Post on 03-Jan-2016
Chapter 6
Taxation & Government Intervention
Adjust for Undesired Market Results
A progressive tax is one whose rates increase as a person's income increases.
Canadian income tax is an example.
A regressive tax is one whose effect decreases as income rises.
Canadian sales tax is an example.
Adjust for Undesired Market Results
A proportional tax is one whose rates are constant at all income levels, regardless of the taxpayer's total annual income.
Adjust for Undesired Market Results
Demerit goods and activities are those considered to be bad for a person, although one may like them.
Addictive drugs are a demerit good; using addictive drugs is a demerit activity.
Adjust for Undesired Market Results
Merit goods and activities are things believed to be good for a person, although one may not engage in them.
Motorcycle helmets are a merit good; using helmets while driving a motorcycle is a merit activity.
Market Failures and Government Failures
Market failures are reasons for government intervention.
Market failures are situations where the market does not lead to a desired result.
Market Failures and Government Failures
Government intervention, however, need not improve the outcome.
Government failures are situations where the government intervenes and makes the situation worse.
Costs of Taxation
The costs of taxation include:The direct cost of the revenue paid to
governmentThe loss of consumer and producer surplus
caused by the taxThe administrative costs of collecting the
tax.
Costs of Taxation
The welfare loss triangle – a geometric representation of the welfare loss in terms of misallocated resources caused by a deviation from a supply-demand equilibrium.
Costs of Taxation
S1
P1–t
Quantity
Price
P0
Q0
P1
Q1
Producer surplus
S0
Demand
Consumer surplus
Deadweight loss
tax
A
B C
D E
F
Benefit Principle
The benefit principle states that the individuals who receive the benefit of the good or service should pay the cost (opportunity cost) of the resources used to produce the good.
Examples are gasoline taxes and airport taxes, both paid by travelers.
Ability-to-Pay Principle
The ability-to-pay principle –individuals who are most able to bear the burden of the tax should pay the tax.
The best example of this is a progressive tax, such as the Canadian income tax.
Applying the Principles of Taxation
Burden Depends on Relative Elasticity
The person who physically pays the tax is not necessarily the person who bears the burden of the tax.
The burden of the tax depends on relative elasticity.
The burden of the tax is rarely shared equally since elasticities are rarely equal.
Who Bears the Burden of a Tax?
590
Pric
e of
luxu
ry b
oats $70,000
60,000
50,000
40,000
30,000
20,000
10,000
Quantity of luxury boats 600200 400
S1
S0
Demand is inelastic.
Demand
taxConsumer pays
Supplier pays
Who Bears the Burden of a Tax?
Inelastic Demand and Incentives to Restrict Supply
When demand is inelastic, producers have incentives to lobby the government to restrict supply.
Farming is a good example.
Advances in productivity increase supply but they result in lower prices.
Long-Run Problems of Price Controls
In the long run, supply and demand tend to be much more elastic than in the short run.
Therefore, price controls will cause large shortages or surpluses in the long run.
Long-Run and Short-Run Effects of Price Controls
P0
Q0
P1
Q1
P2
Q2 Q3
Short run supply
D0
Quantity
Price
Long run supply
D1
Price ceiling
Shortage