Public Choice Theory and the Economics of Taxation

1. Public Choice Theoryand the Economics of Taxation Chapter 17

2. Revealed preference through voting • Voters vote individual preferences • favors outcomes where large benefits are received by minorities, at low cost to the majority • Voters will vote against measures that have negative net benefits for the majority, but may have positive net benefits overall • Voters will vote for measures that have positive net benefits for the majority, but may have negative net benefits overall

4. Voters as interest groups • Where benefits are concentrated, there is an incentive to lobby and provide campaign contributions to achieve political ends • No opposing counterweight if costs are not similarly concentrated • We all end up paying for many programs which only benefit such interest groups • Logrolling can partly undo this bias

7. Median voter model • The median voter is the one whose preferences are realized in public policy • Most voters will be dissatisfied, because a clear majority will desire either more or less government, taxes, services, etc. • These groups will generally cancel out

8. Tax apportionment • Benefits-received principle—charge user fees • Ability-to-pay principle—progressive income tax • Progressive tax—average tax rate increases with income—becomes a higher absolute amount and a higher percentage of total income, as income increases • Regressive tax—average tax rate falls with higher income—becomes a higher absolute amount, but a lower percentage of income, as income increase • Proportional tax—average rate remains the same as income rises or falls—tax increases absolutely with higher income

9. Examples • Income tax—progressive 10 – 35% • Sales tax—highly regressive, though some exempt items (food, and in some states, small purchases of clothing) are designed to mitigate this effect • Corporate income tax—proportional, but proprietorships, partnerships, and closely-held corporations are exempt • Payroll taxes (Social Security & Medicaid)—regressive because high levels of payroll income, and all non-wage income is exempt • Property taxes—regressive like sales tax

10. Tax incidence and efficiency loss • Excise taxes are jointly borne by producers and consumers, depending on demand and supply elasticities • They also result in deadweight loss • Producer and consumer surplus which is completely wiped out and not captured by the government

13. Demand elasticity and sales tax incidence • The more elastic demand (the flatter the demand curve), the more tax incidence (for an excise or sales tax on a particular product) is shifted to producers, because consumers buy significantly less in response to the higher after-tax price • The less elastic demand (the steeper the demand curve), the more the tax burden is carried by consumers, who buy nearly the same quantity regardless of the after-tax price

15. Supply elasticity and tax incidence • The more elastic supply (the flatter the supply curve), the more of the tax burden is paid by consumers • The less elastic supply (the steeper the supply curve), the more the tax burden is paid by producers.

17. Goals for taxation • Government revenue • Income redistribution • Rich to poor • Poor to rich • Their party to my party • Reduce negative externalities • E.g., excise taxes on products with negative externalities

20. U.S. tax incidence • Federal taxes are generally progressive • State and local taxes are generally less so, often being highly regressive • Overall, U.S. taxes are mildly progressive, but this varies from state to state, and even among municipalities within a given state