The Equity Implications of Taxation: Tax Incidence. Explain the three rules of tax incidence.

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The Equity Implications of Taxation: Tax Incidence. Explain the three rules of tax incidence.

Tax incidence-assessing which party (consumers or producers) bears the true burden of a tax.

The goal of determining a tax’s incidence is to assess who ultimately bears the burden of paying a tax. Economic tax incidence can be described by three basic rules:

1)The first and most important rule of tax incidence is that tax laws do not accurately identify who actually bears the burden of the tax.Statutory incidence- the burden of a tax borne by the party that sends the check to the government. tatutory incidence, however, ignores the fact that markets react to taxation. This market reaction determines the economic incidenceof a tax - the burden of taxation measured
 by the change in the resources available to any economic agent as a result of taxation. The economic incidence of any tax is the difference between the individual’s available resources before and after the tax has been imposed.

2)The second rule of tax incidence is that the side of the market on which the tax is imposed is irrelevant to the distribution of the tax burdens: tax incidence is identical whether the tax is levied on producers or consumers.

While there is only one market price when a tax is imposed, there are two different prices that economists often track in these types of tax incidence models.The first is the gross price,the price paid by or received by the party not paying the tax to the government. The second is the after-tax price,the price paid by or received by the party that is paying the tax to the government; it is either lower by the amount of the tax (if producers pay the tax) or higher by the amount of the tax (if consumers pay the tax).

3)The incidence of taxation on producers and consumers is ultimately determined by the elasticities of supply and demand on how responsive the quantity supplied or demanded is to price changes.

- When demand is perfectly inelastic, producers bear none of the tax and consumers bear all of the tax - the full shifting of the tax onto consumers.

- When demand is perfectly elastic, producers bear all of the tax, and consumers bear none of the tax.

These extreme cases illustrate a general point about tax incidence: parties with inelastic demand (or supply) bear taxes; parties with elastic demand (or supply) avoid them.

The current financial system of the Russian Federation.

The financial system of the Russian Federation - a set of different spheres of financial relations, each of which is characterized by the features in the formation, use of funds and a different role in social reproduction. The financial system of the Russian Federation includes:

1. State budget system

2. Extra-budgetary special funds(Внебюджетные специальные фонды)

3. State and bank credit

4. Funds Insurance (property and personal)

5. Finance of businesses and industries related to decentralized finance, which are used to regulate and stimulate the economy and social relations at the micro level and social relations at the micro level

The head of the financial system of the Russian Federation is the Ministry of Finance, which is the executive body ensuring implementation of a uniform financial, budgetary, fiscal and monetary policy and carrying out general management of the organization of finance in Russia. The functions financial activities are performed also by federal and regional public authorities. The system of financial and credit agencies - the system, specially created for the financial management and control in this area (it includes the Ministry of Finance of and financial bodies of the subjects of the Russian Federation).

Central Bank is a government body which performs the state management in the field of banking.

The Audit Chamber (Счетная палата) is a body of financial control over the timely implementation of all articles of the federal budget. Federal Treasury (Федеральное казначейство) monitors the conduct of fiscal policy as a whole. The Federal Tax Service is included in the central government. The Customs Service is also a source of replenishment of the state treasury, and is headed by the Federal Customs Service. Financial institutions:

1.Budget funds

2.Extra-budgetary funds

3. Decentralized Funds

4. Insurance Funds

5. State and municipal loans

6. The currency system

7. Finances of enterprises of different ownership forms

Public finance on federal, regional (state) and municipal (local) levels. Revenues and expenditures. Budget deficit/proficit.

What makes public finance so compelling is the dominant role that governments play in our everyday lives. Public financeis the study of the role of the government in the economy. This study involves answering the four questions of public finance:

- When should the government intervene in the economy?

- How might the government intervene?

- What is the effect of those interventions on economic outcomes?

- Why do governments choose to intervene in the way that they do?

Having decided whether to intervene, the government needs to decide how to intervene.There are many policy options that can be pursued to achieve the same goal, such as public provision, mandates for private provision, and subsidies to private provision.

Government, which consists of both national (federal) and local units (states, counties, cities, and towns), is large and growing throughout the world. The nature of government spending and revenue sources is also evolving over time as governments move away from being providers of traditional public goods (such as defense) to being providers of social insurance (such as health insurance). Governments also affect our lives through regulatory functions in a wide variety of arenas.

