Tax Incidence Elasticity Who actually bears the burden

Tax Incidence & Elasticity Who actually bears the burden of taxes? Chapter 6 (pages 124 -131)

Tax Incidence • Regardless of who pays the tax directly to the Gov’t => buyers & sellers both share some of the tax incidence (tax burden) – Buyers pay more & Sellers receive less • Tax incidence- is the study of who pays a higher burden of a tax – i. e. who pays a higher % of an excise tax If buyers pay $1. 50 $2 per unit tax Sellers pay $0. 50 Buyers have higher tax incidence

Tax Incidence & Elasticity • Tax incidence does not depend on who the tax is “placed on” – i. e. who “sends tax” to the Government • Tax incidence (tax burden) depends on the relative elasticity of demand versus elasticity of supply • Bottom line: Tax incidence is greater on the more inelastic market The Steeper Curve pays more of the tax!

Shifting Curves with Excise Tax • Draw in the tax wedge first & label all new points – Label: Pb, Ps, DWL, Qty sold, CS, PS • Shift the curve of who the Gov’t places the “tax on” – Tax on Buyers => shift Demand Curve – Tax on Sellers => shift Supply Curve to bottom of tax wedge or top • End result: Shift only tells you “who sent check to Gov’t” • DWL, Tax Revenue, Tax Incidence is the same regardless of which curve you shift!

$. 50 Cent Tax on Sellers Example #1 Price buyers pay S 2 Tax Wedge = $0. 50 $3. 30 P 1 = 3. 00 2. 80 S 1 Tax incidence? Last step: tax on sellers Shift supply to the “top” of tax wedge Equilibrium without tax Price sellers receive Buyers pay $0. 30 Sellers pay $0. 20 D 1 So Demand more inelastic 0 90 100 Quantity

Taxes & Shifting Supply/Demand • The end result of a curve shift is identical to a “tax wedge” • A tax on sellers shifts supply curve left by amount of tax • A tax on buyers shifts the demand curve left by amount of tax If Gov’t taxes Sellers If Gov’t taxes Buyers Seller pays Gov’t Supply left to “top of wedge” Buyer pays Gov’t Demand left (bottom of wedge)

Tax Incidence Worksheet Total Welfare after Tax DWL Price Buyer pays Price Seller Receives