public choice theory and the economics of taxation
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Copyright 2008 The McGraw-Hill Companies29-1
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
End Show
29Public Choice Theory and the Economics of Taxation
Copyright 2008 The McGraw-Hill Companies29-2
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
End Show
Chapter Objectives• The Difficulties of Conveying
Economic Preferences Through Majority Voting
• “Government Failure” and Why It Occurs
• Different Tax Philosophies and Ways to Distribute a Nation’s Tax Burden
• Principles Related to Tax Shifting, Tax Incidence, and Efficiency Losses From Taxes
Copyright 2008 The McGraw-Hill Companies29-3
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Public Choice Theory• Government Failures• Revealing Preferences
Through Majority Voting–Inefficient Voting
Outcomes• Inefficient “No” Vote• Inefficient “Yes” Vote
Graphically…
O 29.1
Copyright 2008 The McGraw-Hill Companies29-4
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Revealing Preferences Through Majority Voting
• Our democratic process relies heavily on majority voting
• Majority voting does not always produce efficient outcomes b/c it fails to incorporate strength of preference of the individual voter
• Inefficient “no” vote – Read p.565 and see Figure 29.1 a
• Inefficient “yes” vote – Read p.565 and see Figure 29.1 b
• Inefficient voting may lead to underallocation or overallocation of resources
Copyright 2008 The McGraw-Hill Companies29-5
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Public Choice TheoryInefficient Voting Outcomes
InefficientMajority “No” Vote
InefficientMajority “Yes” Vote
$300 $300
Ben
efit;
Tax
Ben
efit;
Tax
0 0
$700
$250 $200$100
$350 $350
Adams
Adams
Benson
BensonConrad
Conrad
“NO” “NO” “YES” “YES”“YES” “NO”
MSB > MSC$1,150 > $900
Inefficient Since“NO” Wins!
MSB < MSC$800 < $900
Inefficient Since“YES” Wins!
Copyright 2008 The McGraw-Hill Companies29-6
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Public Choice Theory• Interest Groups• Political Logrolling
–Logrolling – Vote Trading• Paradox of Voting
–Preferences–Voting Outcomes
• Median-Voter Model
O 29.2
Copyright 2008 The McGraw-Hill Companies29-7
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Paradox of Voting• Situation in which society may
not be able to rank its preferences consistently through paired-choice majority voting
• Read Voting Outcomes p.567• Median-voter model – under
majority rule, median voter will in a sense determine election outcome
Copyright 2008 The McGraw-Hill Companies29-8
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Government Failure• Special-Interest Effect
–Pork-Barrel Politics• Rent-Seeking Behavior• Clear Benefits, Hidden
Costs• Limited and Bundled
Choice• Bureaucracy and
Inefficiency• Imperfect Institutions
Copyright 2008 The McGraw-Hill Companies29-9
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Government Failure• Government failure – inefficiency
due to characteristics of public sector
• Special-interest effect – small group of well-informed beneficiaries obtain a gov policy that give them large gains at the expense of greater number of persons
• Ex. pork-barrel politics
Copyright 2008 The McGraw-Hill Companies29-10
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Government Failure• Rent-seeking behavior – appeal
to gov for special benefits at the taxpayers’ or someone else’s expense
• Ex. tax breaks that benefit specific corporations, extensive occupational licensing
Copyright 2008 The McGraw-Hill Companies29-11
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Apportioning the Tax Burden• Benefits-Received
Principle• Ability-to-Pay Principle• Tax Progressivity
–Progressive–Regressive–Proportional
• Applications
Copyright 2008 The McGraw-Hill Companies29-12
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
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Principles of Taxation• 1. benefits-received principle –
those who benefit most from government-supplied g&s should pay in proportion to the amount of benefits they receive
• Ex. tax on gasoline• 2 Major Drawbacks:• 1. Difficulty in measuring benefits
received• 2. Logical application to
antipoverty programs
Copyright 2008 The McGraw-Hill Companies29-13
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Principles of Taxation• 2. Ability-to-pay principle – those
