WEBVTT

00:00:00.000 --> 00:00:05.599
♪ [music] ♪

00:00:09.212 --> 00:00:11.771
- [Tyler] In the last lecture,
we showed that the legal incidence

00:00:11.771 --> 00:00:15.016
of a tax does not determine
the economic incidence.

00:00:15.016 --> 00:00:16.434
In this lecture,
we're going to talk

00:00:16.434 --> 00:00:20.695
about how the economic incidence
of taxes actually is determined.

00:00:20.695 --> 00:00:22.754
Who bears the burden of a tax?

00:00:28.255 --> 00:00:31.831
Here is the rule for the economic
incidence of a tax.

00:00:31.831 --> 00:00:34.395
The more elastic side
of the market will pay

00:00:34.395 --> 00:00:37.886
a smaller share of the tax,
a smaller burden.

00:00:37.886 --> 00:00:40.988
Similarly, the less elastic side
of the market

00:00:40.988 --> 00:00:44.342
or rather the more inelastic side
of the market will pay

00:00:44.342 --> 00:00:46.298
a greater share of the tax.

00:00:46.298 --> 00:00:49.797
So more elastic
pays a smaller share,

00:00:49.797 --> 00:00:52.991
less elastic pays a greater share.

00:00:52.991 --> 00:00:55.332
I'm going to show you this
in a couple of diagrams

00:00:55.332 --> 00:00:58.611
and then give you the intuition
for why it's the case.

00:00:58.611 --> 00:01:00.701
Let's suppose
we can't remember the rule.

00:01:00.701 --> 00:01:03.702
Is it the more elastic side
which bears the smaller share

00:01:03.702 --> 00:01:06.073
of the tax or the greater share
of the tax?

00:01:06.073 --> 00:01:09.205
Say we can't quite remember.
Well, no problem.

00:01:09.205 --> 00:01:12.953
Let's just draw the diagram
and read it off as it happens.

00:01:12.979 --> 00:01:15.002
For instance, let's draw a diagram

00:01:15.002 --> 00:01:17.473
which has a pretty elastic
demand curve

00:01:17.473 --> 00:01:21.514
and relatively speaking
a pretty inelastic supply curve.

00:01:21.514 --> 00:01:23.991
Here's the price
when there's no tax.

00:01:23.991 --> 00:01:26.333
Now let's look at what happens
when there is a tax

00:01:26.333 --> 00:01:28.472
and we'll use our wedge method.

00:01:28.472 --> 00:01:30.957
Here's the tax and the height
of the wedge gives us

00:01:30.957 --> 00:01:32.826
the amount of the tax.

00:01:32.826 --> 00:01:34.071
What do we do?

00:01:34.071 --> 00:01:35.921
We drive this wedge
into the diagram

00:01:35.921 --> 00:01:38.402
until the top of it
hits the demand curve

00:01:38.402 --> 00:01:40.937
and the bottom of it
hits the supply curve

00:01:40.937 --> 00:01:43.815
and then we just read
the answer off our diagram.

00:01:43.815 --> 00:01:47.345
Point B, this tells us the price
paid by the buyer.

00:01:47.345 --> 00:01:51.538
Point D, this tells us the price
received by the seller.

00:01:51.538 --> 00:01:53.002
Let's compare.

00:01:53.002 --> 00:01:55.804
When there was no tax,
the price paid by the buyer

00:01:55.804 --> 00:01:58.697
was at A, and with the tax
the price to the buyer

00:01:58.697 --> 00:02:01.028
goes up a little bit to point B.

00:02:01.028 --> 00:02:03.719
The buyer isn't paying much
of a higher price.

00:02:03.719 --> 00:02:06.993
On the other hand the seller
is receiving a lot less.

00:02:06.993 --> 00:02:10.729
In this case, when demand
is more elastic than supply,

00:02:10.729 --> 00:02:13.623
the demanders pay
a smaller share of the tax

00:02:13.623 --> 00:02:16.397
and the suppliers
pay a larger share.

00:02:16.397 --> 00:02:19.396
Therefore we can just read
off the diagram what happens

00:02:19.396 --> 00:02:22.227
when demand
is more elastic than supply.

00:02:22.539 --> 00:02:24.145
You don't have
to remember the rule,

00:02:24.145 --> 00:02:26.567
you don't have to memorize it
because I'm going to give you

00:02:26.567 --> 00:02:29.483
some intuition to make it easy
in just a moment.

