Assignment:
Summary
Tax incidence is the analysis of which individuals bear the ultimate burden of taxes, that is, the burden after the economy has adjusted to any changes caused by the taxes. Incidence is defined as the change in private real incomes and wealth because of an adoption or change of a tax. This is different than statutory incidence, which refers to the actual payments made by taxpayers from whom the tax is collected.
The general rule of tax analysis is the only way to avoid a tax (legally) is to change your behavior. Consumers or sellers who are less willing to change their behavior will bear the larger share of the burden.
The efficiency cost of a tax change arises because consumers or producers change their production or consumption so that marginal social cost no longer equals marginal social benefit.
Tax incidence and tax efficiency are inherently connected. If individuals and businesses do not change their behavior in response to a tax change, then no efficiency cost is created and the tax change is a burden only for those directly taxed.
If individuals and businesses do change their behavior, then the tax change will have an efficiency cost, and determining tax incidence is more complicated. Multimarket analysis is essential when dealing with state and local government taxes because the focus is often on the effect of a tax levied by one state or locality when there is mobility among states or local jurisdictions.
Perfectly elastic supply means that any amount of the product can be supplied at the market price, but that none will be supplied if the price falls below that market equilibrium. This situation is common in state-local government finance, with individual states or localities being small enough that they are price takers for goods sold in national (or world) markets.
Discussion Question:
1. Suppose that the local legislative body in Your College Town (YCT) decides to levy a tax of $.50 for each 12 ounces of beer sold in the city (both by-thedrink and packages). The city sees the tax as a way to have students pay more for the city services they receive. Suppose that the beer market in YCT is competitive, the long-run industry supply in YCT is perfeCtly elastic, and the demand for beer in YCT is very price-elastic.
a. What will the effects of the tax be on the price of beer in YCT, the amount of beer sold, and the number of liquor stores and bars in YCT?
b. Why might the demand for beer in YCT be so price elastic, given that it is known that overall demand for beer is rather inelastic? In view of that, what do you expect the effect of the tax will be on beer sales and the number of stores and bars in surrounding cities?
2. "If supply of a good is perfectly inelastic, then the sellers of that good are expected to bear the full revenue burden of an excise tax on the sale or consumption of that good." Evaluate this statement. Can you think of any examples of goods whose supply is (at least almost) perfectly inelastic?
3. If a unit tax is increased from $1 per unit sold to $2, the efficiency cost of the tax more than doubles. Explain.
4. Under what conditions would it be possible for an excise tax to have no efficiency cost and, in fact, increase economic efficiency? Give an example or two.
Readings:
1. Research Bulletin-Research & Analysis on Current Issues
By Ian J. Allan
2. PRINCIPLES OF TAX ANALYSIS
By CHARLES E. MCLURE