with larger incomes should pay more in taxes (both relative and absolute terms)
Copyright 2008 The McGraw-Hill Companies29-14
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Three tax structures• Defined by relationship b/w avg
tax rate and income• 1. progressive – tax rate
increases as income increases• Ex. Federal indiv. Income tax• 2. proportional – tax rate remains
the same regardless of income• Ex. corporate income tax• 3. regressive – average tax rate
declines as income increases• Ex. sales tax
Copyright 2008 The McGraw-Hill Companies29-15
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
End Show
Tax Incidence• Elasticity and Tax
Incidence–Division of Burden–Elasticities
• Efficiency Loss of a Tax–Tax Revenues–Efficiency Loss–Role of Elasticities
G 29.1
Copyright 2008 The McGraw-Hill Companies29-16
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Tax Incidence• Who ends up paying a tax?• Elasticity and tax incidence:• 1. with a specific supply, the
more inelastic the demand for the product, the larger the portion of tax shifted to consumer
• 2. with a specific demand, the more inelastic the supply, the larger the portion of the tax paid by the producer
Copyright 2008 The McGraw-Hill Companies29-17
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Tax IncidenceIncidence of an Excise Tax
0
2
4
6
8
10
12
14
5 10 15 20 25 Q
P
Pric
e (P
er B
ottle
)
Quantity(Millions of Bottles Per Month)
S
D
S’
Tax $2
Copyright 2008 The McGraw-Hill Companies29-18
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
End Show
Tax Incidence
0
P
P
0
Tax Incidence andElastic Demand
Tax Incidence andInelastic Demand
Demand Elasticity and the Incidenceof an Excise Tax
De
Dt
Tax TaxSt
S
St
S
Q2
P1
Pe
Pa
P1
Pi
Pb
Q1 Q2Q1
aa
b
b
cc
Copyright 2008 The McGraw-Hill Companies29-19
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Tax Incidence
0
P
P
0
Tax Incidence andElastic Supply
Tax Incidence andInelastic Supply
Supply Elasticity and the Incidenceof an Excise Tax
D D
S
SSt
St
P1Pa
Pe
P1
Pb
Pi
Q1Q2 Q1Q2
Tax Tax
aa
bb
c
c
Copyright 2008 The McGraw-Hill Companies29-20
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
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Efficiency Loss of a Tax• Aka deadweight loss of tax• Loss is society’s sacrifice to net
benefit , because the tax reduces levels of production and consumption below levels of economic efficiency
• See Figure 29.5
Copyright 2008 The McGraw-Hill Companies29-21
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
End Show
Tax IncidenceEfficiency Loss of a Tax
0
2
4
6
8
10
12
14
5 10 15 20 25 Q
P
Pric
e (P
er B
ottle
)
Quantity(Millions of Bottles Per Month)
S
D
S’
Tax $2
Tax Paid byConsumers
Tax Paid byProducers
EfficiencyLoss (or
DeadweightLoss)
Copyright 2008 The McGraw-Hill Companies29-22
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Incidence of U.S. Taxes• Personal Income Tax • Corporate Income Tax• Sales and Excise Taxes • Property Taxes• The U.S. Tax Structure
Copyright 2008 The McGraw-Hill Companies29-23
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
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Incidence of U.S. TaxesTaxes on Goods and Services as a Percentage of Total Tax Revenues
GLOBAL PERSPECTIVE
United KingdomNetherlands
GermanyItaly
SwedenCanadaFranceJapan
United States
0 5 10 15 20 25 30 35
32.730.829.2
26.926.4
26.325.4
20.117.6
Source: Organization for Economic Cooperation and Development, 2002
Copyright 2008 The McGraw-Hill Companies29-24
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Government Failure• E.P.A. House Building• 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
Last
Word “…In the News”
Copyright 2008 The McGraw-Hill Companies29-25
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
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Key Terms• public choice theory• logrolling• paradox of voting• median-voter model• government failure• special-interest effect• rent-seeking
• benefits-received principle• ability-to-pay principle• progressive tax• regressive tax• proportional tax• tax incidence• efficiency loss of a tax
Copyright 2008 The McGraw-Hill Companies29-26
Public Choice TheoryGovernment FailureApportioning the Tax BurdenTax IncidenceIncidence of U.S. TaxesLast Word
Key Terms
End Show
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