00:02:29.483 --> 00:02:32.690
You simply have to draw the diagram
and be able to read

00:02:32.690 --> 00:02:34.624
the answer off the curves.

00:02:34.779 --> 00:02:36.434
Let's look at another case.

00:02:36.434 --> 00:02:38.466
In this case, we've drawn
a supply curve

00:02:38.466 --> 00:02:41.028
which is very inelastic
and a demand curve

00:02:41.028 --> 00:02:44.048
which is less elastic
than the supply curve.

00:02:44.048 --> 00:02:46.338
Once again we're going
to take our tax wedge,

00:02:46.338 --> 00:02:49.706
we're going to push it
into the diagram and what happens?

00:02:49.706 --> 00:02:51.127
You can see it right here.

00:02:51.127 --> 00:02:53.288
We just have to read it
off the diagram.

00:02:53.288 --> 00:02:56.422
Now we see that compared
to when there was no tax,

00:02:56.422 --> 00:02:58.943
the price to the buyer
has gone up a lot

00:02:58.943 --> 00:03:01.172
and the price to the sellers
has gone down

00:03:01.172 --> 00:03:03.041
by just a little bit.

00:03:03.041 --> 00:03:05.533
When the supply
is more elastic than demand,

00:03:05.533 --> 00:03:08.020
buyers pay the greater share
of the tax,

00:03:08.020 --> 00:03:10.549
that is the price to the buyer
goes up more

00:03:10.549 --> 00:03:13.070
than the price
to the sellers goes down.

00:03:13.070 --> 00:03:15.651
The buyers pay more of the tax
when the supply curve

00:03:15.651 --> 00:03:17.323
is more elastic.

00:03:17.323 --> 00:03:18.877
Let's give some intuition.

00:03:18.877 --> 00:03:21.794
You can always get the right answer
by drawing the curves.

00:03:21.794 --> 00:03:24.828
And let's consider the intuition
for why that's the case.

00:03:24.828 --> 00:03:27.759
So here's the intuition
for remembering the rule.

00:03:27.759 --> 00:03:31.039
Think about elasticity
as a kind of escape.

00:03:31.039 --> 00:03:34.001
The side of the market
which is the more elastic

00:03:34.001 --> 00:03:36.489
can escape the tax more easily.

00:03:36.489 --> 00:03:40.327
Why does that makes sense?
Remember what elastic demand means.

00:03:40.327 --> 00:03:42.657
It means that demanders
have good substitutes

00:03:42.657 --> 00:03:46.130
for the taxed good
and so they can escape the tax.

00:03:46.130 --> 00:03:48.502
When the tax is high,
the demanders are going to say,

00:03:48.502 --> 00:03:50.926
"We're just going to go buy
the substitutes.

00:03:50.926 --> 00:03:53.254
We have plenty
of good substitutes."

00:03:53.254 --> 00:03:55.303
On the other hand,
think about what it means

00:03:55.303 --> 00:03:57.320
when the demand is inelastic.

00:03:57.320 --> 00:03:59.616
It means that there
are no good substitutes

00:03:59.616 --> 00:04:02.064
so it's hard to escape the tax.

00:04:02.064 --> 00:04:05.378
What about the supply side,
elastic supply?

00:04:05.378 --> 00:04:07.908
Well, that means the resources
which are used to produce

00:04:07.908 --> 00:04:10.206
the taxed good,
they can easily be moved

00:04:10.206 --> 00:04:11.728
to other industries.

00:04:11.728 --> 00:04:14.020
The resources
can move around easily.

00:04:14.020 --> 00:04:17.560
If you try to tax the industry
a lot then the land, the capital,

00:04:17.560 --> 00:04:19.824
the workers in that industry
which were used

00:04:19.824 --> 00:04:21.793
to produce the good,
they're just going to flow

00:04:21.793 --> 00:04:24.418
to other industries
and so the suppliers

00:04:24.418 --> 00:04:26.956
can relatively easily
escape the tax.

00:04:27.718 --> 00:04:30.463
On the other hand,
if supply is inelastic

00:04:30.463 --> 00:04:33.365
that means the resources used
to produce this good,

00:04:33.365 --> 00:04:36.594
they really can only be used
to produce this good.

