9 - Tax incidence and efficiency costs of taxation

Question 1

what is tax incidence

Answer 1

the effect of a tax on prices and the distribution of economic welfare

• changes in economic equilibria when taxes change
• what policy maximises welfare

Question 2

what is legislative/statuatory incidence

Answer 2

who is required by law to pay the tax

Question 3

what is economic incidence

Answer 3

who faces the burden of the tax

Question 4

what is the difference between an excise tax and ad-valorem tax

Answer 4

• excise tax = levied on a quantity
  ($1 per pack)
• ad valorem = fraction of prices (5% sales tax)

Question 5

what are the 2 different prices faced by consumers and producers when tax introduced

Answer 5

producer - p
consumer - pc = p + t

Question 6

when do consumers bear the entire tax burden

Answer 6

• ed = 0
• inelastic demand
• es = infinity
• perfectly elastic supply

Question 7

when do producers bear the entire burden of tax

Answer 7

• es = inelastic supply
• ed = perfectly elastic demand

Question 8

what is the general rule for who bears the burden of the tax more

Answer 8

more inelastic factor bears more of the tax

Question 9

what is deadweight burden

Answer 9

the welfare loss

• change in CS + PS
• individuals and firms making inefficient consumption and production choices to avoid taxation

Question 10

what is the size of DWL related to

Answer 10

the extent which C and P change their behaviour to avoid tax

Question 11

under what circumstances will a tax change not have any efficiency costs
- no DWL

Answer 11

• when the quantity doesnt change
• when demand is inelastic

Question 12

what is DWB relationship with elasticities

Answer 12

DWB increases with absolute sixe of elasticities

Question 13

taxing which types of goods is more efficient - has lowest DWL

Answer 13

best to tax inelastic goods
- less DWL

Question 14

what are the 3 factors that will increase DWL?

Answer 14

1. larger absolute elasticities of supply/demand
2. the size of tax
   - small taxes = relatively small efficiency costs
3. pre-existing distortions
   - already existing tax

Question 15

Oates (2015)
what did they find

Answer 15

• find evidence of bunching below notches
• taxes on window
• see how the number of windows changes
• the more elastic agents = the higher the welfare cost - the more responsive

Question 16

what is the most efficient way to decide how to tax different goods that raise a given amount of revenue while minimising DWL to an individual

Answer 16

• Ramsey tax rule

Question 17

what is the Ramsey tax rule

Answer 17

optimum tax rate such that marginal DWL for last dollar of tax collected is the same across all goods

• tax inelastic demand goods more

Question 18

why is uniform tax rates less efficient than ramsey tax rule

Answer 18

• uniform = more elastic goods will generate larger efficiency costs
• better to tax more the inelastic goods

Question 19

Benzarti (2020)
what did they test and do

Answer 19

want to test the effects of VAT rates increasing and decreasing
- what happened with tax incidence of VAT cut

• Finland got VAT cut of 14 points in jan 2007, that was repealed in 2012
• diff in diff
• analysis of prices of treatment (hairdressers) + control (beauty salons)

Question 20

Benzarti (2020)
what did they find

14% tax cut

Answer 20

• when tax cut 2007
• tax incidence was 50-50 between hairdressers and consumers
• hairdressers pocket 7%
• consumers face 7% lower prices
• when tax cut increased by 14% again
• hairdressers pass all of tax increase to consumers
• full tax incidence on consumers
• prices end up higher than the control in the end

Question 21

what can explain asymmetries

Answer 21

asymmetries between tax cut and tax increase

why: consumers are inattentive to taxes, so producers can pocket tax decreases, and justify tax increases to consumers

Question 22

what are the 3 goals governments have in mind when cutting taxes VAT

Answer 22

1. decrease P and increase D
2. increase cash flow/profits
3. increase wages

Question 23

why does tax incidence make government policies hard

Answer 23

• governments might try and target consumers
• but producers take the incidence of the tax cut
• so tax cut reform doesnt end up helping consumers at all

Question 24

what does tax incidence depend on

Answer 24

determined by relative magntitude of demand and supply elasticities

• limits gov policies

Question 25

can governments affect tax incidence

Answer 25

yes
- they can through using madates and monitoring systems
- but the mandates are hard to implement and enforce
- and unexpected incidence effects mean may not target the right people

Benzarti & Tortarolo (2022)

Question 26

Benzarti and Tortarolo (2022)

what do the do
what are they testing

Answer 26

• test if government can affect tax incidence through mandates
• exploit large and temporary VAT cut on 13 categories of basic food in Argentina supermarkets
• look at small and large chains
• uses price monitoring in large supermarkets

Question 27

Benzarti and Tortarolo (2022)

what do they find

Answer 27

how much of tax cut was passed through as lower prices to consumers
- large supermarket = 85%
- small supermarket = 35%
* gov was successful at engineering price decreases

• after VAT increased - for small stores price increased above og value, for large stores prices fell
• low income hhs shop more at small supermarkets - so really this VAT cut did not effect them that much (targeted group) = unexpected effects

Question 28

how does adding salience into tax incidence formula change things?

if pheta = 0
if pheta = 1

Answer 28

1. 0 –> producers tax incidence is 0
   - all burden on consumers
2. 1 –> tax incidence depends on elasticities

Question 29

what does
pheta = 0
pheta = 1
mean

Answer 29

0 = consumers are not salient - not attentive of taxes

1 = consumers are fully attentive

Question 30

what are the 2 methods to test whether salience matters for sales tax incidence

Answer 30

1. randomised field experiment
2. policy experiment

Question 31

Chetty (2009)
- salience and sales tax

what did they do
randomised field experiment

Answer 31

• treatment store = display price tags with sales tax and total price - for a subset of products
• control = products in the treated store
• diff in diff
• repeat analysis in control stores as placebo DD strategy
• if we see that sales go down - then increased salience = reduce demand - but condusion playing role??

Question 32

Chetty (2009)
- salience and sales tax

what did they do

policy experiment

Answer 32

• compares tax changes made to beer exicses and sales tax of equal size
• change in beer excise and sales taxes across US
• posted price on tag = salient
• tax added at till = not salient

Question 33

Chetty (2009)
- salience and sales tax

what did they find
policy experiment

beer consumption

Answer 33

find that salience matters
- the more salient the tax - behaviours change = demand changes

• beers excise states
• states that increased tax - see lower demand
• states that decreased tax - see higher demand

only seen for beer

• equally big changes in tax for sales tax rate dont see change in demand

Question 34

how does salience of consumers relate to DWL

Answer 34

• the less salient they are
• the less elastic they are - less responsive
• more likely to take on the tax burden
• less DWL

Question 35

what does posting the sales tax do to demand

Answer 35

decrease demand if sales tax increases

Question 36

what is general equilibrium tax incidence

Answer 36

how does imposing tax in one market effect other markets