Taxation

1. Cost and Inefficiency of
Taxes/Subsidies

2. Taxes and Deadweight Loss
• Outcome of Tax
– Buyers pay higher price
– Sellers get lower price
– “Tax Wedge”
– Lower quantity sold
• Burden of Tax
– Split between buyer and seller
– Depends on elasticities

3. Subsidies

4. Size of
Tax
Pre
Tax
Price
Buyer
Post
Tax
Price
Seller
Post
Tax
Price
Pre Tax
Quantity
Post Tax
Quantity

5. Winners and Losers
• Losers
– Buyers: Pay higher price so lower consumer
surplus
– Sellers: Get lower price so lower producer
surplus
• Winners
– Gov’t (other tax payers): gain revenue from
taxes raised = [New Quantity x Tax]

6. Pre
Tax
Price
Buyer
Post
Tax
Price
Seller
Post
Tax
Price
Pre Tax
Quantity
Post Tax
Quantity
Lost Consumer Surplus
Lost Producer Surplus
Losers

7. Pre
Tax
Price
Buyer
Post
Tax
Price
Seller
Post
Tax
Price
Pre Tax
Quantity
Post Tax
Quantity
Taxes Raised: Q x T
Winners

8. • Welfare Before Tax
– Consumer Surplus
– Producer Surplus
– Tax Revenue = 0
• Welfare After Tax
– Smaller Consumer Surplus
– Smaller Producer Surplus
– Positive Tax Revenue
– Smaller overall Welfare

9. Pre
Tax
Price
Buyer
Post
Tax
Price
Seller
Post
Tax
Price
Pre Tax
Quantity
Post Tax
Quantity
Deadweight Loss: CS and
PS lost but not gained
back by tax revenue

10. Pre
Tax
Price
Buyer
Post
Tax
Price
Seller
Post
Tax
Price
Pre Tax
Quantity
Post Tax
Quantity
A
F
E
D
C
B
W/O
Tax
With
Tax
Change
C.S. A+B+C A -(B+C)
P.S. D+E+F F -(D+E)
Tax 0 B+D +(B+D)
Overall A+B+C
+D+E+
F
A+B+D
+F
-(C+E)

11. • Consumer surplus goes down
– Some gained by tax revenue
– Some lost
• Producer surplus goes down
– Some gained by tax revenue
– Some lost
• Overall surplus (welfare) goes down
because of lower quantity in market
– Market is smaller, so some product/service
are not made even though market value is
higher than cost, ie Inefficient

12. Pre
Tax
Price
Buyer
Post
Tax
Price
Seller
Post
Tax
Price
Pre Tax
Quantity
Post Tax
Quantity
Value to buyers (height of
demand curve) higher than
cost to producers (height
of supply curve), so should
produce at these levels, but
not because of tax – this is
why welfare is lost, or
surplus goes down.
The fact that Gov’t gets some
revenue that once was
consumer/producer surplus is not
where loss of welfare comes from

13. Size of tax distortion/DWL
• Greater the elasticity of supply/demand
the greater the shrinkage of the market
and greater deadweight loss
• B/C markets are reacting more (elastic) to
the change in price due to the tax
• So market shrinks more and more welfare
loss because more potential trades that
would have led to gains are loss

14. Tax
Wedg
e
Tax
Wedg
e
DWL
DWL
Q
1
Q
2
Q
1
Q
2
Inelastic Markets – Low
Distortion and DWL
Elastic Markets – High
Distortion and DWL

15. Tax Revenue and Tax Size
• At first as you increase the size of a tax
you increase Revenue (Q x T)
• But at some point increasing size of tax
decreases revenue because the effect
shrinks the market so much there’s not
much to tax

16. Tax
Revenue
Tax
Revenue
Tax
Revenue
Low Tax – Low
Revenue
Med Tax – High
Revenue
High Tax – Low
Revenue

17. Inefficiency due to Subsidy
• Subsidy Increases the market size beyond
the market equilibrium
• This means the supply curve is above the
demand curve at the new quantity
• This means those last products produced
cost more to produce than they are
actually valued in the market
• This is inefficient

