Term
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Definition
The statutory incidence of a tax indicates who is legally responsible for the tax.
- Consumer vs Business (e.g. sales tax, consumer pays)
- Since prices may change in response to the tax, this doesn't tell us who really pays for it |
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The economic incidence of a tax is the change in the distribution of private real income induced by a tax.
- Economic burden of a tax (where the price is actually paid)
- Depending on elasticity involved, there will be some shifting --> depends on individuals' sources and uses of income |
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The difference between statutory incidence and economic incidence.
- What forces determine the extent to which these two differ?
*Elasticity: change in one variable caused by the change in another variable |
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| An individual's average tax rate is the same at each level of income. The ratio of taxes paid to income is constant regardless of income level. |
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| A tax system under which an individual's average tax rate increases with income. |
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| A tax system under which an individual's average tax rate decreases with income. |
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Occurs when freely functioning markets, operating without government intervention, fail to deliver an efficient or optimal allocation of resources.
- Market isn't perfectly competitive
- Not efficient bc economic and social welfare can't be maximized |
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Definition
| Getting the most output for a given input (Ideal Measure) |
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| Requirements for an Efficient Market |
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Definition
1. Information is perfect & free
2. All consumers and firms are price-takers
3. All decisions are private
4. All goods are public |
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Cost or benefit that occurs when the activity of one entity directly affects the welfare of another entity in a way that is outside the market mechanism.
- Reduce economic efficiency
- The activity isn't reflected in the market price |
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Term
| Theories on Government Growth |
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Definition
• Citizen Preferences – citizens want a larger government
• Marxist View – public sector must expand to absorb private excess production
• Chance Events – random events increase growth and inertia prevents return to prior level
• Changes in Social Attitudes – growth is caused by unrealistic demands that ignore opportunity costs
• Income Redistribution – groups use the government to redistribute income to themselves |
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Definition
The rate of interest used to compute present value.
- Used to convert future costs and benefit values into present values |
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The sum of all discounted benefits and discounted costs for the duration of a project.
- Most commonly used measure of the efficiency of a public investment project. |
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Definition
Social welfare depends on individuals’ utilities.
- Utilitarian Social Welfare Function: W = F(U1, U2, ,,,, Un)
-- A change in Ux without a change elsewhere = increase W
- Promoting the greatest good for the greatest # of people |
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Term
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Definition
The concept or idea of fairness in economics.
- Horizontal Equity: people in equal econ positions should be treated equally. Utility definition of horiz. equity: method of classifying people of "equal positions" in terms of their utility levels
- Vertical equity: fairness up and down the wealth ladder |
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Term
| General Equilibrium Model |
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Definition
The study of how various markets are interrelated. Used to model the burden of a tax – more complex than partial equilibrium model. 2-sector, 2-factor models are common: 9 possible taxes (certain combos equivalent to others)
- A tax on a single factor in its use only in a particular sector can affect the returns to all factors in all sectors -- ripple effect. E.g. the Harberger Model |
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Definition
example of the General Equilibrium Model.
- Harberger pioneered the application of gen equil models to tax incidence. |
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Definition
A loss of welfare above and beyond taxes collected (or a cost beyond the tax revenue collected). AKA welfare cost/deadweight cost
ex high taxes on airport rental cars
*Lump sum tax |
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Definition
A tax whose value is independent of the individual's behavior
- certain amount must be paid regardless of taxpayer's activity
- unavoidable, no excess burden |
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Definition
| A change in income that has the same effect on utility as a change in the price of a commodity |
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Definition
shows how quantity demanded changes when prices change, holding utility constant (income compensated)
- Excess burdens depend on movement along the compensated demand curve
- Income Effect; Substitution Effect; Consumer Surplus |
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Definition
| Change in consumption based soley on a change in real income. Related to the Compensated Demand Curve. |
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Definition
| Individuals tend to consume more of one good and less of another when price decreases. Related to the Compensated Demand Curve. |
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Definition
| Difference between what you pay for something and what you are willing to pay for something. Related to the Compensated Demand Curve. |
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Term
| Optimal Commodity Taxation |
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Definition
Sbows how to raise a given amount of revenue with a minimum of excess burden (AKA Efficient Commodity Tax Theory)
- Unless lump sum tax, we know that there will be an excess burden. Try to find a system of taxes with the least burden with this equation: w(T-1)=PxX+PyY
Assumptions: a)consumer only buys 2 commodities (x & y); b) we assume wage is a fixed amount
- Edgeworth's Model: optimal tax derives the criteria for a good tax using an underlying social welfare function, W=f(U1, U2,...,Un) |
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Term
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Definition
To minimize excess burden, tax rates should be set so that the proportional reduction in the quantity demanded of each good is the same
• Excess burden is a consequence of distortions in quantities, not prices.
• Proportional reduction because we’re dealing with commodities rather than prices.
