public finance

1. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 1 of 36
19.5 Conclusion
The Equity Implications of Taxation: Tax Incidence
19.3 General Equilibrium Tax
Incidence
19.2 Tax Incidence Extensions
19.1 The Three Rules of Tax
Incidence
Chapter 19
19.4 The Incidence of Taxation in
the United States
tax incidence Assessing which
party (consumers or producers)
bears the true burden of a tax.

2. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 2 of 36
The Equity Implications of Taxation: Tax Incidence

3. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 3 of 36
The Three Rules of Tax Incidence
19 . 1
The Statutory Burden of a Tax Does Not Describe Who
Really Bears the Tax
statutory incidence The burden
of a tax borne by the party that
sends the check to the government.
economic incidence The burden of
taxation measured by the change in the
resources available to any economic
agent as a result of taxation.

4. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 4 of 36
The Three Rules of Tax Incidence
19 . 1
The Statutory Burden of a Tax Does Not Describe Who
Really Bears the Tax
We can define the tax burden for consumers as
For producers the tax burden is

5. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 5 of 36
The Three Rules of Tax Incidence
19 . 1
The Statutory Burden of a Tax Does Not Describe Who
Really Bears the Tax

6. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 6 of 36
The Three Rules of Tax Incidence
19 . 1
The Statutory Burden of a Tax Does Not Describe Who
Really Bears the Tax
Burden of the Tax on Consumers and Producers
tax wedge The difference between
what consumers pay and what producers
receive (net of tax) from a transaction.

7. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 7 of 36
The Three Rules of Tax Incidence
19 . 1
The Side of the Market on Which the Tax Is Imposed Is
Irrelevant to the Distribution of the Tax Burdens

8. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 8 of 36
The Three Rules of Tax Incidence
19 . 1
The Side of the Market on Which the Tax Is Imposed Is
Irrelevant to the Distribution of the Tax Burdens
Gross Versus After-Tax Prices
gross price The price in the market.
after-tax price The gross price minus
the amount of the tax (if producers pay
the tax) or plus the amount of the tax
(if consumers pay the tax).

9. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 9 of 36
The Three Rules of Tax Incidence
19 . 1
Parties with Inelastic Supply or Demand Bear Taxes;
Parties with Elastic Supply or Demand Avoid Them
The incidence of taxation on producers and consumers is ultimately
determined by the elasticities of supply and demand on how
responsive the quantity supplied or demanded is to price changes.

10. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 10 of 36
The Three Rules of Tax Incidence
19 . 1
Parties with Inelastic Supply or Demand Bear Taxes;
Parties with Elastic Supply or Demand Avoid Them
Perfectly Inelastic Demand

11. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 11 of 36
The Three Rules of Tax Incidence
19 . 1
Parties with Inelastic Supply or Demand Bear Taxes;
Parties with Elastic Supply or Demand Avoid Them
Perfectly Inelastic Demand
full shifting When one party
in a transaction bears all of
the tax burden.

12. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 12 of 36
The Three Rules of Tax Incidence
19 . 1
Parties with Inelastic Supply or Demand Bear Taxes;
Parties with Elastic Supply or Demand Avoid Them
Perfectly Elastic Demand

13. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 13 of 36
The Three Rules of Tax Incidence
19 . 1
Parties with Inelastic Supply or Demand Bear Taxes;
Parties with Elastic Supply or Demand Avoid Them
General Case
Parties with inelastic demand (or supply) bear taxes;
parties with elastic demand (or supply) avoid them.

14. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 14 of 36
The Three Rules of Tax Incidence
19 . 1
Parties with Inelastic Supply or Demand Bear Taxes;
Parties with Elastic Supply or Demand Avoid Them
Supply Elasticities

15. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 15 of 36
The Three Rules of Tax Incidence
19 . 1
Reminder: Tax Incidence Is About Prices, Not Quantities
When the demand for gas is perfectly elastic, we claimed that consumers
bore none of the burden of taxation, and yet the quantity of gas consumed
fell dramatically.
Doesn’t this decrease in consumption make consumers worse off?
If so, shouldn’t that be taken into account when determining tax incidence?
The answer to both questions is “no” because, at both the old and new
equilibria, consumers in this case are indifferent between buying the gas
and spending their money elsewhere.

16. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 16 of 36
Tax Incidence Extensions
19 . 2
To recap:
 The statutory burden of a tax does not describe who
really bears the tax.
 The side of the market on which the tax is imposed
is irrelevant to the distribution of tax burdens.
 Parties with inelastic supply or demand bear taxes;
parties with elastic supply or demand avoid them.

17. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 17 of 36
Tax Incidence Extensions
19 . 2
Tax Incidence in Factor Markets

18. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 18 of 36
Tax Incidence Extensions
19 . 2
Tax Incidence in Factor Markets
Impediments to Wage Adjustment
minimum wage Legally mandated
minimum amount that workers must
be paid for each hour of work.

19. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 19 of 36
Tax Incidence Extensions
19 . 2
Tax Incidence in Factor Markets
Impediments to Wage Adjustment

20. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 20 of 36
Tax Incidence Extensions
19 . 2
Tax Incidence in Imperfectly Competitive Markets
monopoly markets
Markets in which there is
only one supplier of a good.

21. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 21 of 36
Tax Incidence Extensions
19 . 2
Tax Incidence in Imperfectly Competitive Markets
Background: Equilibrium in Monopoly Markets

22. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 22 of 36
Tax Incidence Extensions
19 . 2
Tax Incidence in Imperfectly Competitive Markets
Taxation in Monopoly Markets
Even though the monopolist has market power, a tax on either
side of the market results in the same sharing of the tax burden.
Monopolists cannot “exploit their market power” to avoid the
rules of tax incidence.

23. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 23 of 36
Tax Incidence Extensions
19 . 2
Balanced Budget Tax Incidence
balanced budget incidence
Tax incidence analysis that
accounts for both the tax and
the benefits it brings.

24. Chapter
19
The
Equity
Implications
of
Taxation:
Tax
Incidence
© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 24 of 36
Example 1. Impact and incidence of a producer tax
on apples
• Demand for apples: Qd = 2000-100P
• Supply of Apples Qs = 100 + 200P
• A $2 per bushel tax is placed on producers
• a. who bears the statutory incidence of tax?
• b. who bears the economic incidence of the tax?