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Lecture note Public finance (10th Edition) - Chapter 21: Fundamental tax reform: Taxes on consumption and wealth

In this chapter explain what is meant by tax efficiency, compare the excess burden of different taxes using indifference curves, determine the magnitude of excess burden using the consumer surplus concept, explain the meaning of administrative efficiency and how it can be achieved, show what is meant by tax evasion and how to reduce it, define tax flexibility. | FUNDAMENTAL TAX REFORM: TAXES ON CONSUMPTION AND WEALTH Chapter 21 How a Value-Added Tax Works Producer Purchases Sales Value Added VAT at 20 Percent Rate Farmer $ 0 $400 $ 400 $ 80 Miller 400 700 300 60 Baker 700 950 250 50 Grocer 950 1,000 50 10 Total $2,050 $3,050 $1,000 $200 21- Efficiency and Equity of Personal Consumption Taxes Efficiency issues An income tax and saving and labor supply decisions A consumption tax and saving and labor supply decisions 21- Efficiency and Equity of Personal Consumption Taxes Equity issues Progressiveness Ability to pay Annual versus Lifetime Equity A numerical example A formal model 21- Annual versus Lifetime Equity – A Numerical Example Parameters Income tax rate = 50% Consumption tax rate = 50% Interest rate = 10% Mr. Grasshopper Ms. Ant Income tax Consumption tax Income tax Consumption tax Income period 0 $1,000 $1,000 $1,000 $1,000 Consumption period 0 $500 $500 $0 $0 Taxes period 0 $500 $500 $500 $0 Income | FUNDAMENTAL TAX REFORM: TAXES ON CONSUMPTION AND WEALTH Chapter 21 How a Value-Added Tax Works Producer Purchases Sales Value Added VAT at 20 Percent Rate Farmer $ 0 $400 $ 400 $ 80 Miller 400 700 300 60 Baker 700 950 250 50 Grocer 950 1,000 50 10 Total $2,050 $3,050 $1,000 $200 21- Efficiency and Equity of Personal Consumption Taxes Efficiency issues An income tax and saving and labor supply decisions A consumption tax and saving and labor supply decisions 21- Efficiency and Equity of Personal Consumption Taxes Equity issues Progressiveness Ability to pay Annual versus Lifetime Equity A numerical example A formal model 21- Annual versus Lifetime Equity – A Numerical Example Parameters Income tax rate = 50% Consumption tax rate = 50% Interest rate = 10% Mr. Grasshopper Ms. Ant Income tax Consumption tax Income tax Consumption tax Income period 0 $1,000 $1,000 $1,000 $1,000 Consumption period 0 $500 $500 $0 $0 Taxes period 0 $500 $500 $500 $0 Income period 1 $0 $0 $50 $100 Consumption period 1 $0 $0 $525 $550 Taxes period 1 $0 $0 $25 $550 Present Value of taxes paid $500 $500 $523 $500 21- Annual versus Lifetime Equity – A Formal Model Parameters Income tax rate = t Consumption tax rate = tc Interest rate = r Income Tax Mr. Grasshopper Ms. Ant Income period 0 I0 I0 Consumption period 0 c0G c0A Taxes period 0 tI0 tI0 Income period 1 r(I0 – c0G) r(I0 – c0A) Taxes period 1 tr(I0 – c0G) tr(I0 – c0A) 21- Annual versus Lifetime Equity – A Formal Model Parameters Income tax rate = t Consumption tax rate = tc Interest rate = r Consumption Tax Mr. Grasshopper Ms. Ant Present Value of Lifetime Income I0 = c0G + c1G/(1 + r) I0 = c0A + c1A/(1 + r) Present Value of Lifetime Tax Liability RcG = tcc0G + tcc1G/(1 + r) = tcI0 RcA = tcc0A + tcc1A/(1 + r) = tcI0 21- Retail Sales Tax General sales tax Percent of own-source revenue from sales taxes State: 34.7% Local: 10.0% Selective sales tax (excise tax or differential .