Chapter 13-Taxation and Efficiency Public economics
1 Chapter 13 – Taxation and Efficiency Public Economics
Introduction Are people unaffected by a tax increase if they pay zero in taxes afterwards? No, consumption may have changed in response to the tax increase Bundle consumed is less desirable Excess burden is a loss of welfare above and beyond the tax revenues collected
2 Introduction • Are people unaffected by a tax increase if they pay zero in taxes afterwards? – No, consumption may have changed in response to the tax increase – Bundle consumed is less desirable • Excess burden is a loss of welfare above and beyond the tax revenues collected
Excess Burden defined Two commodities Barley and corn Fixed income Pb and pc are prices of goods No distortions such as externalities imperfect competition, public goods, etc
3 Excess Burden Defined • Two commodities – Barley and corn • Fixed income • Pb and Pc are prices of goods • No distortions such as externalities, imperfect competition, public goods, etc
Excess Burden defined Figure 13. 1 shows the budget constraint (AD), with utility maximized at bundle E1 Ad-valorem tax levied on barley at rate tb raises the price to(1+tb)Pb, and rotates the budget constraint along the x-axis The new budget constraint is AF
4 Excess Burden Defined • Figure 13.1 shows the budget constraint (AD), with utility maximized at bundle E1 . • Ad-valorem tax levied on barley at rate tb raises the price to (1+tb )Pb , and rotates the budget constraint along the x-axis. The new budget constraint is AF
Figure 13.1 A Budget constraint before b CI Budget constraint after barley tax F Ba B Pounds of barley per year
Figure 13.1
Excess Burden defined At each consumption level of barley, the vertical distance between ad and AF shows tax payments in terms of forgone corn Normalize p=$1 so that vertical distance can be measured in either quantity of corn or dollars 6
6 Excess Burden Defined • At each consumption level of barley, the vertical distance between AD and AF shows tax payments in terms of forgone corn. • Normalize Pc=$1 so that vertical distance can be measured in either quantity of corn or dollars
Excess Burden defined Figure 13.2 shows new optimizing choice with the higher prices along budget constraint AF Utility maximized at bundle e2 ·∨ erica| distance between olo&neW budget constraints is GE2 is the tax bill
7 Excess Burden Defined • Figure 13.2 shows new optimizing choice with the higher prices along budget constraint AF. • Utility maximized at bundle E2 . • Vertical distance between old & new budget constraints is GE2 is the “tax bill
Excess Burden defined Any tax will lower utility, but is there an alternative tax that raises the same revenue, GE2, but entails a smaller utility loss? Or greater revenue with the same utility loss? If so, the tax on barley leads to excess burden
8 Excess Burden Defined • Any tax will lower utility, but is there an alternative tax that raises the same revenue, GE2 , but entails a smaller utility loss? Or greater revenue with the same utility loss? • If so, the tax on barley leads to excess burden
Figure 13.2 2 Budget constraint without barley tax Budget constraint with barley tax B B Pounds of barley per year
Figure 13.2
Excess Burden defined Equivalent variation is the amount of income we would have to take away(before any tax was imposed) to induce a move to the lower indifference curve Taking away income is equivalent to a parallel movement inward on the budget constraint Budget constraint H/in Figure 13. 3 shows this 10
10 Excess Burden Defined • Equivalent variation is the amount of income we would have to take away (before any tax was imposed) to induce a move to the lower indifference curve. • Taking away income is equivalent to a parallel movement inward on the budget constraint. • Budget constraint HI in Figure 13.3 shows this
