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- [Tyler] Today we begin[br]the first of several talks

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on taxes and subsidies.

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We're not going to be talking[br]about income taxes

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and income subsidies.

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Those are typically topics[br]for macroeconomics.

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Instead, we'll be talking[br]about taxes and subsidies on goods,

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like a sales tax[br]or a subsidy for wheat.

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These are also called[br]commodity taxes and subsidies.

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So let's get going.

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We're going to be emphasizing[br]three important ideas

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about commodity taxation.

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First, who pays the tax[br]does not depend

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on who writes the check[br]to the government.

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For example, suppose the government[br]is taxing apples.

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The government could make[br]the buyer of apples

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pay for each apple that they buy.

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

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that they sell.

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What we're going to show is that,[br]from the point of view

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of the buyers or sellers,[br]it actually doesn't matter

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how the tax is placed.

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The actual outcomes[br]are going to be identical.

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Another way of putting this[br]is that the economic incidence

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of the tax, who actually pays[br]the tax, does not depend

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

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the check to the government.

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This will become a little bit[br]clearer as we go along.

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Don't worry about it[br]if it's not clear yet.

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The second key point,[br]who pays the tax

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does depend on the relative[br]elasticities of demand and supply.

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In fact, we can summarize[br]point one and point two by saying,

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who pays the tax depends not[br]on the laws of congress

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but rather on the laws[br]of supply and demand.

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The third point[br]is that commodity taxation

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raises revenue,[br]but it also takes away

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some gains from trade, that is,[br]it creates deadweight loss.

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We're going to be looking[br]at point one in this talk,

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and then we'll move on[br]to point two, and point three

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in later talks.

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So, let's start with point one.

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Let's begin our analysis[br]of commodity taxation

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

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the check to the government.

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That is, the legal incidence[br]of the tax falls on the suppliers.

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What does a tax[br]on the suppliers do?

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We can think about a tax[br]on suppliers

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as increasing their costs.

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This is going to shift[br]the supply curve up

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by the amount of the tax,[br]so the supply curve

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shifts up like this.

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Another way of thinking[br]about this, is to remember

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that the supply curve tells us[br]the minimum amount

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which suppliers require to offer[br]a given quantity

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in the marketplace.

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The tax, that is going to increase[br]the minimum amount that suppliers

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are requiring to offer[br]that quantity in the marketplace.

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

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of the tax.

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

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The market equilibrium[br]moves from point A to point B.

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What we see is that of course,[br]the quantity which is exchanged

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goes down, in addition,[br]the price paid

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by the buyers goes up.

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How much do the suppliers get?

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The suppliers collect this amount,[br]the price paid by the buyers,

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

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the tax to the government.

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

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In other words, what the tax does,[br]it means that the buyers

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pay more than before,[br]and the sellers receive

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less than before.

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Without any tax,[br]the price the buyers pay

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is the same as the price[br]the supplier receives.

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With the tax,[br]the buyers pay a certain price,

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but the sellers get less than that.

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They get whatever the buyers pay[br]minus of course, the tax.

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That's the situation[br]when the suppliers pay the tax,

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or the suppliers have to send[br]the check to the government.

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Let's now look at what happens[br]when it's the buyers

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who must send the check[br]to the government.

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Now, we look at the situation[br]when the legal incidence

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is on the buyers.

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We begin just as before[br]with the equilibrium with no taxes.

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No taxes on sellers or buyers.

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Again, that equilibrium[br]is at point A.

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I've also included[br]this supply curve here.

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This is the supply curve[br]when the tax is on the suppliers.

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It's the supply curve[br]from the previous problem.

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It's not relevant for this problem.

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I've included it rather[br]to remind us of where

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the equilibrium[br]on the previous problem was.

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You can think of this[br]as a kind of ghost supply curve.

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It's a supply curve[br]from the previous problem

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coming back to haunt us.

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So what's the effect[br]of a tax on the demanders?

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Think about it this way.

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Suppose the most you were willing[br]to pay for an apple is $1.

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

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Now, suppose you learned[br]that the government has instituted

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a new tax.

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For every apple you buy,[br]you must now pay 25 cents

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to the government.

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Now, how much[br]are you willing to pay

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to suppliers for that apple?

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You're only willing to pay[br]the maximum amount

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that you're going to be willing[br]to pay suppliers

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is now 75 cents.

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The maximum amount[br]that apple was worth to you

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is a dollar.

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If you know you're going[br]to be taxed 25 cents

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if you buy that apple,

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then the most you're going[br]to be willing to pay the supplier

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

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to the government, that's $1.

