economic welfare and income...
TRANSCRIPT
Understanding Economics
4th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson
Chapter 7
Economic Welfare and Income Distribution
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives
In this chapter you will: 1. learn about the concepts of consumer surplus and
deadweight loss, and come to appreciate how these concepts can further our understanding of the operation of markets
2. examine spillover costs and benefits and the ways that government addresses these issues
3. see how income is distributed among Canadian households, how this distribution is measured, and the factors underlying this distribution
4. consider the causes of poverty and the way poverty is measured
5. evaluate the effectiveness of government intervention to change the distribution of income
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Marginal and Total Benefit
Both consumers and producers gain from market activity.
For consumers, these gains can be measured by marginal and total benefit.
Marginal benefit is the extra satisfaction, expressed in dollar terms, from consuming a certain unit of a product.
Total benefit is the total satisfaction, expressed in dollar terms, from consuming a product.
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Consumer Surplus (a)
http://www.reffonomics.com/TRB/chapter4/consumersurplus.swf
Consumer surplus shows the extent to which consumers pay a lower price than the highest one they are willing to pay.
It is defined as the net benefit, expressed in dollar terms, from buying a product at its market price.
It is found, either for an individual or in an entire market, by subtracting total expenditure from total benefit.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Consumer Surplus (b) Figure 7.1, page 172
0 1 2 3 4
Quantity (pizzas per week)
Consumer’s Demand Curve for Pizzas
Consumer’s Demand
Schedule for Pizzas
Quantity
Demanded
(D)
(pizzas)
Total Benefit
($)
Price
($ per
pizza)
$14 1
12 2
10 3
Pri
ce
($
pe
r p
izza
)
4
8
12
16
D
A = $6
B = $30 14
26 (14 + 12)
36 (14 + 12 + 10)
A+B = Total Benefit
B = Total expenditure
10
14
• The consumer pays $10 for each of the 3 pizzas but gets
more marginal benefit from the first 2 pizzas.
• At 2 pizzas the $12 marginal benefit can be split into the
$10 market price and the $2 surplus for that pizza.
• The consumer’s total benefit from eating pizzas is area
AB, and the total expenditure is area B.
• The consumer surplus is area A.
Consumer Surplus (c) Figure 7.2, page 173
0 50 100
Quantity (thousands of pizzas per week)
Market Demand Curve for Pizzas
Market Demand Schedule
for Pizzas
Quantity Demanded
(D)
(thousands of
pizzas)
Price
($ per
pizza)
18 0
14 50
10 100 P
ric
e (
$ p
er
piz
za
)
4
8
12
16
D
2
6
10
14
A = $400,000
B = $1 million
A+B = Total Benefit
B = Total Expenditures 18
• When consumers in the pizza market are charged a price of
$10 they consume 100 000 pizzas
• Adding up consumers’ marginal benefits for all these pizzas
gives a total benefit in the market equal to area AB
• The consumers’ total expenditure on pizzas is area B
• Total consumer surplus in the market is found by subtracting
area B from area AB so it’s equal to area A
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Producer Surplus (a)
http://www.reffonomics.com/TRB/chapter4/producersurplus1.swf
Producer surplus shows the extent to which producers receive a price different from the lowest one they are willing to accept.
It is defined as the difference between the price received from selling each unit of a product and the marginal cost of producing it.
Producer Surplus
At a market price of $10 producers in the pizza market supply 100 000 pizzas
Because market price and marginal cost are the same for the 100 000 pizza there is no producer surplus at this unit
For every previous pizza produced, price exceeds marginal cost giving a total producer surplus equal to area C
Subtract the area under the supply curve D from the total revenue shown by area CD
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
The Case of Perfect Competition
In a perfectly competitive market, the requirement of marginal-cost pricing is met.
Based on this requirement, equilibrium will occur where marginal benefit equals marginal cost, and both consumer surplus and producer surplus are maximized.
The Case of Perfect Competition Figure 7.4, page 175
4
14
12
10
8
6
16
50 100 150
Quantity (thousands of pizzas per week)
0
Pri
ce
($
pe
r p
izza
)
D
18 S
Consumer Surplus
2
Producer Surplus
• If the pizza market is perfectly competitive, then at the equilibrium price of $10 and output of 100 000
pizzas the requirement of marginal-cost pricing is met while the consumer surplus and producer
surplus are both maximized
• At quantities below 100 000 pizzas, marginal benefit exceeds marginal cost
• At quantities above 100 000 pizzas marginal cost exceeds marginal benefit so that a reduction in
quantity will bring about greater economic welfare
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When a Market Becomes
Uncompetitive
When a market becomes uncompetitive, for example due to government policy, price rises. The result is that a portion of the consumer surplus becomes producer surplus.
