Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 4 The Economics of the Public Sector
Chapter 12 of 36 The Design of the Tax System
Section 19 of 22
The person who bears the burden of a tax is not always the person who pays the tax.
Taxes alter supply and demand and equilibrium prices and affect people beyond those who actually pay the tax.
Many discussions of tax equity ignore the indirect effects of taxes.
They often are based the “flypaper theory” of tax incidence.
This theory holds the burden of a tax, like a fly on flypaper, sticks wherever it first lands.
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Someone might argue a tax on expensive fur coats is vertically equitable, paid for by the rich who buy the coats, because most buyers of furs are wealthy.
But these buyers can easily substitute other luxuries for furs.
The main effect of a tax on furs might be to reduce the sale of furs but the burden of this tax might fall more on those who make and sell furs than on those who buy them.
Most workers who make and sell furs in shops are not wealthy and many might lose their jobs because of the tax.
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A real-life example, repeated from Chapter 6:
In 1990, Congress passed a law adding a 10% luxury tax on yachts.
The goal was to raise revenue for the federal government from the rich Because only the rich could afford to buy yachts, taxing yachts seemed a logical and progressive tax.
Because of the forces of supply and demand, the result was different than Congress expected but economists could have predicted.
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The demand for yachts is elastic, millionaires can easily forgo buying a yacht.
They can instead buy some other luxury such as a bigger house or a European vacation.
However, the supply of yachts is inelastic.
Yacht factories are not easily converted to alternative uses.
Workers who build yachts cannot easily change careers.
With elastic demand for yachts and inelastic supply of yachts, the burden of this tax fell mostly on the suppliers.
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The tax on yachts significantly reduced the demand for yachts.
The tax burden was largely placed on the firms and workers who build and supply yachts.
It resulted in some yacht companies going out of business, and many workers losing their jobs.
So, the burden of this tax fell more on middle class suppliers and workers than on rich buyers.
Realizing this, Congress in 1993 repealed the luxury tax on yachts.
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Per Figure 5
Case of elastic demand for product - yachts.
Tax incidence, burden, is mostly on suppliers.
Quantity demanded and supplied amount, and sales and jobs lost Q1~Q2 is large.
Triangle area between demand and supply curves deadweight loss amount is large.
Case of inelastic demand for product - salt.
Tax incidence is mostly on consumers.
Quantity demanded and supplied amount, and sales and jobs lost Q1~Q2 is small.
Triangle area deadweight loss amount is small.
… …
fur coats and yachts
kegawa kōto to yotto
毛皮コートとヨット
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