A government budget is a government document presenting the government's proposed revenues andspending for a financial year. A positive balance is called a government budget surplus, and a negative balance is a government budget deficit. The meaning of "deficit" differs from that of "debt", which is an accumulation of yearly deficits. Deficits occur when a government's expenditures exceed the revenue that it generates. The deficit can be measured with or without including the interest payments on the debt as expenditures.

It is clear that the government plays a central role in the lives of people. It is also clear that there is ongoing disagreement about whether that role should expand, stay the same, or contract.













3.2.If the tax is on the sale of rutabagas, the buyer bears the statutory incidence, since the

“sticker price” of rutabagas does not include the tax. Economic incidence is determined by

relative elasticities. In this case, the quantity supplied is more responsive to a change in

price, so the less elastic consumers will bear most of the economic incidence.

To calculate the relative burdens, solve the equilibrium condition with and without the

tax. Without the tax: 2,000 – 100P = – 100 + 200P. Price = $7.00. With the tax, the price the

supplier receives is reduced by $2.00. The equilibrium condition is

2,000 – 100P = - 100 + 200(P – 2) (The firm keeps $2 less per rutabaga)

2,000 – 100P = 200P – 500

2,500 = 300P, Price = $8.33.

The consumers’ tax burden = (posttax price – pretax price) + tax payments by consumers,

here $8.33 – $7.00 + 0 ≈ $1.33. (Used to pay $7.00 now pay $8.33)

The producers’ tax burden = (pretax price – posttax price) + tax payments by producers,

here $7.00 – $8.33 + $2.00 ≈ $.67. In this case the consumer bears a larger share of the tax

burden than the producer. (Used to receive $7, now keep 8.33 – 2 = 6.33 or .67 less.)


2.1 The effect of a corporate tax on corporate investment. The effect of depreciation allowance and the investment tax credit on corporate investment.

Effective corporate tax rate. The Effects of a Corporate Tax on Corporate InvestmentWhat happens if we introduce taxes into this story? Imagine first that the corporate tax is simply a tax at a rate t on cash earnings minus labor costs (there are no tax deductions of any type for investment spending). The cash earnings per dollar spent on the machine per period is MPK, so once this tax is imposed, the earnings per dollar spent on the machine drop to MPK 3 (1 2 t) (since the new tax must be paid on each dollar of earnings). This reduction in actual return causes the marginal benefit curve to shift down to MB2, as shown in Figure 24-5: the taxation of corporate earnings has reduced the marginal benefit of investing. The costs per dollar of investment remain at d 1 r, so the marginal cost curve remains at its initial level. The new optimal investment choice is at point B, and investment falls to K2.

Firms invest less when the government takes some of their return through corporate taxation. This is because the firm’s after-tax actual rate of return on the investment must be large enough to meet the required rate of return, d 1 r. As a result, the pre-tax rate of return must be higher than it is without taxation, and that only occurs if the firm is investing less. For example, with a

tax rate of 50%, the firm must earn $0.40 of return on a dollar of investment to pay back its $0.20 of cost in depreciation and financing. Thus, the firm must invest less: it should stop investing at the point where the marginal dollar of investment has a $0.40 return rather than continuing to invest until that marginal dollar of investment has a $0.20 return. In this scenario, corporate taxation leads to less investment.

The Effects of Depreciation Allowances and the Investment Tax Credit on Corporate InvestmentThis description of the effect of taxes on corporate investment does not include the influence of tax deductions for investment such as depreciation allowances or investment tax credits. These tax deductions act as discounts off the price of investments, lowering the marginal cost by offsetting some of the costs of financing and depreciation. Recall that depreciation allowances are typically spread out over the purchase year and future years and that to value such streams of benefits we need to consider their present discounted value (PDV). The value of any given depreciation allowance schedule, z, is the PDV of the stream of depreciation

allowances associated with a new machine purchase, as a fraction of the purchase price of the machine. If the firm could expense the machine (deduct its full value in the year of purchase), z would be 1.0 because the deduction allowance is 100% of the purchase price. As depreciation allowances are spread out over future years, z falls because the PDV of the depreciation allowances falls as the allowances become more distant.