Also there is a net reduction in both the consumer surplus and producer surplus due to the reduction in market output. This net reduction is known as the deadweight loss.
When a Market Becomes Uncompetitive Figure 7.5, page 176
0
Deadweight
Loss
4
14
12
10
8
6
16
50 100 150
Quantity (thousands of pizzas per week)
Pri
ce
($
pe
r p
izza
)
D
18
S
2
75
• If some pizza-makers are allowed to collude, they might restrict output to 75 000 pizzas raising
market price to $12
• Area E represents the transfer of consumer surplus into producer surplus which is gained by
the colluding pizza-makers
• Area FG represents the deadweight loss—combining a fall in both consumer surplus and
producer surplus—as a result of the lower output
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7.2 Spillover Costs (a) http://www.reffonomics.com/TRB/chapter15/LightHouse1.swf
Spillover costs are the negative external effects of producing or consuming a product.
http://www.reffonomics.com/textbook2/microeconomics2/swiftfile/externalities/negativeexternality.swf
Adding these costs to private costs raises the supply curve.
The preferred outcome is at a lower quantity than in a perfectly competitive market.
Government intervention (e.g. an excise tax) can produce the preferred outcome.
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Spillover Costs (b) Figure 7.6, Page 179
0 1 2 3 4 5 6 7
Millions of Litres
Market Demand Curve for Strawberries
Demand and Supply
Schedules for Gasoline
Quantity
Demanded
Quantity
Supplied
Price
($ per
litre)
6
5
4
3
2 P
ric
e (
$ p
er
litr
e)
0.50
1.00
1.50
2.00
2.50
(millions of litres)
8
a
b
Spillover
Costs,
Excise
Tax
D S0 S1
8
7
6
5
4
4
5
6
7
8
$2.50
2.00
1.50
1.00
0.05
(D) (S0) (S1)
• Without government intervention, equilibrium occurs at point b
• To account for spillover costs, the government may impose an excise tax
of $1/litre
• The supply curve shifts from So to S1 moving equilibrium to point a
Spillover Benefits (a)
Spillover benefits are the positive external effects of producing or consuming a product.
http://www.reffonomics.com/textbook2/microeconomics2/swiftfile/externalities/positiveexternality.swf
Adding these benefits to private benefits raises the demand curve.
The preferred outcome is at a higher quantity than occurs in a perfectly competitive market.
Government intervention (e.g. a consumer subsidy) can produce the preferred outcome.
Public good –a product whose benefits cannot be restricted to certain individuals (e.g. national defence)
Spillover Benefits (b) Figure 7.7, page 180
0 8 9 10 11 12 13
Thousands of Students
Demand and Supply Curves for an
Engineering Education Demand and Supply Schedules
for an Engineering Education
Enrollment
Demanded
Quantity
Supplied
Tuition
($ per
year)
10
11
12
13
14
Tu
itio
n (
$ p
er
ye
ar)
1000
2000
3000
4000
5000
(thousands of students)
14
a
b
6000
Spillover
Benefits,
Student
Subsidy
S D0 D1
8
9
10
11
12
$6000
5000
4000
3000
2000
12
11
10
9
8
(S0) (S1) (S)
• Without government intervention in the market for engineering
education, equilibrium occurs at point a
• If spillover benefits are determined to be $2000 per student,
government can create a subsidy for students pursuing a career in
engineering
• The demand curve shifts from Do to D1 and the new equilibrium is at
point b with $2000 of each student’s tuition paid
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Canadian Distribution of Income
Canada’s distribution of income can be shown using the Lorenz curve.
This curve is a graph showing the cumulative distribution of income for households categorized into five groups based on their income levels.
