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- [Tyler] Today we begin the first of[br]several talks on taxes and subsidies.

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We're not going to be talking about income[br]taxes and income subsidies. Those are

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typically topics for macroeconomics.[br]Instead, we'll be talking about taxes and

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subsidies on goods, like a sales tax or a[br]subsidy for wheat. These are also called

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commodity taxes and subsidies. So let's[br]get going.

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We're going to be emphasizing

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three important ideas about commodity[br]taxation. First, who pays the tax does not

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depend on who writes the check to the[br]government. For example, suppose the

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government is taxing apples. The[br]government could make the buyer of apples

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pay for each apple that they buy. Or they[br]could require the sellers of the apples

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pay for each apple that they sell. What[br]we're going to show is that, from the

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point of view of the buyers or sellers, it[br]actually doesn't matter how the tax is

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placed. The actual outcomes are going to[br]be identical. Another way of putting this

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is that the economic incidence of the tax,[br]who actually pays the tax, does not depend

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on the legal incidence, who is in law[br]required to write the check to the

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government. This will become a little bit[br]clearer as we go along. Don't worry about

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it if it's not clear yet. The second key[br]point, who pays the tax does depend on the

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relative elasticities of demand and[br]supply. In fact, we can summarize point

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one and point two by saying, who pays the[br]tax depends not on the laws of congress

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but rather on the laws of supply and[br]demand. The third point is that commodity

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taxation raises revenue, but it also takes[br]away some gains from trade, that is, it

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creates deadweight loss. We're going to be[br]looking at point one in this talk, and

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then we'll move on to point two, and point[br]three in later talks. So, let's start with

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point one.[br]Let's begin our analysis of commodity

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taxation by assuming the suppliers are the[br]one who have to send the check to the

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government. That is the legal incidence of[br]the tax falls on the suppliers. What does

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a tax on the suppliers do? We can think[br]about a tax on suppliers as increasing

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their costs. This is going to shift the[br]supply curve up by the amount of the tax,

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so the supply curve shifts up like this.[br]Another way of thinking about this, is to

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remember that the supply curve tells us[br]the minimum amount which suppliers require

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to offer a given quantity in the[br]marketplace. The tax, that is going to

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increase the minimum amount that suppliers[br]are requiring to offer that quantity in

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the marketplace. It shifts up that minimum[br]amount required by just the amount of the

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tax. With the new supply curve we find the[br]new equilibrium. The market equilibrium

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moves from point A to point B. What we see[br]is that of course, the quantity which is

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exchanged goes down, in addition, the[br]price paid by the buyers goes up. How much

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do the suppliers get? The suppliers[br]collect this amount, the price paid by the

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buyers, but now they have to give a[br]certain amount of that, the tax to the

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government. The suppliers end up receiving[br]this amount after tax, right here. In

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other words, what the tax does, it means[br]that the buyers pay more than before, and

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the sellers receive less than before.[br]Without any tax, the price the buyers pay

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is the same as the price the supplier[br]receives. With the tax the buyers pay a

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certain price, but the sellers get less[br]than that. They get whatever the buyers

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pay minus of course, the tax. That's the[br]situation when the suppliers pay the tax,

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or the suppliers have to send the check to[br]the government. Let's now look at what

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happens when it's the buyers who must send[br]the check to the government. Now, we look

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at the situation when the legal incidence[br]is on the buyers. We begin just as before

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with the equilibrium with no taxes.[br]No taxes on sellers or buyers. Again, that

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equilibrium is at point A. I've also[br]included this supply curve here. This is

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the supply curve when the tax is on the[br]suppliers. It's the supply curve from the

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previous problem. It's not relevant for[br]this problem. I've included it rather to

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remind us of where the equilibrium on the[br]previous problem was. You can think of

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this as a kind of ghost supply curve. It's[br]a supply curve from the previous problem

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coming back to haunt us. So what's the[br]effect of a tax on the demanders? Think

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about it this way. Suppose the most you[br]were willing to pay for an apple is one

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dollar. Again, most you're willing to pay[br]for that apple, a dollar, no more. Now,

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suppose you learned that the government[br]has instituted a new tax. For every apple

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you buy, you must now pay 25 cents to the[br]government. Now, how much are you willing

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to pay to suppliers for that apple?[br]You're only willing to pay the maximum

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amount that you're going to be willing to[br]pay suppliers is now 75 cents. The maximum

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amount that apple was worth to you is a[br]dollar. If you know you're going to be

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taxed 25 cents if you buy that apple, then[br]the most you're going to be willing to pay

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the supplier is 75 cents, because 75 cents[br]plus the 25 cent tax to the government,

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that's one dollar. That's the most you're[br]willing to pay to get the apple. In other

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words, what a tax on demanders does is it[br]reduces their willingness to pay, and that

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means the demand curve shifts. Which way?[br]The demand curve shifts down by the amount

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of the tax. So let's shift. The tax is[br]exactly the same amount that was before.