18. Subsidy Wedge
Initial
Price
New
Seller
Price
New
Buyer
Price
New Producer
Surplus
New Consumer
Surplus
Nobody
Gains/Values
Government Pays for all
3 regions but the one
region is lost, ie
inefficient

20. Equity &
Equality
Learning Objectives
To understand the concept of equality
To understand the concept of equity

21. Last summer in Microeconomics
Learning Objectives
To understand the concept of equality
To understand the concept of equity
Equity &
Equality
Distribution of Income
Distribution of Wealth
Inequality
•Causes
•Consequences

22. Equality – the situation where goods and services
in a society are distributed equally
The benefits of equality:
•Improves social cohesion – less difference
•Improves health – greater access
•Can encourage economic growth – less saving
Issues created by equality:
•Lack of incentive to work harder; what’s the point?
•Profit motive drives the economy
•International competitiveness: in highly re-distributive
economies (high taxes and benefits) may act as an
uncompetitive constraint in the economy

23. Equity
Equity – the concept of ‘fairness’
Difference between efficiency and equity
Efficiency – increasing the size of the economic pie
Equity – dividing up the economic pie in equal portions
Do competitive markets result in fair distribution?
A fair distribution of income would result all people in society to
satisfy their basic needs and wants and enjoy a satisfactory
standard of living.
There can be no universal definition of equity:
•What some will consider fair reward for work done, others may
consider unfair
•Refers to a “good” distribution of welfare across society
The significance of equity:
•The concept of fairness will be part of the economic policy
making process
•Many economic policies will aim to improve equity

24. Types of Equity
Equity applies in the construction of tax systems:
Vertical Equity - people with a greater ability to pay taxes should
pay more (poor v. rich) (Robin Hood approach)
Examples. Income tax, welfare spending, health care, education,
State GST allocation.
Could possibly impact on peoples incentive to work longer hours
or even to work.
Could cause the pie to shrink
What is better - an increasing pie divided into unequal shares,
Or a smaller pie divided into equal shares

25. • Horizontal Equity - people with a similar ability to pay taxes
should pay the same or similar amounts
• Provide people with the same opportunity to succeed
• Example, (equal opportunity legislation) people should be free
to choose their own pathway in life,
• Choose how much education they undertake, choose their
own occupation (as long as its lawful)
• Key provision in market economy is private property rights
• Welfare and income assistance
• Truly equitable tax systems will deliver horizontal and vertical
equity.
• E.g. income tax has both horizontal and vertical equity.
Types of Equity

26. Redistribution
Using the tax and benefit system to transfer wealth from the
wealthy to the poor.
Improves equity:
•Raises consumption by the poor
Issues:
•May damage the incentive to work
Table 1: Comparable Tax Rates
1996-99 2004-05 2016-17
Taxable income MTR Taxable income MTR Taxable income MTR
$0 – $5,400 0% $0 – $6,000 0% 0 – $18,200 0%
$5,401– $20,700 20% $6,001– $21,600 17% $18,201 – $37,000 19%
$20,701 –$38,000 34% $21,601– $58,000 30% $37,001 – $87,000 32.5%
$38,001– $50,000 43% $58,001– $70,000 42% $87,001 – $180,000 37%
$50,001 + 47% $70,001 + 47% $180,001 and over 45%

27. Possible Essay question
Discuss the benefits and constraints of using the tax system to create
a more equitable society.
What else could make society more equitable?
Possible essay question:
Explain the concept of equity. How is it demonstrated in the economy?
(4 marks)
Explain what happens to efficiency when equity is targeted by the government
(6 marks)Jan.
2009)Get Ethan to lead a discussion on an essay plan!
Learning Objectives
To understand the concept of equality
To understand the concept of equity
Equity &
Equality