© 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? © 2003 McGraw-Hill Ryerson Limited. 7 - 3 Taxation and Government Taxation and Government Government needs tax revenues to function. © 2003 McGraw-Hill Ryerson Limited. 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. © 2003 McGraw-Hill Ryerson Limited. 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. © 2003 McGraw-Hill Ryerson Limited. 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. © 2003 McGraw-Hill Ryerson Limited. 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. © 2003 McGraw-Hill Ryerson Limited. 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. © 2003 McGraw-Hill Ryerson Limited. 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. © 2003 McGraw-Hill Ryerson Limited. 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 [...]...7 - 11 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 © 2003 McGraw-Hill Ryerson Limited 7 - 12 The Benefits of Taxation The benefits of taxation are the goods and services that government provides © 2003 McGraw-Hill Ryerson Limited 7 - 13 The Benefits of Taxation Some of these benefits... 35 Government Intervention Taxation is but one way in which government affects our lives Other forms of government intervention include price controls © 2003 McGraw-Hill Ryerson Limited 7 - 36 Price Ceiling A price ceiling is a government- set maximum price which the market price cannot exceed Generally, the price ceiling is set below market equilibrium price It is an implicit tax on producers and. .. Principles of Taxation Governments should tax inelastic goods or services – those are captured by broad based taxes such as income and sales tax © 2003 McGraw-Hill Ryerson Limited 7 - 23 Difficulty in Applying the 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 © 2003 McGraw-Hill... principles of taxation are difficult to apply The two principles often conflict © 2003 McGraw-Hill Ryerson Limited 7 - 21 Difficulty of Applying the 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 © 2003 McGraw-Hill Ryerson Limited 7 - 22 Difficulty of Applying the Principles of Taxation. .. - 14 The Benefits of Taxation Other goods have the qualities of a public good – fire and police services are examples © 2003 McGraw-Hill Ryerson Limited 7 - 15 The Benefits of Taxation Some benefits are provided for reasons of equity or because they provide positive externalities For example, education and healthcare © 2003 McGraw-Hill Ryerson Limited 7 - 16 The Benefits of Taxation Measuring the... since they are often provided at a zero price © 2003 McGraw-Hill Ryerson Limited 7 - 17 Two Principles of Taxation Government follows two general principles when deciding about taxation The benefit principle and The ability-to-pay principle © 2003 McGraw-Hill Ryerson Limited 7 - 18 Two Principles of Taxation The benefit principle states that the individuals who receive the benefit of the good or service... cannot easily change their behaviour The more inelastic one’s relative supply and demand, the larger the tax burden one will bear © 2003 McGraw-Hill Ryerson Limited 7 - 26 Burden Depends on Relative Elasticity If demand is more inelastic than supply, consumers will pay the higher share If supply is more inelastic than demand, suppliers will pay the higher share © 2003 McGraw-Hill Ryerson Limited 7... 60,000 50,000 40,000 30,000 20,000 10,000 tax Consumer pays S0 Supplier pays Demand 510 200 400 600 Quantity of luxury boats © 2003 McGraw-Hill Ryerson Limited 7 - 28 Who Bears the Burden of a Tax? Fig 7-3b, p 166 Price $70,000 60,000 50,000 40,000 30,000 20,000 10,000 Demand is inelastic S1 Consumer pays S0 Supplier pays Demand 590 Quantity of luxury boats © 2003 McGraw-Hill Ryerson Limited 7 - 29 Who... Limited 7 - 30 Tax Incidence and Current Policy Debates The analysis of tax incidence is helpful when discussing current policy debates © 2003 McGraw-Hill Ryerson Limited 7 - 31 Employment Insurance Premiums Both employer and employee contribute to the Employment Insurance The burden falls mainly on employees because, on average, labour supply is less elastic than labour demand © 2003 McGraw-Hill Ryerson... taxes and airport taxes, both paid by travelers © 2003 McGraw-Hill Ryerson Limited 7 - 19 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 best example of this is a progressive The tax, such as the Canadian income tax © 2003 McGraw-Hill Ryerson Limited 7 - 20 Difficulty of Applying the Principles of Taxation . 3 Taxation and Government Taxation and Government Government needs tax revenues to function. © 2003 McGraw-Hill Ryerson Limited. 7 - 4 How Much Should How Much Should Government Tax? Government. © 2003 McGraw-Hill Ryerson Limited. Taxation and Government Taxation and Government Intervention Intervention Chapter 7 Chapter 7 © 2003 McGraw-Hill Ryerson Limited. 7. 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