl$ c&rve + lar%er proportion paid

!$ deanders!$ deanders

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Elasticities and Tax !ncidenceElasticities and Tax !ncidence

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Perfectl" Elastic or Perfectl"Perfectl" Elastic or Perfectl"

!nelastic Suppl"!nelastic Suppl" Perfectl$ inelastic s&ppl$Perfectl$ inelastic s&ppl$

' tax placed on deanders, (ill !e s"ifted' tax placed on deanders, (ill !e s"ifted

entirel$ to s&ppliersentirel$ to s&ppliers

Perfectl$ elastic s&ppl$Perfectl$ elastic s&ppl$ ' tax placed on deanders, (ill !e paid' tax placed on deanders, (ill !e paid

entirel$ !$ deandersentirel$ !$ deanders

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Perfectl" !nelastic Suppl"Perfectl" !nelastic Suppl"

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Perfectl" Elastic Suppl"Perfectl" Elastic Suppl"

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Shifts in the Tax #urdenShifts in the Tax #urden

Tax s"iftin% can !eTax s"iftin% can !e

ill&stratedill&strated

al%e!raicall$al%e!raicall$

Ratio of t"e slope ofRatio of t"e slope oft"e s&ppl$ c&rve tot"e s&ppl$ c&rve to

t"e slope of t"et"e slope of t"e

deand c&rvedeand c&rve

Q') )/(Q* P (P Q') P*)/(Q*(P

S

D

−−

−−

*

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The $elfare Cost of TaxationThe $elfare Cost of Taxation

'lso *no(n as:'lso *no(n as: Excess !&rden of taxationExcess !&rden of taxation

-ead(ei%"t loss of taxation-ead(ei%"t loss of taxation

'rises !eca&se taxpa$ers alter t"eir'rises !eca&se taxpa$ers alter t"eir

!e"avior in response to a tax!e"avior in response to a tax

Taxpa$ers are !etter off if t"e$ paid taxTaxpa$ers are !etter off if t"e$ paid tax(it"o&t alterin% !e"avior(it"o&t alterin% !e"avior

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The $elfare Cost of TaxationThe $elfare Cost of Taxation

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Excess #urden as a Cost ofExcess #urden as a Cost of

TaxationTaxation S"o&ld !e ta*en into acco&nt ("enS"o&ld !e ta*en into acco&nt ("en

calc&latin% total cost of taxationcalc&latin% total cost of taxation

Tax (it" ini& excess !&rden isTax (it" ini& excess !&rden is

optial fro an efficienc$ standpointoptial fro an efficienc$ standpoint

Minii.in% social cost + inii.in% excessMinii.in% social cost + inii.in% excess

!&rden!&rden

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%ump Sum Taxes%ump Sum Taxes

Copletel$ eliinates excess !&rden ofCopletel$ eliinates excess !&rden of

taxationtaxation Example:Example: one/s"ot "ead taxone/s"ot "ead tax

No a!ilit$ to c"an%e !e"aviorNo a!ilit$ to c"an%e !e"avior

-iffic&lt to appl$ in t"e real (orld-iffic&lt to appl$ in t"e real (orld

't odds (it" e0&it$ %oals't odds (it" e0&it$ %oals

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Excess #urden and !ndividualExcess #urden and !ndividual

ChoiceChoice Excess !&rden exists !eca&se a tax:Excess !&rden exists !eca&se a tax:

Ta*es t"e tax a(a$ fro t"e taxpa$erTa*es t"e tax a(a$ fro t"e taxpa$er

-isco&ra%es cons&ption of t"e taxed %ood-isco&ra%es cons&ption of t"e taxed %ood

Better off if tax did not distort relativeBetter off if tax did not distort relative

prices !et(een %oodsprices !et(een %oods

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Excess #urden and !ndividualExcess #urden and !ndividual

ChoiceChoice

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!nelastic %a&or Suppl" and the!nelastic %a&or Suppl" and the

