6: cost of taxation Flashcards
WHICH GOODS OR SERVICES SHOULD GOVT TAX
TO RAISE THE REVENUE IT NEEDS?
THOSE WITH THE SMALLEST DWL.
WHEN IS THE DWL SMALL VS. LARGE?
TURNS OUT IT DEPENDS ON THE PRICE ELASTICITIES
OF SUPPLY AND DEMAND.
WHAT DETERMINES THE SIZE OF THE DWL?
THE PRICE ELASTICITY OF DEMAND (OR SUPPLY) MEASURES HOW MUCH QD (OR QS) CHANGES
WHEN P CHANGES.
WHEN SUPPLY
IS INELASTIC,
IT’S HARDER FOR FIRMS
TO LEAVE THE MARKET
WHEN THE TAX REDUCES
PS
SO, THE TAX ONLY
REDUCES Q A LITTLE,
AND DWL IS SMALL.
The more elastic is supply,
the easier for firms
to leave the market when
the tax reduces PS
the greater Q falls below the
surplus-maximizing quantity,
the greater the DWL.
When demand
is inelastic,
it’s harder for consumers to
leave the market when the tax
raises PB
So, the tax only reduces Q a
little, and DWL is small.
The more elastic is demand,
the easier for buyers to leave the
market when the tax increases
PB
the more Q falls below the
surplus-maximizing quantity,
and the greater the DWL.
A BIGGER GOVERNMENT PROVIDES MORE SERVICES,
BUT REQUIRES HIGHER TAXES, WHICH CAUSE DWLS.
THE LARGER THE DWL FROM TAXATION,
THE GREATER THE ARGUMENT FOR SMALLER GOVERNMENT.
THE TAX ON LABOR INCOME IS ESPECIALLY IMPORTANT; IT’S THE BIGGEST SOURCE
OF GOVT REVENUE.
MARGINAL TAX RATE
(THE TAX ON THE LAST DOLLAR OF EARNINGS) IS ABOUT 40%.
HOW BIG IS THE DWL FROM THIS TAX?
IT DEPENDS ON ELASTICITY….
IF LABOR SUPPLY IS INELASTIC, THEN THIS DWL IS SMALL.
Welfare without a tax
the equilibrium price and quantity are found at the intersection of the
supply and demand curves.
Welfare without a tax
- The demand curve reflects buyers’ willingness to pay, consumer surplus is the area between
the demand curve and the price, A + B + C - The supply curve reflects sellers’ costs, producer surplus is the area between the supply
curve and the price, D + E + F