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Let's shift the demand curve down by the[br]amount of the tax. We find now that the

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new equilibrium is at point B. Notice[br]first of all, that the quantity has

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declined. The quantity exchange has[br]declined by exactly the same amount as

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before in the previous problem. What about[br]the price received by the sellers? The

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sellers now receive this price.[br]Low and behold, that's exactly the same

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price as it was before. How about the[br]price paid by the buyers? The buyers now

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pay what they paid to the suppliers, plus[br]they must pay the tax to the government.

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This distance is the tax. Low and behold,[br]the price after tax paid by the buyers is

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once again exactly what it was when the[br]tax was on the suppliers. When the tax is

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on the buyers, the buyers pay more than[br]before. The sellers receive less than

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before by exactly the same amounts. The[br]quantity declines by the same amount, too.

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The net price, or the total price paid by[br]the buyers is the same. The total price

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received by the sellers is the same. Now[br]that you know the idea, I'm going to show

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you a simpler way of demonstrating this.[br]What we just showed is that it doesn't

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matter whether the suppliers must write[br]the check to the government or the

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demanders must write the check to the[br]government in order to pay the tax. In

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other words, we can analyze the tax by[br]shifting the supply curve up, or by

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shifting the demand curve down. As long as[br]we analyze the same size tax, we're going

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to get equivalent outcomes. It's going to[br]come out the same whichever choice of tax

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we make. There's actually a simpler way of[br]thinking about this. What we can think

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about such a tax is doing, is driving a[br]wedge between what the buyer is paying and

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what the sellers receive. When there's no[br]tax, what the buyers pay is what the

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sellers receive, but when there's a tax,[br]the buyers pay more than what the sellers

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receive. The difference is what the[br]government gets. The difference is the

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amount of the tax. So let's think about[br]this as a tax wedge. Let's say this tax

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wedge, this side is, let's say a dollar.[br]Another way of analyzing the tax is to

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drive this wedge into the diagram until[br]the top of the wedge hits the demand

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curve, and the bottom of the wedge just[br]touches the supply curve. Let's take a

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look. I'm going to drive the wedge in.[br]What this tells us is that the price the

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buyer pays will be here, point B.[br]The price the suppliers receive will be

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point D. The difference is the tax. For[br]instance, if the buyers end up paying

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$2.65, then the sellers must receive $1.65[br]if the tax is a dollar. Similarly, if the

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suppliers receive a $1.65 and the tax is a[br]dollar, the buyers must be paying $2.65.

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With this wedge, we could read off the[br]diagram the price the buyer pays, the

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price the seller receives, and the[br]quantity exchanged. We don't even have to

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shift any curves. We just drive the wedge[br]into this diagram. Let's do an

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application. In the United States, under[br]the Federal Insurance Contributions Act,

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FICA, 12.4% of earned income up to an[br]annual limit must be paid into social

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security, and 2.9%, an additional 2.9%[br]must be paid into Medicare. Half of this

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amount comes directly from the employee.[br]You can see it on your own paychecks. This

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is the FICA tax, and half the amount comes[br]from the employer. The question is, does

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the fact that it's a 50/50 split, does[br]this make a difference? Does this mean for

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example, that since the employer is paying[br]half that this is necessarily a good deal

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for the employee? No it doesn't mean that.[br]What we now know is that we could have

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100% of this tax paid by the employee, or[br]we could have 100% of this tax paid by the

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employer. This wouldn't make a difference,[br]not to wages, not to prices, not to

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anything. It would change the legal[br]incidence of the tax, but it would not

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change the final economic incidence. I[br]haven't said here who actually pays the

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tax. That's what we're going to be talking[br]about in the next lecture. What I've said

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here is that it doesn't matter who pays[br]the tax from a legal point-of-view of who

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is obliged to deliver that money. So the[br]legal incidence again, does not have a

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bearing on the economic incidence of the[br]tax.

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What we're going to talk about in the next[br]lecture is what does determine the

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economic incidence of a tax. It turns out[br]to be elasticities of supply and demand,

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and that's what we'll take up in the next[br]lecture. Thanks again for listening.

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- If you want to test yourself, click[br]Practice Questions. Or if you're ready to

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move on, just click Next Video.

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