Lecture 5(i)Announcements

Midterm Covers through Lec5(ii) Practice midterm at Moodle (look at it before recitation sections this week)

Question and Answer Sessions Wed: 4-5:30pm (Anderson 210)Wed: 7:30-9pm (Anderson 210)Thur: 3:30-5pm (Anderson 210)

My Office Hours This Weeko Wed 1:30-3:25 (usual)o Thur: 1:30-2:30 (extra)

Large Lectures (Wiley 175) cancelled this Friday.

Next Mon (Oct 9), go to evening midterm, 7-8pm instead of lecture. Room locations posted at Moodle

Bring #2 pencils and University IDDon’t Bring: Calculators and Scratch Paper.

Lecture1. More on tax rates2. Price Controls

Key Principle in Economics:Look at Incentives at the Margin

When talking about incentive effects of taxes, we look at themarginal tax tate

Rate paid on last dollar earned.

Key rate used in decision making

A word about federal taxation of corporations:U.S. statutory rate: 35 percentHigh compared to other countries.

However, there are all sorts of credits and deductions. (Many corporations pay nothing). Average tax collected more like 15 percent.

A key feature of the new tax proposal is that the statutory rate is lowered to 20 percent. However, many tax preferences remain. My reading of the situation is that the tax cut will result in a significant decline in tax revenue from corporations.

There are also proposed changes in personal income tax. Let’s see how the proposed changes might affect taxes in a few example cases.

Case 1: GoldieSuppose wage is 10,000Current system:Standard deduction (6,000)+1 exemption (4,000)No federal income tax!

but

pays social security and medicare

can make case labor bears burden of employer contribution .

Marginal Tax rate = 15.3 (percent)= sum of employee+employer shares of soc. sec +medicare tax

Proposed tax changestandard deduction is doubled to 12kbut exemption gone.Bottom rate is 12 percent, not 10.

No effect if Goldie makes 10,000

What about if he makes 20,000?Before, pay 10% above 10,000 = $1,000

Now, pay 12% above 12,000= $910. Savings of $90! Hurray!

Gary Cohn (Trump economic advisor) “family making about $100,000 can expect a tax cut of $1,000…can renovate their kitchen, can buy a new car.” LOL

Plan also takes away state income deduction. (and the $4,000 exemption just noted)

People filing returns with itemized deductions in high tax states (California, New York, and Minnesota) could very well pay more in taxes under the plan.

Case 2: Steph CurrySalary $35,000,000 year

Marginal Rate under current system:

39.6 (Federal income tax)

+ 8.0 (CA highest rate is 13.3, but is offset by deducting it on his federal return)

+ 2.9 (Medicare)+ 0.9 Medicare surchare

= 51.4 percent

Proposed plan

35.0 (Federal income tax)

+ 13.3 state (can’t deduct it)

+ 2.9 (Medicare)+ 0.9 Medicare surchare

= 52.1 percent

(and even higher if the highest new marginal rate goes above 35.0)

But don’t feel too bad for Steph!

1. Estate tax (40% on estates above $11 million for couple) is eliminated

2. Business incomeHe has endorsement income said to be more than $35 million year.

Probably has it set up as a limited liability corporation (LLC) where profits pass through directly to Steph. (Without pass through the money gets taxed twice: first the corporate tax, and then personal income tax when the money goes to Steph as a dividend.)

Current pass through rate for Steph is 39.6 percent

Proposed plan: it is 25 percent!

What is happening with pass through is the biggest story of the proposed tax changes.It will blow up the budget.

3. Alternative minimum tax gone.

2. Price Controls

Price Ceiling Pceiling

Regulation: P ≤ Pceiling

Examples?

Price Floor Pfloor

Regulation: P ≥ Pfloor

Examples?

Key point: With price controls market quantity is minimum of supply and demand.

Binding price ceiling

→ Excess Demand

Binding price floor

→ Excess Supply

Look at the Market for Uber Rides

Uber has a usual fare for an area.

Also has “surge pricing”

Market For Rides in Nightlife Area

Ban surge pricing altogether?Bill introduced in New York legislature

Q

$

D9PM

S

D2AM

Outcome: Still have surge pricing for everyday kinds of things

If a natural disaster, put a cap (equal to some highest rate past month)

Also, Uber donates money it gets during disasters to a charity.

Good politics

Impact on Consumer Surplus of Price Ceiling in EconlandLaw in EconLand: Illegal for anyone to sell widget for more than $3.

At ceiling price of $3:QD =7 QS = 3

QCeiling = minimum of QD and QS

= 3

Producer Surplus easy to calculate(All sellers who want to sell are able to sell). So we use normal rule of calculating area under the PS line (the price producers get) and above the supply curve.

Easy to calculate ∆PS

Change in PS from $3 ceiling

What is CS?It depends

There are 7 people who want a widget (D1, D2, D3, D4, D5, D6, D7), but only 3 are for sale. CS depends on who gets the widgets because they differ in willingness to pay.

CS under the price ceiling is

NOT THIS!

3 widgets consumed, not 7!

One Extreme: Case 1Perfectly Efficient RationingHighest value consumers get the widgets (rationing goes their way)

CS = _______

For this extreme case, how does consumer surplus compare with its level in the free market?

Lesson:

What about overall total surplus?

Opposite Extreme: Case 2Perfectly Inefficient RationingLowest Value Consumers that want widget get it. CS is much lower!

CS = _______

Something in between?Uniform Rationing (likelihood of getting good unrelated to willingness to pay)

What if D2, D4, and D6 get widget?

Case 3: Uniform Rationing

CS = ______

Review price ceiling in Aplia experiment from last week.

Rationing in ApliaLand

What case is most relevant?