Lecture 5(i) Announcements Midterm Covers through Lec5(ii) Practice midterm at Moodle (look at it before recitation sections this week)

Transcription

1 Lecture 5(i) Announcements Midterm Covers through Lec5(ii) Practice midterm at Moodle (look at it before recitation sections this week) Question and Answer Sessions Wed: 4-5:30pm (Anderson 210) Wed: 7:30-9pm (Blegen 5) Thur: 3:30-5pm (Anderson 210) My Office Hours This Week o Wed 1:30-3:25 (usual) o Thur: 1:30-2:30 (extra)

2 Large Lectures (Wiley 175) cancelled this Friday. Next Mon (Oct 12), go to evening midterm, 7-8pm instead of lecture. Rooms posted later today Bring #2 pencils and University ID Don t Bring: Calculators and Scratch Paper. Lecture 1. More on marginal tax rates 2. Price Controls

3 Key Principle in Economics: Look at Incentives at the Margin That s where the decision making is taking place Last Class: Name Tax S1,S2,S3, D1,D2,D3 each pay $2 Key thing: D4, D5, S4, S5 decision making not distorted. These are the marginal units affected by the tax. Name Tax a metaphor for policies to give tax breaks at the margin, (e.g. real estate tax break for some new business that wouldn t open but for the break.)

4 When talking about incentive effects of taxes on labor, we look at the marginal tax tate Rate paid on last dollar earned. Key rate used in decision making about how much to work. Come back to example of the students. Talked about payroll tax (social security and medicare)

5 How collected? 7.65% taken out of worker paycheck subtract from wage to get P S 7.65% collected from firm add to wage to get P D But who bears the burden of the tax? Depends elasticity of supply elasticity of demand

6 Suppose demand and supply for student labor looks like this $ S D Q bears burden of social security tax Good arguments that labor demand is highly elastic (for most workers). So we will go with this.

7 Case 1: Student (Collegee student making lesss than $6,200 a year.) Below federal and state cutoff but pays social security and medicare. Conclusion: Marginal Tax rate = 15.3 (percent)

8 Joe Mauer Taxed on earned income. Faces the highest marginal rates 40 ( Federal income tax) (deduct on Fed) + 3 (Medicare, above soc sec cap) = 49 percent (and faces sales taxes when he trys to spend the money)

9 Case 3: Donald Trum mp We haven t seen his tax return yet. Good bet to assume most of it is capital gains income. Marginal Tax Rate 20 (high income capital gains) +4 (Obamacare tax) + 6 (New York tax net of deduction) =30 percent.! A lot lower than Mau uer (who faces higher taxes on earn ned income)

10 With the big spread between taxes on earned income and capital gains, there is an incentve to reclassify earned income into capital gains. Biggest story in news about that? Carried Interest in compensation of elite fund managers Trump plan: Get rid of carried interest loophole But lower top marginal rate for earned income to 25%!

11 Jeb! Plan Get rid of carried interest loophole Lower top marginal rate for earned income to 28% State and Local taxe s not deductable. How affect Mauer?

12 40 28 Federal State (deduct on Fed) back up to (Medicare, above soc sec cap) = 41 percent Federal Government: Beforee got 36 percent (net of deduction) Now gets 28 percent Jeb! sayss don t worry y. His plan will grow economy enough to offset loss.

13 Tough argument to make e. More likely would have to: Cut federal spending Raise taxes elsew where (like a gas tax) Evidencee from Kansas Expe eriment (Gov. Brownback s word ds in 2012) Cut rate from 6.5% to 5.0 No tax on small business income. Ooops: blew hole in budget Cut education spending Raise sales taxes

14 2. Price Controls Price Ceiling P ceiling Regulation: P P ceiling Examples? Price Floor P floor Regulation: P P floor Examples?

15 Key point: With price controls market quantity is minimum of supply and demand. Binding price ceiling Excess Demand Binding price floor Excess Supply

16 $ S D Q

17 Impact on Consumer Surplus of Price Ceiling in Econ nland Law in EconLand: Illegal for anyone to sell widget for more than $3.

18 At ceiling price of $3: Q D =7 Q S = 3 Q Ceiling = minimum of Q D and Q S = 3 Producer Surplus easy to calculate (All sellers who want to sell are able to sell). So we use normal rule of calculating area under the P S line (the price producers get) and above the supply curve. Easy to calculate PS

19 Change in PS from $3 ceiling

20 What is CS? It depends There are 7 people who want a widget (D1, D2, D3, D4, D5, D6, D7), but only 3 are for sale. CS depends on who gets the widgets because they differ in willingness to pay.

21 CS under the price ceiling is NOT THIS! 3 widgets consumed, not 7!

22 One Extreme: Case 1 Perfectly Efficient Rationing Highest value consumers get the widgets ( rationing goes their way) CS =

23 For this extreme case, how does consumer surplus compare with its level in the free market? Lesson: What about overall total surplus?

24 Opposite Extreme: Case 2 Perfectly Inefficient Ratio oning Lowest Value Consumers that want widget get it. CS is muc ch lower! CS =

25 Something in between? Uniform Rationing (likelihood of getting good unrelated to willingness to pay) What if D2, D4, and D6 get widget?

26 Case 3: Uniform Rationing CS =

27 Review price ceiling in Aplia experiment from last week.

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29 Rationing in ApliaLand What case is most relevant?