$elfare Cost of an !ncome Tax$elfare Cost of an !ncome Tax Perfectl$ inelastic s&ppl$ c&rve + noPerfectl$ inelastic s&ppl$ c&rve + no

excess !&rdenexcess !&rden Ina!ilit$ to s&!stit&te o&t of ar*et isIna!ilit$ to s&!stit&te o&t of ar*et is

criticalcritical

Exaple: incoe tax and la!or s&ppl$Exaple: incoe tax and la!or s&ppl$

If inelastic s&ppl$ is !eca&se of offsettin%If inelastic s&ppl$ is !eca&se of offsettin%

incoe and s&!stit&tion effects) t"ere isincoe and s&!stit&tion effects) t"ere isstill an excess !&rdenstill an excess !&rden

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!nelastic %a&or Suppl" and the!nelastic %a&or Suppl" and the

$elfare Cost of an !ncome Tax$elfare Cost of an !ncome Tax

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Utilit" 'unctions and ExcessUtilit" 'unctions and Excess

#urden#urden 1or a tax to "ave not excess !&rden)1or a tax to "ave not excess !&rden)

t"ere &st !e no s&!stit&tion effectt"ere &st !e no s&!stit&tion effect

Individ&als cannot s&!stit&te a(a$ froIndivid&als cannot s&!stit&te a(a$ fro

relativel$ "i%"er price of taxed %oodrelativel$ "i%"er price of taxed %ood

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Utilit" 'unctions and ExcessUtilit" 'unctions and Excess

#urden#urden

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(inimi)ing the Excess #urden(inimi)ing the Excess #urden

of Taxationof Taxation #eneral a%nit&de of#eneral a%nit&de of

(elfare loss(elfare loss 23 to 45 cents of23 to 45 cents of

ever$ dollar raisedever$ dollar raised T"e Rase$ R&leT"e Rase$ R&le

Taxes s"o&ld !eTaxes s"o&ld !e

placed on %ood inplaced on %ood in

inverse proportion toinverse proportion toelasticit$ of deandelasticit$ of deand

for t"e %oodsfor t"e %oods

1221 // E E T T =

Example:Example:

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The Ramse" RuleThe Ramse" Rule

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The (arginal Cost of Pu&licThe (arginal Cost of Pu&lic

SpendingSpending T"e "i%"er %overnent spendin% is) t"eT"e "i%"er %overnent spendin% is) t"e

%reater (ill !e t"e cost of increased%reater (ill !e t"e cost of increased

%overnent spendin%%overnent spendin%

Excess !&rden rises (it" %overnent si.eExcess !&rden rises (it" %overnent si.e

Soe potentiall$ !eneficial pro6ects notSoe potentiall$ !eneficial pro6ects not

!eneficial at c&rrent level of %overnent!eneficial at c&rrent level of %overnent

o&tla$so&tla$s

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Additional Costs of the TaxAdditional Costs of the Tax

S"stemS"stem Copliance CostsCopliance Costs

'dinistrative Costs'dinistrative Costs

Political CostsPolitical Costs

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Earmar*ed TaxesEarmar*ed Taxes

Reven&es are desi%nated to a specificReven&es are desi%nated to a specific

activit$activit$ Example:Example: Social Sec&rit$ pa$roll taxSocial Sec&rit$ pa$roll tax

Most &sed at local %overnent levelMost &sed at local %overnent level

'lternative: %eneral f&nd financin%'lternative: %eneral f&nd financin%

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Advantages and DisadvantagesAdvantages and Disadvantages

of Earmar*ingof Earmar*ing -isadvanta%es-isadvanta%es

Lac* of 1lexi!ilit$Lac* of 1lexi!ilit$

'dvanta%es'dvanta%es Better opport&nit$ to receive level of o&tp&tBetter opport&nit$ to receive level of o&tp&t

t"e$ find satisfactor$t"e$ find satisfactor$

Reoves discretion fro la(a*ersReoves discretion fro la(a*ers

Ma*e transparent "o( &c" taxpa$ers pa$Ma*e transparent "o( &c" taxpa$ers pa$

for an activit$for an activit$

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