Applied Public Economics Tax Incidence PDF

Applied Public Economics Tax Incidence Michael Gerfin University of Bern Spring 2024 Contents 1. Introduction 2. Partial Equilibrium Incidence 3. Tax Incidence: Empirical Applications 4. Tax Incidence with Salience Effects 2 / 49 Introduction Introduction Tax incidence is the study of the effects of...

Applied Public Economics Tax Incidence Michael Gerfin University of Bern Spring 2024 Contents 1. Introduction 2. Partial Equilibrium Incidence 3. Tax Incidence: Empirical Applications 4. Tax Incidence with Salience Effects 2 / 49 Introduction Introduction Tax incidence is the study of the effects of tax policies on prices price changes are functions of supply and demand curves these depend on production and utility functions hence price changes induced by taxes have impact on producer and consumer rents Economic and statutory incidence are equivalent when prices are constant What happens to market prices when a tax is introduced or changed? Increase tax on cigarettes by $1 per pack Introduction of Earned Income Tax Credit (EITC) Food stamps program Effect on price → distributional effects on smokers, profits of producers, shareholders, farmers,... 3 / 49 Introduction Introduction Tax incidence is an example of positive analysis Typically the first step in policy evaluation An input into thinking about policies that maximize social welfare Theory is informative about signs and comparative statics but is inconclusive about magnitudes Incidence of cigarette tax: elasticity of demand w.r.t. price is crucial Labor vs. capital taxation: mobility of labor, capital are critical 4 / 49 Partial Equilibrium Incidence 1. Introduction 2. Partial Equilibrium Incidence 3. Tax Incidence: Empirical Applications 4. Tax Incidence with Salience Effects 5 / 49 Partial Equilibrium Incidence Partial Equilibrium Model: Setup Two goods: x and y Government levies an excise tax on good x Excise or specific tax: levied on a quantity (e.g. gallon, pack) Ad-valorem tax: fraction of prices (e.g. sales tax) Let p denote the pre-tax price of x and q = p + t denote the tax inclusive price of x Good y, the numeraire, is untaxed Perfect competition → firms are price-taking 6 / 49 Partial Equilibrium Incidence Partial Equilibrium Model: Demand Consumer has wealth Z and utility function u(x, y) Utility maximization gives demand D as a function of price q, D(q) Let εD = ∂D q ∂q D(q) = ∂ log D ∂ log q denote the price elasticity of demand 7 / 49 Partial Equilibrium Incidence Partial Equilibrium Model: Supply Producers use y to produce x Production function is concave, so marginal cost of producing x is increasing With perfect optimization, profit maximization gives supply S as a function of pre-tax price p, S(p) (because the tax will never be part of profit) Let εS = ∂S p ∂p S(p) denote the price elasticity of supply 8 / 49 Partial Equilibrium Incidence Partial Equilibrium Model: Equilibrium The equilibrium condition Q = S(p) = D(p + t) defines p as a function of t, p(t) Goal of analysis: characterize dp dt , the effect of a tax on price First consider some graphical examples to build intuition, then analytically derive formula 9 / 49 Partial Equilibrium Incidence Graphical Example I 10 / 49 Partial Equilibrium Incidence Graphical Example II 11 / 49 Partial Equilibrium Incidence Formula for Tax Incidence Implicitly differentiate equilibrium condition D(p(t) + t) = S(p(t)) to obtain incidence on producers: 1 dp ∂D = ∂S dt ∂p ( ∂p − ⇒ ∂D ∂p ) dp εD = dt εS − εD Incidence on consumers is: dq dp εS =1+ = dt dt εS − εD 12 / 49 Partial Equilibrium Incidence Formula for Tax Incidence in a Picture 13 / 49 Empirical Applications 1. Introduction 2. Partial Equilibrium Incidence 3. Tax Incidence: Empirical Applications 4. Tax Incidence with Salience Effects 14 / 49 Empirical Applications Applications 1 2 Doyle and Samphantharak (2008), $2.00 Gas! Studying the effects of a