Taxation and Government Intervention ppt

© 2003 McGraw-Hill Ryerson Limited.
Taxation and Government
Taxation and Government
Intervention
Intervention
Chapter 7
Chapter 7
© 2003 McGraw-Hill Ryerson Limited.
7 - 2
Laugher Curve
Laugher Curve
Two economists meet on the street.
Q. How’s your wife?
A. Relative to what?
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7 - 3
Taxation and Government
Taxation and Government

Government needs tax revenues to
function.
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7 - 4
How Much Should
How Much Should
Government Tax?
Government Tax?

In order to answer how much
government should tax, we must know
the costs and benefits of taxation.


The benefits result from the roles of
government.
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7 - 5
How Much Should
How Much Should
Government Tax?
Government Tax?

From previous chapters we know that
government’s roles include:

Providing a stable set of institutions and
rules.

Promoting effective and workable
competition.

Correcting for externalities.
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7 - 6
How Much Should
How Much Should
Government Tax?
Government Tax?

From previous chapters we know that
government’s roles include:


Creating an environment that fosters
economic stability and growth.

Providing public goods.

Adjusting for undesirable market results.
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7 - 7
The Costs of Taxation
The Costs of Taxation

The costs of taxation include:

The direct cost of the revenue paid to
government

The loss of consumer and producer surplus
caused by the tax

The administrative costs of collecting the
tax.
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7 - 8
The Costs of Taxation
The Costs of Taxation

When government raises taxes, there is
a loss of consumer and producer
surplus that is not gained by
government.


This is known as deadweight loss.
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7 - 9
The Costs of Taxation
The Costs of Taxation

Graphically the deadweight loss is
shown on a supply-demand curve as
the welfare loss triangle.

The welfare loss triangle – a geometric
representation of the welfare loss in
terms of misallocated resources caused
by a deviation from a supply-demand
equilibrium.
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7 - 10
The Costs of Taxation
The Costs of Taxation
Fig. 7-2, p 162
Fig. 7-2, p 162
S
1
= S
0
+t
P
1
–t

Quantity
Price
P
0
Q
0
P
1
Q
1
Producer
surplus
S
0
Demand
Consumer
surplus
Deadweight
loss
tax
A
F
C
E
B
D
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The Costs of Taxation
The Costs of Taxation


There are additional costs of taxation.

Resources must be allocated by
government to collect the tax and by
individuals to comply with it.
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7 - 12
The Benefits of Taxation
The Benefits of Taxation

The benefits of taxation are the goods
and services that government provides.
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7 - 13
The Benefits of Taxation
The Benefits of Taxation

Some of these benefits are the part of
the basic institutional structure of a
market economy that allows it to
function efficiently.

The basic legal system is an example.
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7 - 14
The Benefits of Taxation
The Benefits of Taxation

Other goods have the qualities of a

public good – fire and police services
are examples.
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7 - 15
The Benefits of Taxation
The Benefits of Taxation

Some benefits are provided for reasons
of equity or because they provide
positive externalities. For example,
education and healthcare.
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7 - 16
The Benefits of Taxation
The Benefits of Taxation

Measuring the benefits of these goods
is difficult since they are often provided
at a zero price.
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7 - 17
Two Principles of Taxation
Two Principles of Taxation

Government follows two general
principles when deciding about taxation

The benefit principle and

The ability-to-pay principle

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7 - 18
Two Principles of Taxation
Two Principles of Taxation

The benefit principle states that the
individuals who receive the benefit of
the good or service should pay the cost
(opportunity cost) of the resources used
to produce the good.

Examples are gasoline taxes and airport
taxes, both paid by travelers.
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7 - 19
Two Principles of Taxation
Two Principles of Taxation

The ability-to-pay principle states that
individuals who are most able to bear
the burden of the tax should pay the
tax.

The best example of this is a progressive
tax, such as the Canadian income tax.
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7 - 20
Difficulty of Applying the
Difficulty of Applying the
Principles of Taxation

Principles of Taxation

The principles of taxation are difficult to
apply.

The two principles often conflict.
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7 - 21
Difficulty of Applying the
Difficulty of Applying the
Principles of Taxation
Principles of Taxation

The elasticity concept helps provide
insight into the taxation debates.

The more broadly the good or service is
defined, the more inelastic its demand.
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7 - 22
Difficulty of Applying the
Difficulty of Applying the
Principles of Taxation
Principles of Taxation

Governments should tax inelastic goods
or services – those are captured by
broad based taxes such as income and
sales tax.
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7 - 23
Difficulty in Applying the
Difficulty in Applying the
Principles of Taxation
Principles of Taxation

In the language of consumer and
producer surplus, if the government
seeks to minimize the welfare loss, it
should tax goods with inelastic supplies
and demands.
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7 - 24
Who Bears the Burden of a
Who Bears the Burden of a
Tax?
Tax?

The person who physically pays the tax
is not necessarily the person who bears
the burden of the tax.

The burden of the tax depends on
relative elasticity.
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7 - 25
Burden Depends on Relative
Burden Depends on Relative
Elasticity
Elasticity


The tax burden is greater if a person
cannot easily change their behaviour.

The more inelastic one’s relative supply
and demand, the larger the tax burden
one will bear.