Effective Corporate Tax RateNow that we understand how taxes affect a firm’s investment decisions, we can summarize mathematically the net impact of the tax system on investment decisions. The effect of taxes is summarized by the effective corporate tax rate,the percentage increase in the rate of pretax return to capital that is necessitated by taxationThe rate of return earned by the firm on its investments must rise to finance the tax payments. How much it must rise is a function of the tax rate, the treatment of depreciation, and the presence of the ITC. These factors therefore come together to determine the overall effect of taxation on investment decisions

1.2 Tax incentives for retirement savings. Limitations on tax – subsidized retirement savings.Tax incentives for retirement savings . some economists and policy makers argue that

we save too little in the United States and that our economic growth suffers as a result. Moreover, despite the existence of the Social Security program, some remain concerned that worker shortsightedness may cause workers to undersave for retirement. As a result of these concerns, the U.S. government has introduced a series of tax subsidies to encourage retirement savings. In this section, we review the structure and effects of these subsidies.

pension planA n employersponsored plan through which employers and employees save on a (generally) tax-free basis for the employees’ retirement.

defined benefit pension plansPension plans in whichworkers accrue pension rightsduring their tenure at the firm,and when they retire, the firmpays them a benefit that is afunction of that workers’ tenureat the firm and of their earnings.

defined contribution pension plansPension plans in whichemployers set aside a certainproportion of a worker’s earnings(such as 5%) in an investmentaccount, and the workerreceives this savings and anyaccumulated investment earnings when she retires.

Limitations on Tax-Subsidized Retirement SavingsMost of the vehicles for tax-subsidized retirement savings that we reviewed earlier feature a limit on annual contributions, such as the $5,000 limit for IRAs. These limits complicate the theoretical analysis. Suppose that Andrea is making savings decisions in a world with and without an IRA available. Her original after-tax budget constraint, BC2, between consumption in period one and period two is the line AB, with a slope of 2(1 1 r 3 [1 2 t]), where r is the interest rate earned on her savings and t is the tax rate paid on interest earnings. Without the IRA, the price of first-period consumption, in terms of forgone second-period consumption, is 1 1 r 3 (1 2 t), since that is how much second-period consumption she could have if she consumed one dollar less today.

1.3 Explain the Crowd -Out Problem in Education. How would this "solve" with the Educational Vouchers? How vouchers will lead to excessive school specialization or to Segregation?

Crowd-out problem: As the government provides more of a public good, the private sector will provide less.

Education is a public good that is provided to some extent by the private sector. As such, an important problem with the system of public education provision is that it may crowd out private education provision. Indeed, it is possible that providing a fixed amount of public education can actually lower educational attainment in society through inducing choice of lower quality public schools over higher-quality private schools

Vouchers might increase segregation by student skill level or motivation. As the motivated and high-skilled students flee poor-quality public schools for higher-quality private schools, the students left behind willbe in groups that are of lower motivation and skill. That is, school choice is likely to reduce segregation along some dimensions but increase it along others.

Vouchers might solve this crowd-out problem by allowing people to choose the optimal level of education for themselves, as well as interjecting competition into the education market.

At the same time, vouchers may lead to increased educational stratification, and the education market may face difficulties in implementing competition.Existing evidence suggests that private school choice through vouchers can move students to better schools, but a much richer evaluation of the total social effects of vouchers is needed before policy conclusions can be drawn.

1 E

2 B

3 А

4 А

5 B

6 A

7 B

8 E

9 E

10 E

3.1 a.What is the price of an additional dollar of local spending in each case? The “price” of spending $1 on road construction is reduced to 50¢ by the matchinggrant. The other 50¢ of the $1 spent comes from the matching grant. The block grantwould not change the relative price of road construction. Since block grant money can beused to purchase anything, the price, or opportunity cost, of $1 worth of road construc-tion is still a $1.


b.Which of the two methods do you think would lead to higher levels of local spend-ing on roads? Explain your answer. Both grants will increase spending through the income effect: Minnegan is wealthierwith either and is likely to spend more money on several projects, including roads. Thematching grant reduces the relative cost of road construction, however, so in addition tothe income effect, the substitution effect will induce more road building. The matchinggrant is more likely to lead to higher levels of spending on roads.


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