Payroll Tax • An Ad Valorem Tax • Statutory distinction between employers and employees is irrelevant. • Economic incidence depends on elasticity of Supply and Demand. • e.g.: If labor supply is perfectly inelastic workers pay all of tax regardless of statutory incidence.
Capital Taxation • Like other taxes--Draw S & D, statutory incidence determines which curve moves. • Shift if unit tax. • Pivot if ad valorem tax. • Open Economy: Normal S & D • owners of capital will bear part of tax • Open Economy, perfectly mobile capital: S is perfectly elastic. • Capitalists bear no tax. • Generally, the more open the economy the better able capitalist are to avoid tax.
Tax on Monopoly • Previously looked at competitive models. • Unit tax on good sold by monopolist. • Shifts D & MR down by amount of tax. • Leads to decrease in quantity. • Consumers pay more, monopolist nets less. • Profits shrink. • Despite its power, monopolists can suffer from taxation.
Taxation of Oligopolist • Incidence depends on how prices change. • Economists don’t have a single, generally accepted model of how oligopolists set prices. • Therefore, economists are uncertain about tax incidence under oligopolies. • However, for an oligopolist the best thing they can do is form a cartel and increase there profits by acting like a monopolist. (restrict Q, increase P) • To the extent taxes cause oligopolies to cut back on output, they move closer to the cartel solution. This causes their before-tax profits to increase--perhaps by enough to completely offset the burden of the tax.
Profit Taxes • Remember Economic profits are supranormal or excess accounting profits. • A profit tax has no affect on MR or MC. • Thus the firm won’t change Q or P. • Therefore, profit taxes are completely absorbed by firms. • With no economic distortions, the tax is efficient. • May be hard to implement because you would need to determine normal profits.
Land Taxes and Capitalization • Land is durable and fixed in supply. • In competitive markets the price of land should reflect the present value of a stream of after-tax rents. • When the tax is imposed the price of land falls by the PV of all future tax payments. • This process is called capitalization. • The burden of the tax forever is on whoever owns the land at the time the tax is announced
General Equilibrium • Have been looking at only one market--partial equilibrium. • Now want to look at how, for example, a tax in the auto industry will affect the markets for steel and beer. • To keep it simple we will look at a world where there is no savings and only two commodities (food and manufactures) and two factors of production (capital and labor).
Different Taxes • Partial Factor taxes: • tKF = tax on capital used to make food. • also: tKM, tLF, tLM. • Factor taxes: • tK, tL • Consumption tax: • tF, tM • Income tax: • t
Tax Equivalence • Any two sets of taxes that generate the same change in relative prices have equivalent incidence effects. • A tax on both goods is the same as an income tax. • A tax on both factors in an industry is the same as a consumption tax on that industry. • A partial factor tax on one factor in both industries is the same as a general factor tax.
Harberger Model • Assumptions: • Constant Returns to Scale • One industry is capital intensive the other labor intensive. • Perfect factor mobility • Competitive profit maximizers • Fixed amount of capital and labor • Consumers have identical preferences. • Look at differential tax incidence
A Commodity tax: tF • Increases relative price of food, people buy less food, more manufactures. • Some of the K & L used in food production goes into manufactures production. • If food is relatively more capital intensive, then the only way the manufacturing sector will absorb lots of capital is if the price of capital falls in both sectors. • More generally, a tax on the output of a particular sector will hurt all of the suppliers of the input used intensively in that sector.
Commodity Tax (cont.) • Things which increase the damage done to capitalists by a tax on food. • The more elastic the demand for food. • The greater the difference in K/L ratios between the food and manufactures sectors. • The harder it is to substitute capital for labor in the manufactures sector. • Because capitalists and laborers have identical preferences, we don’t need to look at the tax effects on the uses side of the budget.
Other Taxes • Income Tax (t): Factor supplies are by assumption fixed. Thus, this tax burden cannot be shifted. The burden falls in proportion to people’s incomes. • Tax on Labor (tL) Since both sectors are taxed, labor won’t migrate between sectors. Since labor supply is fixed (inelastic), workers bear full burden of tax
Partial Factor Tax (TKM) • Output Effect: The price in the taxed sector (manufactures) will rise causing a decrease in the quantity demanded by consumers • Will decrease the relative price of the intensively used factor • Factor Substitution Effect: The price on the taxed factor (capital) will increase causing the manufacturing sector to use less capital and more labor. • If Manufacturing is capital intensive, both effects work in the same direction, and the relative price of capital must fall. If Manufacturing is labor intensive, the net result is theoretically ambiguous. This partial factor tax could actually hurt labor. • Hurts capital as long as labor can be substituted for capital
Changing the Assumptions • Different Consumer tastes: Affects distribution on uses side. • For example, if capitalists consume a lot of manufactures and these goods are labor intensive, then a tax on capital may hurt labor. • Mobility of Factors: If a factor is immobile, the taxed factor will bear the entire burden of a partial factor tax. It cannot escape the tax by migrating to another sector. • Variability of factors: If factors are variable, then in the long run, less of the taxed factor will be supplied. • For example, if capital is taxed, less will be supplied in long run, this will increase returns to capital, and weaken the returns to labor. That is, in the long run, some of the tax can be shifted onto labor.