gas tax moratorium, Journal of Public Economics Hastings and Washington (2010), The First of the Month Effect: Consumer Behavior and Store Responses, AEJ: Econ. Policy More examples are in the exercises 15 / 49 Empirical Applications Doyle and Samphantharak, 2008 Question: who bears the burden of the gas tax? Setting: Gas prices spike above $2.00 in 2000, near election, political desire to provide tax relief Repeal and subsequent reinstatement of sales tax in Indiana and Illinois Reforms known to be temporary and timing of reinstatement was known ex-ante Exogenous change, independent of market price 16 / 49 Empirical Applications Doyle and Samphantharak, 2008 Homogeneous product (no quality differences) Highly important tax: total revenue in the US 8 billion $ per year (EIA, 2005) Fall and rise in price → potential asymmetries in response can be identified Effects on retail prices and cross-border competition 17 / 49 Empirical Applications Doyle and Samphantharak, 2008 Institutional Background Election year in Indiana (IN) plus exceptional gas prices Governor of IN declares energy emergency IN suspends 5% sales tax on gas starting July 1 for 60 days Suspension was extended three times and tax was reinstated on Oct 30 Gas prices had already fallen in September which suggests that reinstatement was not tied to market conditions Illinois (IL) suspends 5% sales tax on gas starting July 1, reinstates on Dec 31 18 / 49 Empirical Applications Doyle and Samphantharak, 2008 Institutional Background Excise taxes were not affected by the moratorium Sales tax is levied from the retailer Posted gas prices include any taxes (salient tax) Station owners can deduct excise tax from the tax base when computing the sales tax Sales tax applies to ca. 90% (80%) of posted price in IL (IN) Full-shifting therefore implies 4.5% change in price in IL and 4% change in prices in IN 19 / 49 Empirical Applications Empirical Approach Difference-in-Difference estimation comparing treated states with neighboring states (MI, OH, MO, IA, WI) There should be a sharp discontinuity at the time of tax repeal and reinstatement Start with graphical evidence Next consider regression equation (controls for area characteristics X , brand FE), s = station, b = brand, t=time, P = retail price, W SP = whole sale price ln Pbst = γ0 + γ1 T reated + γ2 P ostref orm + γ3 (T reated · P ostref orm) + γ4 ln(W SP )s + γ5 X + δb + εbst 20 / 49 Empirical Applications Graphical Analysis: Effect of tax repeal Local linear regression of difference in log prices (IL,IN vs. neighbors) Effect of about -2.7% 21 / 49 Empirical Applications Graphical Analysis: Effect of tax increase Prices rose by about 4% (2.8%) in IN (IL) 22 / 49 Empirical Applications Diff-in-Diff Results: Tax-Repeal 23 / 49 Empirical Applications Diff-in-Diff Results: Tax-Repeal γ3 /0.04 = 0.72 (IN) and γ3 /0.045 = 0.64 (IL) measures relative incidence Estimated effects imply an approx. 70% pass-through rate (70% of the tax decrease reflected in lower price for consumers) The elasticity of demand is thought to be in range from -0.05 to -0.25 (Hughes et al., 2006) Recall that dq εS dqdt = ⇒ εS = εD dt (εS − εD ) (1 − dqdt) A pass-through rate of 0.7 implies a supply elasticity in the range of 0.1 − 0.6 24 / 49 Empirical Applications Hastings and Washington 2010 Question: How does food stamps subsidy affect grocery store pricing? Food stamps typically arrive at the same time for a large group of people, e.g. first of the month Use this variation to study: 1 2 Whether demand changes at beginning of month (violating permanent income hypothesis) How much of the food stamp benefit is taken by firms by increased prices rather than consumers (intended recipients) 25 / 49 Empirical Applications Hastings and Washington: Data Scanner data from several grocery stores in Nevada Data from stores in high-poverty areas (> 15% food stamp recipients) and in low-poverty areas (