Tax Incidence

1. Tax Incidence

2. Categories of Taxes • Regressive Taxes: tax the poor more than the rich, in terms of percentage of income (e.g., sales tax) • Progressive taxes: tax the rich more than the poor, in terms of percentage of income (e.g., a graduated income tax) • Proportional tax: taxes the same percentage, regardless of income (“flat tax”) • Received benefit taxes: tax only those people who benefit from the service (e.g., road tax charged to car owners for vehicle licenses) • Taxes to address market failure or discourage purchase of demerit goods

3. Types of Taxes • Personal Income Taxes • Tax on calculated income • Taxable income calculated sources of income and deductions • In US, most sources of income mail annual statements to citizens (W2, 1099 forms etc.) • Marginal rates increase with income • Property Taxes • Typically local taxes levied on assessed value • Typically seen as progressive, because most poor do not own property • Sales Taxes • Fixed percentage on sales. In US, local and state. • Poor pay large percentage of income because. • Excise Taxes • Imposed on specific items, often to discourage consumption • Payroll taxes fund Social Security and Medicare

4. Tax Incidence • For sales and excise tax, key question: when tax is applied, who will pay it? • If producers pass entire tax on to consumers, consumers may stop buying product • If producers pay all tax, producers may stop producing product • Elasticity of S & D shows us the compromise

5. Tax Incidence Analysis • Elasticity of S & D determine tax incidence • Determine tax incidence by • Placing vertical line equal to tax amount as wedge into S&D • Noting resulting change in P • If ΔP > half of tax, the most of tax falls on consumer • If ΔP < half of tax, the most of tax falls on supplier • Elastic S places greater incidence on consumer • Elastic D places greater incidence on seller