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Public Choice Theory and the Economics of Taxation

29. Public Choice Theory and the Economics of Taxation. 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

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Public Choice Theory and the Economics of Taxation

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  1. 29 Public Choice Theory and the Economics of Taxation

  2. 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

  3. O 29.1 Public Choice Theory • Government Failures • Revealing Preferences Through Majority Voting • Inefficient Voting Outcomes • Inefficient “No” Vote • Inefficient “Yes” Vote Graphically…

  4. 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

  5. Benefit; Tax Benefit; Tax 0 0 Public Choice Theory Inefficient Voting Outcomes Inefficient Majority “No” Vote Inefficient Majority “Yes” Vote $700 Adams $350 $350 Benson Conrad $300 $300 $250 $200 Benson $100 Conrad Adams “YES” “NO” “NO” “NO” “YES” “YES” “NO” Wins! “YES” Wins! Inefficient Since Inefficient Since MSB > MSC MSB < MSC $1,150 > $900 $800 < $900

  6. O 29.2 Public Choice Theory • Interest Groups • Political Logrolling • Logrolling – Vote Trading • Paradox of Voting • Preferences • Voting Outcomes • Median-Voter Model

  7. 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

  8. Government Failure • Special-Interest Effect • Pork-Barrel Politics • Rent-Seeking Behavior • Clear Benefits, Hidden Costs • Limited and Bundled Choice • Bureaucracy and Inefficiency • Imperfect Institutions

  9. 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

  10. 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

  11. Apportioning the Tax Burden • Benefits-Received Principle • Ability-to-Pay Principle • Tax Progressivity • Progressive • Regressive • Proportional • Applications

  12. 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

  13. Principles of Taxation • 2. Ability-to-pay principle – those with larger incomes should pay more in taxes (both relative and absolute terms)

  14. 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

  15. G 29.1 Tax Incidence • Elasticity and Tax Incidence • Division of Burden • Elasticities • Efficiency Loss of a Tax • Tax Revenues • Efficiency Loss • Role of Elasticities

  16. 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

  17. P 14 12 10 Price (Per Bottle) 8 6 4 2 0 5 10 15 20 25 Q Quantity (Millions of Bottles Per Month) Tax Incidence Incidence of an Excise Tax S’ S Tax $2 D

  18. P P 0 0 Q Q Tax Incidence Demand Elasticity and the Incidence of an Excise Tax St St Tax Tax S S a Pi a Pe b P1 P1 b De Pb Pa c c Dt Q2 Q1 Q2 Q1 Tax Incidence and Elastic Demand Tax Incidence and Inelastic Demand

  19. P P 0 0 Q Q Tax Incidence Supply Elasticity and the Incidence of an Excise Tax St S Tax Tax St a Pe S a Pi b b P1 P1 Pa c Pb c D D Q1 Q1 Q2 Q2 Tax Incidence and Elastic Supply Tax Incidence and Inelastic Supply

  20. 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

  21. P 14 12 10 Price (Per Bottle) 8 6 4 2 0 5 10 15 20 25 Q Quantity (Millions of Bottles Per Month) Tax Incidence Efficiency Loss of a Tax S’ Tax Paid by Consumers S Tax $2 Efficiency Loss (or Deadweight Loss) Tax Paid by Producers D

  22. Incidence of U.S. Taxes • Personal Income Tax • Corporate Income Tax • Sales and Excise Taxes • Property Taxes • The U.S. Tax Structure

  23. GLOBAL PERSPECTIVE Incidence of U.S. Taxes Taxes on Goods and Services as a Percentage of Total Tax Revenues 0 5 10 15 20 25 30 35 United Kingdom Netherlands Germany Italy Sweden Canada France Japan United States 32.7 30.8 29.2 26.9 26.4 26.3 25.4 20.1 17.6 Source: Organization for Economic Cooperation and Development, 2002

  24. Government Failure Last Word “…In the News” • 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

  25. 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 Key Terms

  26. Next Chapter Preview… Antitrust Policy and Regulation Chapter 30!

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