Chapter 17 - Public choice theory and the economics of taxation. Learning objectives of this chapter include: Conveying economic preferences through majority voting; government failure; tax philosophies and the tax burden; tax shifting, tax incidence, and efficiency losses from taxes.
Chapter 17 Public Choice Theory and the Economics of Taxation McGrawưHill/Irwin Copyrightâ2009byTheMcGrawưHillCompanies,Inc.Allrightsreserved Chapter Objectives Conveying economic preferences through majority voting • Government failure • Tax philosophies and the tax burden • Tax shifting, tax incidence, and efficiency losses from taxes 17-2 Majority Voting • Can result in inefficiency – Over or underproduction of a public good – Individuals think only of themselves – Strength of preferences ignored • Interest groups • Logrolling 17-3 Majority Voting Inefficient Majority “Yes” Vote Benefit; Tax Benefit; Tax Inefficient Majority “No” Vote $700 Adams $350 $300 $250 Benson “YES” “NO” $350 Benson Conrad “YES” “YES” $300 $200 $100 Conrad “NO” “NO” Wins! Inefficient Since MSB > MSC $1,150 > $900 Adams “NO” “YES” Wins! Inefficient Since MSB < MSC $800 < $900 17-4 Majority Voting • Paradox of voting – Paired choice majority voting – Flawed procedure – Outcome depends on vote order • Median voter model – Politicians appeal to the middle – Extremes pick the middle – Implications 17-5 Government Failure • Special-interest effect – Pork-barrel politics • • • • • Rent-seeking behavior Clear benefits, hidden costs Limited and bundled choice Bureaucracy and inefficiency Imperfect institutions 17-6 The Tax Burden • How should the tax burden be apportioned? • Benefits-received principle • Ability-to-pay principle • Progressive tax • Regressive tax • Proportional tax 17-7 Types of Taxes • • • • • Personal income tax Sales tax Corporate income tax Payroll tax Property tax 17-8 Tax Incidence • Who really pays the tax? • Excise tax – Tax burden depends on elasticity – Inelastic vs elastic • Efficiency loss of an excise tax – Deadweight loss – Depends on elasticity – Transfer of surplus to govt 17-9 Tax Incidence of an Excise Tax P St 14 S Price (Per Bottle) 12 Tax $2 10 D 10 15 20 Quantity 25 (Millions of Bottles Per Month) Q 17-10 Tax Incidence • Why impose an excise tax? – Discourage consumption – Redistributive goals – Reduce negative externality • Burden of the excise tax? – Depends on elasticity – Availability of substitutes 17-11 Tax Incidence and Elasticity Smaller efficiency loss with inelastic demand P P St Tax Pe P1 Pa St Tax S S a Pi a b c Q2 P1 Pb De Q1 Tax Incidence and Elastic Demand Q b c Di Q2 Q1 Q Tax Incidence and Inelastic Demand 17-12 Tax Incidence and Elasticity Smaller efficiency loss with inelastic supply P P Tax Pe P1 Pa St S Tax St a S b Pi P1 a b c Pb c D Q2 Q1 Tax Incidence and Elastic Supply D Q Q2 Q Q Tax Incidence and Inelastic Supply 17-13 Efficiency Loss of a Tax P S’ 14 Tax Paid by Consumers Price (Per Bottle) 12 S Tax $2 10 Efficiency Loss (or Tax Paid by Deadweight Loss) Producers 10 15 20 Quantity D 25 (Millions of Bottles Per Month) Q 17-14 Incidence of U.S Taxes • Workers bear full burden of: – Social security tax – Medicare tax – Income tax • Burden of corporate income tax: – Stockholders (short run) – Workers (long run) 17-15 U.S Tax Structure • Federal tax system progressive • State and local system is regressive • Overall tax structure slightly progressive 17-16 Taxes on General Consumption • Sales tax, excise tax, value-added tax Percentage of GDP, 2005 10 12 14 Iceland Denmark Sweden New Zealand France Germany Italy Canada Japan United States Source: Organization for Economic Cooperation and Development 17-17 Government Failure • Examples of pork barrel politics – Chicago “wilderness” program – Bison meat, cauliflower, and pumpkin supports – Catfish as livestock spending – 9,300 special projects in 2003 – Waste and fraud in Katrina relief spending 17-18 Key Terms • • • • • • public choice theory logrolling paradox of voting median-voter model government failure special-interest effect • earmarks • rent seeking • benefits-received principle • ability-to-pay principle • progressive tax • regressive tax • proportional tax • tax incidence • efficiency loss of a tax 17-19 Next Chapter Preview… Antitrust Policy and Regulation 17-20 ... institutions 1 7- 6 The Tax Burden • How should the tax burden be apportioned? • Benefits-received principle • Ability-to-pay principle • Progressive tax • Regressive tax • Proportional tax 1 7- 7 Types... ability-to-pay principle • progressive tax • regressive tax • proportional tax • tax incidence • efficiency loss of a tax 1 7- 19 Next Chapter Preview… Antitrust Policy and Regulation 1 7- 20 ... spending 1 7- 18 Key Terms • • • • • • public choice theory logrolling paradox of voting median-voter model government failure special-interest effect • earmarks • rent seeking • benefits-received