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Income Distribution in Selected Years Figure 7.8, page 182
Lowest 20% Second 20% Third 20% Fourth 20% Highest 20%
Average of total
1951
4 11 18 23 43
1961
4 12 18 25 41
1971
4 11 18 25 43
1981
5 11 18 25 42
1991
5 10 17 25 44
2004
4 10 16 24 47
Average Income (2004)
$12 900 26 900 47 500 72 300 142 700
61 000
Percentage of Total Pre-Tax Income Received by Each Fifth of Households
http://www40.statcan.gc.ca/l01/cst01/famil106a-eng.htm
http://www40.statcan.gc.ca/l01/cst01/famil105a-
eng.htm?sdi=income
http://www40.statcan.gc.ca/l01/cst01/famil21a-
eng.htm?sdi=average%20income
The Lorenz Curve (page 183)
A graph showing the cumulative distribution of income among a country’s households
http://www.reffonomics.com/TRB/chapter19/LorenzCurveLesson5.swf
http://www.econedlink.org/lessons/index.php?lid=885&type=educator
http://www.youtube.com/watch?v=AQWN_DqcHG4&safety_mode=true&persist_safety_mode=1&safe=active
http://visualeconomics.creditloan.com/income-distribution-by-country/
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Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Interpreting the Lorenz Curve
In using the Lorenz curve as a distribution measure, it is useful to compare it with curves for two hypothetical economies:
For an economy of perfect equality, where all have identical incomes, the Lorenz curve would be a 45-degree line emanating from the origin.
For an economy of perfect inequality, where one household receives all of the economy’s income, the Lorenz curve would follow the horizontal and vertical axes of the graph.
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The Gini Coefficient
The Gini coefficient provides a single numerical measure of income distribution.
It is defined as the area between a Lorenz curve and the 45-degree line of perfect equality, divided by the entire triangular area under the 45-degree line.
The coefficient varies from 0 to 1, with 0 representing perfect equality and 1 representing perfect inequality.
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Wage Determinants (a)
There are seven main wage determinants:
labour productivity
education
experience
job conditions
regional disparities
market power
discrimination
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Labour Productivity
In any given market, labour productivity determines the wage of that worker.
Labour productivity is defined as output per worker in a given time.
It is the most important determinant of wages.
The output of each worker varies because of such factors as the worker’s ability to do the job and the state of technology
With more capable workers or a technological innovation, labour productivity rises, pushing up the prevailing wage
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Distribution of Earnings (2004) Figure 7.10, page 185
Earnings
Under $5000 $5000 - $9999 $10 000 - $14 999 $15 000 - $19 999 $20 000 - $24 999 $25 000 - $29 999 $30 000 - $34 999 $35 000 - $39 999 $40 000 - $44 999 $45 000 - $49 999 $50 000 - $49 999 $60 000 and over
Percentage of All Earners
15.7 11.2 8.9 7.3 7.1 6.9 6.3 5.8 5.2 4.2 6.5 15.0
100.0
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Education
In general, the more education a worker needs to perform a job, the higher the pay
usually adds to a worker’s pay but has opportunity costs as well
serves two main purposes (consumption and investment in human capital)
A student will undertake an educational program if its benefits (both monetary and nonmonetary) exceed its opportunity costs.
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Education and Average Family Income
(2004) Figure 7.11, page 185
Education
University Degree Post-secondary diploma Some post-secondary High school graduate Some high school 0 to 8 years of school
Average Incomes (Managerial)
$80 300 53 100 44 300 55 900 36 400 31 600
Experience
On-the-job experience increases a worker’s productivity, pushing up the wage rate
In many industries, workers gain certain privileges the longer they work for a single employer
Seniority rights: the workplace privileges provided to workers who have the longest experience with their employer
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Experience
Older workers are often paid higher wages and can apply first for promotions and overtime work, allowing them to earn higher incomes than their younger colleagues
The positive effect of workplace experience on earnings is one of the main reasons average incomes rise with age during the first part of a person’s working life
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Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Age and Average Income (2000) Figure 7.12, page 187
Job Conditions
Working conditions can make one job less appealing than the other
In order to attract workers to less-appealing occupations, employers must offer higher wages
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Regional Disparities
In Canada, workers in the same occupation earn different incomes, depending on the region they live in
In a perfectly functioning labour market, workers in a single occupation would move from one part of the country to another until wage disparities in this occupation were eliminated
Labour trends tend to be immobile—why?
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Market Power
As a rule, earnings in labour markets that are unionized tend to be higher than in non-unionized markets
Professional groups (doctors and Lawyers) can play a similar role in providing their members with market power
There are two main types of labour unions:
Industrial unions include all workers in a certain industry.
Craft unions include workers in a particular occupation and restrict who can be members.
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Job Discrimination
Job discrimination relates to hiring, wage, and promotion decisions based on criteria other than a worker’s credentials or performance.
Job discrimination can be direct, in which case employees are paid different amounts for substantially the same work.
