Tax IncidenceTax Incidence

Categories of TaxesCategories of Taxes• Regressive Taxes: tax the

poor more than the rich, in terms of percentage of income (e.g., sales tax)

• Progressive taxes: tax the rich more than the poor, in terms of percentage of income (e.g., a graduated income tax)

• Proportional tax: taxes the same percentage, regardless of income (“flat tax”)

• Received benefit taxes: tax only those people who benefit from the service (e.g., road tax charged to car owners for vehicle licenses)

• Taxes to address market failure or discourage purchase of demerit goods

Types of TaxesTypes of Taxes• Personal Income Taxes

– Tax on calculated income– Taxable income calculated sources of

income and deductions– In US, most sources of income mail

annual statements to citizens (W2, 1099 forms etc.)

– Marginal rates increase with income• Property Taxes

– Typically local taxes levied on assessed value

– Typically seen as progressive, because most poor do not own property

• Sales Taxes– Fixed percentage on sales. In US,

local and state.– Regressive because poor pay large

percentage of income.• Excise Taxes

– Imposed on specific items, often to discourage consumption

– Payroll taxes fund Social Security and Medicare

Tax IncidenceTax Incidence

• For sales and excise tax, key question: when tax is applied, who will pay it?

• If producers pass entire tax on to consumers, consumers may stop buying product

• If producers pay all tax, producers may stop producing product

• Elasticity of S & D shows us the compromise

Tax Incidence AnalysisTax Incidence Analysis• Elasticity of S & D determine

tax incidence• Determine tax incidence by

– Placing vertical line equal to tax amount as wedge into S&D

– Noting resulting change in P

– If ΔP > half of tax, the most of tax falls on consumer

– If ΔP < half of tax, the most of tax falls on supplier

• Elastic S places greater incidence on consumer

• Elastic D places greater incidence on seller