Lecture Economics (18th edition): Chapter 17 - McConnell, Brue, Flynn''s

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.

Public Choice Theory and the Economics of Taxation

Chapter 17

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

Majority Voting

Inefficient Majority “No” Vote

Inefficient Majority “Yes” Vote

$700

$250

$200

$100

$350 $350

Adams

Adams

Benson

Benson

Conrad

Conrad

“NO” “NO” “YES” “YES”

“YES” “NO”

MSB > MSC

$1,150 > $900

Inefficient Since

“NO” Wins!

MSB < MSC

$800 < $900

Inefficient Since

“YES” Wins!

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

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

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.

Tax Incidence of an Excise Tax

0 2 4 6 8 10 12

14

P

Quantity

(Millions of Bottles Per Month)

S

D

Tax $2

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

Tax Incidence and Elasticity

0

P

Q Q

P

0

Tax Incidence and Elastic Demand

Tax Incidence and Inelastic Demand

Smaller efficiency loss with inelastic demand

S

S

Q 2

P 1

P e

P a

P 1

P i

P b

a a

b b

c c

17-12

Tax Incidence and Elasticity

0

P

Q Q

P

0

Tax Incidence and Elastic Supply

Tax Incidence and Inelastic Supply

Smaller efficiency loss with inelastic supply

S

S

P 1

P a

P e

P 1

P b

P i

Q 1

a

a

b b

c c

Efficiency Loss of a Tax

0 2 4 6 8 10 12 14

P

Quantity

(Millions of Bottles Per Month)

S

D

S’

Tax $2

Tax Paid by Consumers

Tax Paid by Producers

Efficiency Loss (or Deadweight Loss)

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)

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

Percentage of GDP, 2005

Iceland Denmark Sweden New Zealand

France Germany

Italy Canada Japan United States

0 2 4 6 8 10 12 14

• Sales tax, excise tax, value-added tax

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

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Antitrust Policy and

Regulation

17-20