Job discrimination can also be indirect, involving a discriminatory division of jobs.
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Reasons for Income Inequality (Other
Incomes)
There are three main reasons for income inequality in addition to wage determinants:
Risk-taking--entrepreneurs
Ability—professional athletes
Wealth—ownership of financial assets such as stocks and bonds or real assets such as land and buildings
Wealth is more unequally distributed than income.
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Distribution of Wealth in Selected
Countries Figure 7.13, page 189
Sweden (1975)
Canada (1984)
France (1986)
US (1986)
0
10
20
30
40
50
60
70
80
90
Top 1% Top 5% Top 20%
Share
of
Wealth H
eld
by
Top W
ealth H
old
ers
(%
)
Assignment
Page 190 7.3 Practice Questions 1 and 2
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7.4 Poverty
http://www.cbc.ca/news/canada/story/2011/09/28/poverty-report.html
One of the main reasons behind the economic goal of income equity is the desire to minimize poverty
Poverty is a situation in which a person’s income is inadequate to provide the necessities of life such as food, clothing and shelter
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
The Poverty Line
The poverty line is the income level below which a household is classified as poor.
In Canada, the average family spends 44% of its household after-tax income on food, clothing and shelter
The Poverty Line
Statistics Canada defines as poor any household that spends more than 64% of its after-tax income on food, clothing, and shelter.
In dollar terms, the poverty line (also known as the low-income cut-off—LICO) depends on the number of household members and the size of the community they live in.
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The Poverty Line
People in rural areas or small towns can generally live more cheaply than those in urban centres
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Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
The Poverty Line for Various
Households (2004) Figure 7.14, page 191
1 person 2 persons 3 persons 4 persons 5 persons 6 persons 7 or more persons
500 000 and over
$16 853 20 512 25 542 31 865 36 285 40 241 44 107
100 000 to 499 999
$14 253 17 347 21 601 26 948 30 686 34 032 37 378
30 000 to 99 999
$14 075 17 131 21 332 26 613 30 032 33 610 36 931
Less than 30 000
$12 617 15 357 19 121 23 856 27 165 30 127 23 089
$11 025 13 418 16 709 20 844 23 736 26 324 28 912
Urban Areas (categorized by size)
Rural Areas
Size of Household Unit
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The Incidence of Poverty
Using Stats Canada’s LICO poverty line an estimated 3.5 million Canadians lived in poverty in 2004
870,000 were children under the age of 18
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The Incidence of Poverty (b) Figure 7.15, page 192
All persons
Gender Males Females Age Under 18 Between 18 and 64 65 and over
Persons in economic families Males in economic families Females in economic families Elderly persons in economic families Persons under 18 in female lone-parent families Persons under 18 in two-parent families
Unattached individuals Males Females Elderly males Elderly females
Percentage of Households Below the Poverty Line in 2004
11.2 10.6 11.7 12.8 11.7 5.6
8.1 7.5 8.6 1.6 40.0 8.1
29.6 28.7 30.5 11.6 17.0
Gender Household Type and Age
Poverty rates are higher among unattached individuals than among those who are part of an economic family
Unattached females are more likely to be poor than unattached males
Single-parent families are more likely to be poorer than two-parent families
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Employment
While poverty is more common among the unemployed, a notably high proportion of the employed are poor as well
For nonelderly unattached individuals classified as poor a large portion are employed for at least part of the year
This group is known as the “working poor”
They are often found in primary industries like fishing where wages are low and seasonal employment is common
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Region
Historically poor households tend to be concentrated in certain regions particularly the Atlantic provinces and parts of Quebec
Poverty exists throughout Canada e.g. over a third of Canada’s poor live in Ontario
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Debates over the Measurement of
Poverty
In recent years there has been considerable criticism of the use of Statistics Canada’s LICO measure
The federal government has recently introduced an alternative measure of poverty known as the Market Basket Measure (MBM) which is based on an absolute definition of those items considered as necessities
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
7.4 Debates over the
Measurement of Poverty
A household making an income lower than the amount needed to buy these items is then considered poor using the MBM measure
International Labour Organization (ILO) stats
http://www.ilo.org/global/topics/economic-and-social-development/poverty/lang--en/index.htm
http://www.globalissues.org/article/4/poverty-around-the-world#WorldBanksPovertyEstimatesRevised
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
7.5 The Canadian Welfare Society
A welfare society is one in which the government plays a major role in attempting to ensure the economic well-being of its citizens.
