Introduction

Joshua Gans and Andrew Leigh found that in Australia a

potential $10,000 reduction in the estate tax postponed death
by about a week
There is also a small but noticeable trend for people to live
until after their birthdays or other major events
o If death can be postponed for major events, then why
not postpone death to save on taxes
Birth can also be advanced for tax reasons
Not only are more children born in late December than in
early January, but also the extra births appear to be clustered
among those who have the most to gain from a tax deduction
Commodity Taxes
Commodity taxes: taxes on goods such as those on fuels,
cigarettes, and liquor
Some truth about commodity taxations
o Who pays the tax does not depend on who writes the
check to the government
o Who pays the tax does depend on the relative
Elasticities of supply and demand
o Commodity taxation raises revenue and creates lost
gains from trade (deadweight loss)
Who ultimately pays the Tax does not depend on who writes the
check

The government can collect a tax in one of two ways:

o Tax sellers for every unit sold
o Tax buyers for every unit bought
o The tax has exactly the same effects whether it is
paid for by sellers or by buyers
o Who ultimately pays a tax is determined by the laws of
supply and demand
While supply curve is up $1, the price does not rise by $1
o At a $1 increase, quantity supplied is greater than
quantity demanded
Sellers cant pass all of the tax onto apple buyers
because there would not be enough buyers to
purchase supplies
o Tax=price paid by buyers-price received by sellers

o When taxed on suppliers, market price includes the tax

but when tax is placed on buyers, the market price does
not include tax
Tax must be paid so the final price paid by buyers
will be the same, and so is the final price received
by sellers
Who ultimately pays the tax depends on the Elasticities of supply
and demand
The more elastic side of the market will pay a smaller share of
a tax (smaller burden)
The less elastic (more inelastic) side of the market will pay a
greater share of a tax (larger burden)
Elastic demand means that demanders have good substitutes
for the tax good and so can escape the tax
Elastic supply means that the resources used to produce the
taxed good can easily be moved to other industries so they
can escape the tax
Someone must pay the tax so burden is determined by the
relative Elasticities
A tax drives a tax wedge between the price paid by buyers
and the price received by sellers
o We can use the wedge shortcut to show that who pays a
tax is determined by the relative Elasticities of demand
and supply
o Elasticity measures how responsive quantities
demanded (or supplied) are to price changes
o When demand is more elastic than supply, demanders
pay less of the tax than sellers
o When supply is more elastic than demand, suppliers pay
less of the tax than buyers
Heath insurance mandate
o Firms can escape the tax several ways:
Can substitute capital (machines) for labor.
Can move overseas.
Can shut down.
o Workers have fewer options:
Costs of leaving the labor force are high.
Demand is therefore more elastic than supply.
Result: most of the tax is paid by workers.
Cigarette Taxes

o Cigarettes are taxed from $2.57 per pack in New Jersey

to $0.07 in South Carolina (2009 rates).
o Because nicotine is addictive, demand is inelastic.
o Manufacturers can escape the taxes by selling overseas
or in other states
o Conclusion: supply is more elastic than demand, so
most of the tax is paid by buyers
A Commodity Tax Raises Revenue and Creates a Deadweight
Loss (Reduces the Gains from Trade)
With no tax, consumer plus producer surplus is maximized
With tax, consumer plus producer surplus is smaller and tax
revenues are larger
But tax revenues increase by less than the decrease in
producer and consumer surplus
This creates a deadweight losslost gains from trades that do
not occur
Results in reduced gains from trade
in a free market trade occurs whenever the buyers
willingness to pay exceeds the suppliers willingness to sell
(i.e., whenever the demand curve lies above the supply
curve)
Some of the consumer and producer surplus is transferred to
the government in the form of tax revenues, but notice that
consumer and producer surplus together decrease by more
than government revenue increases
Elasticity of demand
o the deadweight loss from taxation is larger the more
elastic the demand curve
o If demand is elastic, a tax deters many trades.
o If demand is inelastic, there is little deterrence and thus
fewer lost gains from trade.
Consumers lose but the government does not gain
from trips that are not taken.
Elasticity of Supply
o The deadweight loss from taxation is lower the less
elastic the supply curve.
o If supply is elastic, a tax deters many trades.
o If supply is inelastic, there is little deterrence and thus
fewer lost gains from trade.

a tax on food would generate less deadweight loss than one

on fruit, and a tax on all consumption goods would generate
even less deadweight loss than an equal-revenue tax on food
o broad-based taxes will tend to create less deadweight
loss than more narrowly based taxes