Economics for your Classroom
Ed Dolan’s Econ Blog
Who Really Pays Taxes?
The Question of Tax Incidence
June 21, 2014
Terms...
Who Really Pays Taxes?
 Governments have been collecting taxes
since the dawn of history, but there is still
confusion ov...
Example 1: A gasoline tax
 Suppose that in the state of
Virginia, there is initially no
gasoline tax
 The gasoline marke...
Elasticity of Supply and Demand
 The elasticity of supply and
demand will play an important part
in our story
 Elasticit...
Effect of a $1 per Gallon Tax on the Supply Curve
 Now suppose the state imposes a
$1 per gallon tax
 Sellers will be wi...
Effects of a $1 per Gallon Tax on Quantity Supplied and Demanded
 The tax will affect the choices
made by buyers as well ...
New Equilibrium After the Tax
 Consumers will continue to move
along their demand curve until they
reach point E2, where ...
Incidence of the Gasoline Tax
 In the new equilibrium, total tax
revenue will be $8 million per day,
equal to the area of...
Example 2: A tax on apartment rents
 For our second example,
consider the market for rental
apartments in a small city
 ...
Elasticity of Supply and Demand
 Compared with the market for
gasoline, demand is more elastic,
because owning a house or...
Effect of a $250 tax on the Supply Curve
 Now suppose the city imposes a
$250 per month on apartment
rentals
 Owners wil...
Effects on owners and renters
 The tax will affect the choices
made by renters as well as
owners
 As owners attempt to p...
Equilibrium after tax
 Renters will continue to move
along their demand curve until
they reach point E2, where the
quanti...
Incidence of the Rental Tax
 In the new equilibrium, total tax
collected by the government will
be $400,000 per month, eq...
Conclusions
 The incidence of a tax depends on the
relative elasticity of supply and demand
 If supply is more elastic t...
Click here to learn more about Ed Dolan’s Econ texts
or visit www.bvtpublishing.com
For more slideshows, follow Ed Dolan’s...
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Who Really Pays Taxes? The Question of Tax Incidence

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Who really pays taxes? This sideshow explains why the person who is legally obligated to pay them is not always the person who bears the economic burden

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Who Really Pays Taxes? The Question of Tax Incidence