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That's the most you're willing[br]to pay to get the apple.

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In other words, what a tax[br]on demanders does

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is it reduces[br]their willingness to pay,

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and that means[br]the demand curve shifts.

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

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So let's shift.

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The tax is exactly[br]the same amount that it was before.

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

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We find now[br]that the new equilibrium

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is at point B.

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Notice first of all,[br]that the quantity has declined.

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

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as before in the previous problem.

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What about the price[br]received by the sellers?

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The sellers now receive this price.

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Lo and behold,[br]that's exactly the same price

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as it was before.

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How about the price[br]paid by the buyers?

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The buyers now pay[br]what they paid to the suppliers,

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plus they must pay the tax[br]to the government.

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This distance is the tax.

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Lo and behold, the price after tax[br]paid by the buyers

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is once again exactly[br]what it was when the tax

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was on the suppliers.

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When the tax is on the buyers,[br]the buyers pay more than before.

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The sellers receive less[br]than before

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by exactly the same amounts.

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

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The net price,[br]or the total price paid

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by the buyers is the same.

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The total price received[br]by the sellers is the same.

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Now that you know the idea,[br]I'm going to show you a simpler way

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of demonstrating this.

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What we just showed[br]is that it doesn't matter

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whether the suppliers[br]must write the check

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to the government, or the demanders[br]must write the check

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to the government[br]in order to pay the tax.

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In other words,[br]we can analyze the tax

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by shifting the supply curve up,[br]or by shifting

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the demand curve down.

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As long as we analyze[br]the same size tax,

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we're going to get[br]equivalent outcomes.

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It's going to come out the same[br]whichever choice of tax we make.

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There's actually a simpler way[br]of thinking about this.

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What we can think[br]about such a tax is doing,

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is driving a wedge[br]between what the buyer is paying

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and what the sellers receive.

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When there's no tax,[br]what the buyers pay

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is what the sellers receive,[br]but when there's a tax,

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the buyers pay more[br]than what the sellers receive.

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The difference[br]is what the government gets.

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The difference[br]is the amount of the tax.

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So let's think about this[br]as a tax wedge.

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Let's say this tax wedge,[br]this side is, let's say a dollar.

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Another way of analyzing[br]the tax is to drive this wedge

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into the diagram[br]until the top of the wedge

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hits the demand curve,[br]and the bottom of the wedge

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just touches the supply curve.

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Let's take a look.

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I'm going to drive the wedge in.

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What this tells us[br]is that the price the buyer pays

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will be here, point B.

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The price the suppliers receive[br]will be point D.

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The difference is the tax.

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For instance, if the buyers[br]end up paying $2.65,

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

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Similarly, if the suppliers receive[br]a $1.65 and the tax is a dollar,

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the buyers must be paying $2.65.

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

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the price the buyer pays,[br]the price the seller receives,

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and the quantity exchanged.

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We don't even have[br]to shift any curves.

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We just drive the wedge[br]into this diagram.

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Let's do an application.

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In the United States,

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under the Federal Insurance[br]Contributions Act -- FICA --

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12.4% of earned income[br]up to an annual limit

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must be paid into social security,[br]and 2.9%, an additional 2.9%

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must be paid into Medicare.

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Half of this amount comes directly[br]from the employee.

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You can see it[br]on your own paychecks.

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This is the FICA tax,[br]and half the amount comes

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from the employer.

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The question is, does the fact[br]that it's a 50/50 split,

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does this make a difference?

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Does this mean for example,[br]that since the employer

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is paying half that this is necessarily[br]a good deal for the employee?

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No, it doesn't mean that.

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What we now know[br]is that we could have 100%

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

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of this tax paid by the employer.

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

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not to anything.

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It would change[br]the legal incidence of the tax,

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but it would not change[br]the final economic incidence.

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I haven't said here[br]who actually pays the tax.

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That's what we're going[br]to be talking about

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in the next lecture.

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What I've said here[br]is that it doesn't matter

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who pays the tax[br]from a legal point-of-view

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of who is obliged[br]to deliver that money.

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So the legal incidence again,[br]does not have a bearing

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on the economic incidence[br]of the tax.

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What we're going to talk[br]about in the next lecture

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is what does determine[br]the economic incidence of a tax.

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It turns out to be elasticities[br]of supply and demand,

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

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Thanks again for listening.

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- [Narrator] If you want[br]to test yourself,

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click "Practice Questions."

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Or if you're ready to move on,[br]just click "Next Video."

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♪ [music] ♪