Tax Incidence and General Equilibrium Analysis
Explore the concept of tax incidence in a general equilibrium framework, focusing on tracing taxes back to the original owners of factors such as producers, consumers, capital owners, labor, and landlords. The analysis covers partial equilibrium and general equilibrium models, including static and dynamic approaches with insights on one-sector models, full employment of labor and capital, and the impact of ad valorem taxes on capital owners.
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Presentation Transcript
Tax Incidence General Equilibrium Analysis (AGZ, pg 96-100) 2015
Typical goal: trace out ful incidence of taxes back to original owners of factors. In general: Partial equilibrium: "producer" vs. consumer General equilibrium: capital owners vs. labor vs. landlords, etc.
Two types of GE models: 1. Static: many sectors or many factors of production Workhorse analytical model: Harberger (1962): 2 sector and 2 factors of production( we first focus on the 1 sector model) Computational General Equilibrium: many sectors, many factors of production model 2. Dynamic Characterize impacts over time or across generations Asset price effects: capitalization
ONE SECTOR MODEL One consumption good, X. K= capital, L=Labor = ( , ), , 0 0 X F K L F F K L Total stock of capital is fixed, K Labor supply: w = , 0 Ls L L p w = wage; p= price of X
Full employment of L and K. Perfect competition: returns equal to marginal productivity w w = , 8 ( ) F L K a L p p w r = , 8 ( ) FK L K b p p r = return to capital.
Remember that the previous equations come from: ( , ) Max p F L K wL r K L . . .: c p o p F L K p F = = ( , ( , L K ) ) w r L K
w p w p = , (8 ) a F L K L w/p ( ) , F L K L L(w/p) w p 0 0 L L Fig. 3.2 (a)
w p r p = , (8 ) b F L K K r/p ( ) K , F L K L r p 0 K K Fig. 3.2 (a)
Kt Incidence of an ad valorem tax on r, Capital is fixed. Equation (8.a) doesn t change. The real wage and labor supply do not change. Equation (8.b) changes: + (1 ) w p r t = , (8 ) c F L K K K p Marginal productivity of capital doesn t change Tax burden-> owners of capital
t w r p + L (1 K F ) w r = , (8 ) b (8. ) K = c ( ) , p F L K K p 0 L p r/p ( ) , F L K K K ( + ) , F L K t K 1 K r p 0 r p 1 K K Fig. 3.2 (a)
The net return to capital decreases proportional to the tax r p + r p = 0 1 t K 1 The ratio r/w also decreases proportional to the tax
Lt An ad valorem tax on wages Things are more complicated now. Equation(8a) becomes: + (1 ) w p w t = , (8 ) d F L K L L p The amount of Labor goes down That will affect the labor market equation (8b)
Labor goes down-> marginal productivity of labor In general, capital bears some of the burden How much? It depends on the elasticities A) Infinity labor supply elasticity (or inelastic demand): i. wage doesn t change. ii. Employment and marginal productivity of capital change (and the net profit) ->Capital bears the whole burden B) Inelastic supply (elastic demand): Labor bears the tax burden (partial equilibrium is fine)
Tax on wages r/p w/p F K F w p L K L F + L t 1 L * ( , ) F L K K w p r p 0 * 0 w p * r p 0 L *L k L Fig. 3.2
Tax on consumption Equations (8.a) and (8.b) become: p w p = , (8 ) F L K w e L + 1 t c p + w p = , (8 ) F L K r f K 1 t c p= pn (1+tc) , where pn is the net price received by firms
From (8.c), (8.d), (8.e) y (8.f) we can see that, if t t t = = C K L p + w p = , (8 ) F L K w e L 1 t c + (1 ) w p w t = , (8 ) d F L K L L p p + w p = , (8 ) F L K r f K 1 t c + (1 ) w p r t = , (8 ) F L K c K K p
A general consumption tax is equivalent to a tax on the two porduction factors (labor and capital) This result holds true for any number of sectors and factors.
How much of the tax burden goes to capital or to labor depends on the elasticities. For example, if labor supply is elastic the burden goes to the owners of capital. The theory is not very informative: model mainly used to illustrate negative result that "anything goes" More interest now in developing methods to identify what actually happens
CBO INCIDENCE ASSUMPTIONS (Gruber, Saez) Income taxes are borne fully by the households that pay them. Payroll taxes are borne fully by workers, regardless of whether these taxes are paid by the workers or by the firm. Excise taxes are fully shifted to prices and so are borne by individuals in proportion to their consumption of the taxed item. Corporate taxes are fully shifted to the owners of capital and so are borne in proportion to each individual s capital income.
The most difficult assumption to assess is the incidence of the corporate tax. It seems likely that at least some of the corporate tax is borne by consumers and workers, rather than its full incidence being solely on capital owners, although there is no convincing empirical evidence on this question. Sometimes corporate taxes are allocated 75% to owners of capital(not only shareholders but owners of capital in general) in proportion to capital income and 25% to labor in proportion to labor income [controversial]