Transfer payments and personal income taxes are the most important elements of Canada’s welfare society.
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Transfer Payments and Income
Equity
Transfer payments are now usually based on the principle of means testing rather than universality.
Universality —benefits apply to all individuals no matter what their incomes
Advantage: treating everyone in the same way
Drawback: expense—in order to provide substantial help to those who needed it most a large sum of money was paid to all recipients
Transfer Payments and Income
Equity
Means Testing —transfer payments vary according to a recipient’s income
Advantage: benefits can be directed to those who need them most so poor households receive the highest payments
Drawback: governments may use means testing to limit spending by narrowing qualifications
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Transfer Payments and Income
Equity
Transfer payments are greatest as a percent of income for the poorest fifth of households, but the second-poorest fifth of households receives the largest share of these payments.
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Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Transfer Payments and Income Equity (b) Figure 7.16, page 195
Lowest 20% Second 20% Third 20% Fourth 20% Highest 20%
Average of Total
Average Transfer Payments Received (2004)
$7 000 9 300 8 000 6 500 4 800
7 100
Transfer Payments as a Percent of Total Income
(2004)
54.5% 31.4 16.9 9.0 3.4
11.7
Share Received of Total Transfer
Payments (2004)
19.7% 26.1 22.5 18.3 13.5
Impact on Income Distribution
Government transfer payments to individual households from all three levels of government are an average of between 10 and 20% of households’ income
Payments to unattached individuals represent a larger proportion, as a rule, than for families
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Principles of Taxation
There are two main principles of taxation:
benefits received (e.g. gasoline taxes for roadwork)
ability to pay (e.g. personal income tax)
Benefits Received
Suggests that taxes should be geared to the benefits each taxpayer gains from government activity
In this case government services are paid for in the same ways that products are bought and sold in the private sector
The guiding philosophy behind some taxes e.g. proceeds from gas taxes are often earmarked for road construction and maintenance
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Ability to Pay
The philosophy more closely tied to the goal of income equity
According to this principle, taxes should vary in the proportion of a taxpayer’s financial resources
It is difficult to measure ability to pay
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Taxes and Income
progressive taxes: increase as a proportion of income as income rises
Well-off tax payers are taxed more in both $ terms and % terms
http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html#federal
http://www.cra-arc.gc.ca/tx/bsnss/tpcs/pyrll/t4032/jn10/menu-eng.html
Proportional Taxes
proportional taxes: stay constant as a proportion of income as income rises
While taxpayers with different incomes pay proportionately the same tax, the well-off taxpayer pays a higher $ amount
E.g. Income $10 000 taxed at 6% pays $600
$20 000 taxed at 6% pays $1 200
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Regressive Taxes
regressive taxes: decrease as a proportion of income as income rises
Taxpayers with low incomes pay proportionately more of their incomes for the tax than do well-off taxpayers even though the well-off taxpayer may pay more as a $ amount
http://www.reffonomics.com/TRB/chapter23/FiscalPolicy/typesoftaxesinteractive3b.swf
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Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Taxes and Income Equity
Sales and excise taxes tend to be regressive (unless combined with a system of tax credits) since the poor spend a higher proportion of their incomes on consumption items than do the rich who are most likely to save part of their incomes
Property taxes are often regressive, largely because the poor devote a higher proportion of their incomes to housing than the rich do
Taxes and Income Equity
Corporate income taxes are difficult to classify as either progressive or regressive
To the extent that these taxes these taxes reduce the income of shareholders—a rich group of Canadian society—they are progressive
Corporations that have considerable market power may succeed in passing on the burden of tax to consumers in the form of higher prices for their product—in this case the corporate tax is regressive
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Taxes and Income Equity
Personal income taxes are progressive, with the proportion of income paid in tax rising significantly with a household’s income level
Post-tax incomes in Canada are much more equally distributed than they would otherwise be
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Copyright © 2008 by McGraw-Hill Ryerson Limited. All rights reserved.
Personal Income Taxes and Income
Equity (2004) Figure 7.17, page 197
Lowest 20% Second 20% Third 20% Fourth 20% Highest 20%
Average of Total
Average Personal Income Taxes
Paid
$ 700 2 700
6 300 11 900 31 900
10 700
Personal Income Taxes as a Percent of Total Income
5.4% 9.1 13.3 16.4 22.4
17.5
Share Paid of Total Personal
Income Taxes
1.2% 5.0 12.0 22.3 59.5