*NOTE: Ramsay Rule can also be expressed in terms of elasticity (see inverse elasticity rule card) |
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Term
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Definition
The Ramsay Rule expressed in terms of elasticity:
when goods are unrelated in consumption, relative tax rates should be inversely related to compensated demand elasticities.
o Efficient decisions distort taxes as little as possible
o Potential for distortion is greater the more elastic the demand for a commodity (elastic meaning there are other options)
o Efficient taxation requires that you tax on goods that are not elastic |
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Term
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Definition
When there are 2 commodities, efficient taxation requires taxing the commodity that is complementary to leisure at a relatively high rate
• Ex: entertainment, video games, alcohol
• Taxing complements to leisure provides an indirect way to “get at” leisure, and move closer to the perfectly efficient outcome that would be possible if leisure were taxable (taxing leisure would create the “first best” result if possible) |
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Term
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Definition
Altering behavior in such a way as to reduce your legal tax liability
• There’s nothing illegal about tax avoidance |
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Term
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Definition
not paying taxes legally due
• Considered “cheating”
• Various ways to commit tax fraud: double bookkeeping, moonlight for cash, underreport income, deal in cash |
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Term
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Definition
People in equal positions should be treated equally
•To make horizontal equity operational, one must define “equal positions”
o Income (conventionally measured) is inadequate in this context because it represents the outcomes of peoples’ decisions not their position
o Wage rate is also an insufficient measurement because it doesn’t account for human capital investments – it is also difficult to compute
o Utility definition is more precise, but has very different policy implications and contains and inherent bias toward the pretax status quo
o Other definitions focus on the rules by which taxes are chosen |
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Term
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Definition
| Fairness in changing tax structures |
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Term
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Definition
Standard for defining income. The money value of the net increase in an individual's power to consume during a period. Requires the inclusion of all sources of potential increase in consumption, regardless of whether the actual consumption takes place or what form it takes. Decreases in potential to consume should be subtracted (e.g. business expenses).
Satisfies both fairness and efficiency.
Income = Consumption + ΔNet Worth |
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Term
| Difficulties with the Haig-Simmons Criterion |
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Definition
- Distinguishing between consumption expenditures and costs of obtaining income
- Difficulty in measuring capital gains and losses, esp when unrealized.
- Imputed income from durables.
- The valuation of in-kind services |
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Term
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Definition
| Allows a certain amount of income or other value to be legally excluded to avoid or reduce taxation. An amount per family member that can be subtracted from adjusted gross income. Phased out for people at high-income levels. |
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Term
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Definition
| A specific type of expenditure that can be subtracted from adjusted gross income in the computation of taxable income. Must list each item separately on the tax return and prove that the expenditures have been made. Entails high administrative costs. |
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Term
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Definition
| Subtraction of a fixed amount from adjusted gross income that does not require documentation. Used in lieu of itemizing deductions -- simpler. Adjusted annually for inflation. |
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Term
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Definition
| The proportion of the last dollar of income taxed by the government. The *change* in taxes paid with respect to a change in income. |
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Term
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Definition
| Ratio of taxes paid to income. If increases with income, it's progressive. If falls with income, its regressive. |
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Term
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Definition
Marginal tax rate is constant throughout the entire range of incomes; limited deductions. Trade-off is btwn size of personal exemption and the marginal tax rate (higher exemption = higher marginal tax rate applied to maintain revenue)
Pro: reduces excess burden & incentive to cheat; simplicity; equity
Con: Shifts burden from rich to middle class; simplicity is an illusion |
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Term
| Adjusted Gross Income (AGI) |
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Definition
| Total income from all taxable sources less certain expenses incurred in earning that income. Less certain expenses = "above-the-line" deductions. |
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Term
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Definition
| A graph of the tax rate-tax revenue relationship. Shape determined by the elasticity of labor with respect to the net wage. Equilibrium point = tax rate where you generate optimal source of revenue. |
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Term
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Definition
The theory that individuals' consumption and saving decisions during a given year are based on a planning process that considers lifetime circumstances.
- shows the effect of taxes on saving
- amount saved per year depends on income that year + expected future income + past income received (lifetime resources) |
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Term
| Tobin's Model of Portfolio Consumption |
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Definition
Individuals make their decisions about whether to invest in an asset based on 2 characteristics-- the expected return on the asset, and how risky that return is. Prefer high returns and low risk. Relationship between taxes and portfolio compositions.
*Impact of proportional tax with Full Loss Offset (see card) |
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Term
| Items included in Haig-Simmons Income |
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Definition
- Employer pension contributions and insurance purchase
- Transfer payments, including Social Security benefits, unemployment compensation, and welfare
- Capital Gains - an increase in the value of an asset (Realized vs unrealized)
- Income in-kind (Imputed rent) |
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Term
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Definition
| A subtraction from tax liability (not taxable income). Credit value is independent of the individual's marginal tax rate (whereas deductions are dependent on marginal tax rates). |
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Definition
Part of Tobin's Model of Portfolio Composition. Individuals can deduct all losses from taxable income -- turns govt into the investor's silent partner.
- If investor gains, govt shares in gain (and vice versa).
- Impact on returns: highs are less high, lows are less low
- Impact on risk: risk both less desirable and more desirable. Reduces attractiveness of risky assets bc positive rate of return is lowered by presence of tax. BUT makes more attractive bc it decreases risk. |
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