Class #40 "Cost of Taxes" (12/07/11)

      In contrast to the excise tax, which is targeted at sellers, the legal incidence of a sales tax is on the buyers. However by graphing supply and demand before and after the tax, we see that the economic incidence of the tax is exactly the same as the excise tax. 75% lands on the buyers, and 25% lands on the sellers.


The cost of taxes is the value of the forgone trades The value of all the bubble gym that doesn't get sold = deadweight loss.
Taxes are merely transfers - the problem is that they change people's behavior. The tax makes you substitute away from bubble gum. Tax gives sellers an incentive to sell something else other than gum.

How big is America's deadweight loss? 30% of the value of taxes is lost because it costs resources to collect taxes and the way we currently collect taxes is very inefficient.

If you want buyers to pay the tax (i.e. sales tax), which side of the market will be affected? Buyers. What happens to their demand curve? Demand cure will shift by the entire amount of the tax.

The Excise and Sales tax graphs look identical. Conclusion: the legal incidence of a tax doesn't matter. Legal an economic incidence are independent.

Economic incidence is determined by the relative elasticity of the supply and demand curves. A very steep demand curve means it is very inelastic (people will buy a lot regardless of the price).

Whichever party is less sensitive to price change will bear the burden of the tax.

Rizzo

-Daniel Gaona