  1. Economics for your Classroom Ed Dolan’s Econ Blog Who Really Pays Taxes? The Question of Tax Incidence June 21, 2014 Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.
  2. Who Really Pays Taxes?  Governments have been collecting taxes since the dawn of history, but there is still confusion over who really pays them  The question of tax assessment tells us who bears the legal responsibility for paying a given tax.  The question of tax incidence tells us who bears the economic burden of a tax  This slideshow will explain why the answers to these two questions are not the same June 21, 2014 Ed Dolan’s Econ Blog Sign on an abandoned gasoline pump: 29.9 cents per gallon, all taxes included
  3. Example 1: A gasoline tax  Suppose that in the state of Virginia, there is initially no gasoline tax  The gasoline market is in equilibrium at point E1, where the price is $2 per gallon and the quantity sold is 10 million gallons per day June 21, 2014 Ed Dolan’s Econ Blog
  4. Elasticity of Supply and Demand  The elasticity of supply and demand will play an important part in our story  Elasticity means the percentage change in quantity associated with a 1 percent change in price  Notice that in the neighborhood of the equilibrium point, supply is more elastic than demand, that is, a 1 percent change in price would cause a larger percentage change in the quantity supplied than in the quantity demanded June 21, 2014 Ed Dolan’s Econ Blog
  5. Effect of a $1 per Gallon Tax on the Supply Curve  Now suppose the state imposes a $1 per gallon tax  Sellers will be willing to supply the same quantity as before only if they can raise the price including tax by $1  That means the tax-inclusive supply curve shifts upward by $1, from S1 to S2  The old supply curve S1 shows what is left for sellers after the tax is paid June 21, 2014 Ed Dolan’s Econ Blog
  6. Effects of a $1 per Gallon Tax on Quantity Supplied and Demanded  The tax will affect the choices made by buyers as well as sellers  As sellers attempt to pass the tax along, consumers will move up and to the left along the demand curve, reducing the quantity demanded  As buyers purchase less gasoline, sellers will move down and to the left along S1 June 21, 2014 Ed Dolan’s Econ Blog
  7. New Equilibrium After the Tax  Consumers will continue to move along their demand curve until they reach point E2, where the quantity demanded at the price including tax equals the quantity supplied  In the new equilibrium, the price, including tax, will be $2.80 and the quantity will fall to 8 million gallons per day  The price received by sellers, after the tax is paid, will fall to $1.80 June 21, 2014 Ed Dolan’s Econ Blog
  8. Incidence of the Gasoline Tax  In the new equilibrium, total tax revenue will be $8 million per day, equal to the area of the entire shaded rectangle ABFE  Consumers will bear 80% of the burden ($6.4 million), equal to the blue shaded area ABDC, because the price they pay including tax has gone up by 80 cents  Sellers will bear 20% of the burden ($1.6 million), equal to the tan area CDFE, because the price they receive after the tax is paid goes down by 20 cents June 21, 2014 Ed Dolan’s Econ Blog
  9. Example 2: A tax on apartment rents  For our second example, consider the market for rental apartments in a small city  In equilibrium 2,000 apartment units are rented at a rental price of $500 per month June 21, 2014 Ed Dolan’s Econ Blog
  10. Elasticity of Supply and Demand  Compared with the market for gasoline, demand is more elastic, because owning a house or condominium is a good substitute for renting an apartment  The supply is less elastic. An increase in rents will make a few more apartments available, but not very many, at least in the short run June 21, 2014 Ed Dolan’s Econ Blog
  11. Effect of a $250 tax on the Supply Curve  Now suppose the city imposes a $250 per month on apartment rentals  Owners will be willing to supply the same quantity as before only if they can raise the rent including tax by $250  That means the tax-inclusive supply curve shifts upward by $250, from S1 to S2  The old supply curve S1 shows what is left for owners after the tax is paid June 21, 2014 Ed Dolan’s Econ Blog
  12. Effects on owners and renters  The tax will affect the choices made by renters as well as owners  As owners attempt to pass the tax along, renters will move up and to the left along the demand curve, reducing the quantity demanded  As occupancy of rental apartments decreases, owners will move down and to the left along S1 June 21, 2014 Ed Dolan’s Econ Blog
  13. Equilibrium after tax  Renters will continue to move along their demand curve until they reach point E2, where the quantity demanded at the price including tax equals the quantity supplied  In the new equilibrium, the rent, including tax, will be $550 and the number of apartments occupied will decrease to 1,600 units  The rental price per month received by owners, after the tax is paid, will fall to $300 June 21, 2014 Ed Dolan’s Econ Blog
  14. Incidence of the Rental Tax  In the new equilibrium, total tax collected by the government will be $400,000 per month, equal to the area ABFE  Renters will bear 20% of the burden, or $80,000 per month, equal to the area ABDC, because the price they pay including tax has gone up by $50  Owners will bear 80% of the burden, or $320,000 per month, equal to the area CDFE, because the price they receive after the tax is paid goes down by $200 June 21, 2014 Ed Dolan’s Econ Blog
  15. Conclusions  The incidence of a tax depends on the relative elasticity of supply and demand  If supply is more elastic than demand, more of the economic burden of the tax will be born by customers than by suppliers  If demand is more elastic than supply, more of the burden will be born by suppliers than by customers  If demand and supply are equally elastic, the economic burden of the tax will be divided equally June 21, 2014 Ed Dolan’s Econ Blog
  16. Click here to learn more about Ed Dolan’s Econ texts or visit www.bvtpublishing.com For more slideshows, follow Ed Dolan’s Econ Blog Follow @DolanEcon on Twitter

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