Chapter 13 Taxes Macroeconomics Barro Chapter 13 Taxes

Chapter 13 Taxes Macroeconomics - Barro Chapter 13

Taxes in the United States Macroeconomics - Barro Chapter 13 2

Types of Taxes Macroeconomics - Barro Chapter 13 3

Types of Taxes Macroeconomics - Barro Chapter 13 4

Types of Taxes • taxes fall on forms of income: individual income taxes, corporate profits taxes, and contributions for Social Security and Medicare. • Other taxes are based on expenditures: sales taxes, excise taxes, and customs duties. Macroeconomics - Barro Chapter 13 5

Types of Taxes • The marginal tax rate is the additional tax paid on an additional dollar of income. The average tax rate is the ratio of total taxes paid to total income. – An important property of the U. S. federal individual income tax is that the marginal tax rate rises with income. Macroeconomics - Barro Chapter 13 6

Types of Taxes Macroeconomics - Barro Chapter 13 7

Types of Taxes Macroeconomics - Barro Chapter 13 8

Types of Taxes Macroeconomics - Barro Chapter 13 9

Taxes in the Model • Household Budget Constraint – C + ( 1/P)·B+ K = ( w/P)·Ls+ r·(B/P+K) + V − T • Let τw be the marginal tax rate on labor income. – a higher τw will generate more tax revenue for the government unless the amount of labor income falls sharply. Macroeconomics - Barro Chapter 13 10

Taxes in the Model • Let τw be the marginal tax rate on labor income. – a higher τw will generate more tax revenue for the government unless the amount of labor income falls sharply. • after-tax real wage rate, = (1−τw)·(w/P) Macroeconomics - Barro Chapter 13 11

Taxes in the Model • If the marginal tax rate, τw, rises, for a given w/P, (1−τw)·(w/P) falls. – We predict that the household would reduce the quantity of labor supplied, take more leisure time, and consume less. Macroeconomics - Barro Chapter 13 12

Taxes in the Model • V − T = −G. – Therefore, if government purchases, G, are unchanged real transfers net of real taxes, V − T, must also be unchanged. For given G, we do not get any changes in household real income through the term V − T. – In other words, if G is fixed, there are no income effects from a change in τw. Macroeconomics - Barro Chapter 13 13

Taxes in the Model Macroeconomics - Barro Chapter 13 14

Taxes in the Model • For a given pretax real wage rate, w/P, a higher τw implies a lower after-tax real wage rate, (1 − τw) · (w/P). • A rise in τw shifts the labor supply curve leftward from the blue one labeled Ls to the green one labeled (Ls ). • This decrease in labor supply reflects the substitution effect from the higher laborincome tax rate, τw Macroeconomics - Barro Chapter 13 15

Taxes in the Model • a higher marginal tax rate on labor income, τw, lowers the quantity of labor input, L. This effect will spill over to the market for capital services because the reduction in L tends to reduce the marginal product of capital services, MPK. Macroeconomics - Barro Chapter 13 16

Taxes in the Model Macroeconomics - Barro Chapter 13 17

Taxes in the Model • Y= A· F(κ K, L) – we found that a rise in the labor-income tax rate, τw, reduced the quantities of labor, L, and capital services, κK. – A higher marginal tax rate on labor income, τw, leads to a reduction in overall market activity, as gauged by real GDP, Y. Macroeconomics - Barro Chapter 13 18

Taxes in the Model • A Tax on Asset Income – C+ ( 1/P)·B+ K = ( w/P) ·Ls+ r · ( B/P +K) + V − T – Suppose now that real taxes, T, depend on a household’s real asset income, r · (B/P + K) – r = ( R/ P) · κ − δ(κ) – Let τr be the marginal tax rate on asset income. Macroeconomics - Barro Chapter 13 19

Taxes in the Model • A Tax on Asset Income – For the choice between C 1 and C 2 is the aftertax real interest rate, (1 τr)·r. If τr rises, for given r, (1− τr)·r declines. – Households have less incentive to defer consumption, and it reacts by increasing C 1 compared to C 2. For given real income in year 1, an increase in τr motivates the household to consume more and save less in year 1. Macroeconomics - Barro Chapter 13 20

Taxes in the Model • A Tax on Asset Income – (1−τr) · r = (1−τr)·[(R/P)·κ−δ(κ) ] Macroeconomics - Barro Chapter 13 21

An Increase in Government Purchases Financed by a Labor Income Tax • We know that a decrease in (1 − τr ) · r has intertemporal -substitution effects on consumption. • The household raises year 1’s consumption, C 1, compared to year 2’s, C 2. • For given real income in year 1, the household consumes more and saves less in year 1. That year 1’s real GDP, Y 1, does not change, and that Y 1 = C 1 + I 1 + G 1. We are assuming that government purchases, G 1, are unchanged. • The increase in C 1 must correspond to an equal-sized reduction in year 1’s gross investment, I 1. • Thus, the key result is that a higher tax rate, τr , on asset income leads to higher C 1 and lower I 1. Macroeconomics - Barro Chapter 13 22

An Increase in Government Purchases Financed by a Labor Income Tax • Effects from a permanent increase in government purchases, G. assumed, that the increase in G was financed by lump-sum taxes. – Our finding was that an increase in G by one unit left real GDP, Y, unchanged and reduced consumption, C, by about one unit. – Gross investment, I, was unchanged. – Also unchanged were the real wage rate, w/P, the real rental price, R/P, and the real interest rate, r. Macroeconomics - Barro Chapter 13 23

An Increase in Government Purchases Financed by a Labor Income Tax • We will get different results if the combination of permanently increased government purchases, G, and the higher marginal income tax rate, τw, affects the quantity of labor supplied, Ls. Macroeconomics - Barro Chapter 13 24

An Increase in Government Purchases Financed by a Labor Income Tax • the various forces that affect Ls. – an increase by one unit in each year’s government purchases, G, required real taxes less real transfers, T − V, to rise by one unit in each year. – We found in this chapter that the substitution effect from a higher marginal tax rate, τw, on labor income reduces the quantity of labor supplied. Macroeconomics - Barro Chapter 13 25

An Increase in Government Purchases Financed by a Labor Income Tax Macroeconomics - Barro Chapter 13 26

An Increase in Government Purchases Financed by a Labor Income Tax • We see that the overall effect from a rise in government purchases, G, on the quantity of labor supplied, Ls, depends on the offsetting influences from an income effect and a substitution effect. The income effect predicts that Ls would rise. The substitution effect predicts that Ls would fall. The overall effect on Ls is uncertain. Macroeconomics - Barro Chapter 13 27

An Increase in Government Purchases Financed by a Labor Income Tax • Empirically, the overall effect from permanently increased government purchases, G, on the quantity of labor supplied, Ls , seems to be small. Macroeconomics - Barro Chapter 13 28

Transfer Payments • Suppose that the government increases real transfers, V, and finances these expenditures with increased real taxes, T, collected by a tax on labor income. • In this case, marginal income tax rates, τw, rise for two reasons. – First, the rise in T goes along with a higher τw for households that pay individual income taxes. – Second, for households that are receiving transfers—such as poor welfare recipients—the expansion of the transfer program raises the implicit marginal income tax rate, τw, because of the income testing for benefits. • We therefore predict even stronger effects In particular, labor input, L, capital services, κK, and real GDP, Y, tend to decline. Macroeconomics - Barro Chapter 13 29