00:04:36.594 --> 00:04:38.890
They're fixed, they're hard
to move around,

00:04:38.890 --> 00:04:40.727
and those factors
are not that useful

00:04:40.727 --> 00:04:43.474
for producing other goods,
so that makes it difficult

00:04:43.474 --> 00:04:46.616
for the suppliers
when the supply curve is inelastic.

00:04:46.637 --> 00:04:48.963
That means it's difficult
for the suppliers

00:04:48.963 --> 00:04:50.842
to escape the tax.

00:04:51.051 --> 00:04:52.963
What if the demanders
and the suppliers

00:04:52.963 --> 00:04:54.752
are both pretty elastic?

00:04:54.752 --> 00:04:55.984
Well, here's the thing.

00:04:55.984 --> 00:04:59.990
Somebody has to pay the tax,
both sides can't escape the tax

00:04:59.990 --> 00:05:02.618
at least if the good is going
to be bought and sold,

00:05:02.618 --> 00:05:07.296
therefore the burden is determined
by the relative elasticities.

00:05:07.296 --> 00:05:11.308
It's about which side has it easier
to escape the tax

00:05:11.308 --> 00:05:13.547
and that side will pay
less of the tax.

00:05:13.547 --> 00:05:16.508
The side which is less elastic,
they're going to pay

00:05:16.508 --> 00:05:19.581
more of the tax
because that side finds it harder

00:05:19.581 --> 00:05:21.690
to escape the tax.

00:05:21.690 --> 00:05:25.521
So let's do an application,
say social security taxes.

00:05:25.881 --> 00:05:28.619
Last time we showed
that the legal incidence

00:05:28.619 --> 00:05:31.346
of social security taxes
has no bearing

00:05:31.346 --> 00:05:33.903
on the economic incidence,
but we didn't say

00:05:33.903 --> 00:05:36.445
what the economic incidence
actually is.

00:05:36.445 --> 00:05:38.268
So let's do that now.

00:05:38.268 --> 00:05:41.159
We're going to have the price
of labor up here, the wage,

00:05:41.159 --> 00:05:43.712
and the quantity
of labor down here.

00:05:43.712 --> 00:05:46.199
The whole question
now boils down to

00:05:46.199 --> 00:05:48.382
is the demand for labor,
more elastic

00:05:48.382 --> 00:05:51.169
than the supply of labor
or vice versa?

00:05:51.169 --> 00:05:53.560
Think about the demanders
of labor, businesses,

00:05:53.560 --> 00:05:56.215
what substitutes
for labor do they have?

00:05:56.215 --> 00:05:59.859
If the price of labor goes up,
what can those businesses do?

00:06:00.159 --> 00:06:02.571
What about the supply
of labor, the workers?

00:06:02.665 --> 00:06:05.794
If their wage goes down,
what can they do?

00:06:05.794 --> 00:06:07.790
If you think about it,
I think you'll see

00:06:07.790 --> 00:06:10.692
that for most workers,
especially full time workers,

00:06:10.692 --> 00:06:13.784
they don't really have a lot
of good substitutes for work.

00:06:13.784 --> 00:06:16.416
Most workers need some kind of job.

00:06:16.416 --> 00:06:19.906
Even if their wage goes down,
they're going to continue to work

00:06:19.906 --> 00:06:22.176
because they need to pay the bills.

00:06:22.176 --> 00:06:24.940
On the other hand,
the demanders of labor

00:06:24.940 --> 00:06:26.663
if the wage were to go up,

00:06:26.663 --> 00:06:29.369
they could substitute
capital for labor,

00:06:29.369 --> 00:06:31.836
they could move their investments
to other countries.

00:06:31.836 --> 00:06:34.096
They have quite a few
good substitutes.

00:06:34.096 --> 00:06:35.779
So if that's actually how it works,

00:06:35.779 --> 00:06:38.128
we should probably draw
the diagram like this

00:06:38.128 --> 00:06:40.613
with a fairly inelastic
supply of labor

00:06:40.613 --> 00:06:43.776
and a fairly elastic
demand for labor.

00:06:43.776 --> 00:06:46.849
Economists have done studies
of this and on average

00:06:46.849 --> 00:06:48.683
this is what they find.

00:06:48.683 --> 00:06:52.651
So now think about your FICA taxes,
that's a tax on labor.

00:06:52.651 --> 00:06:54.127
What's the effect of that?

00:06:54.127 --> 00:06:56.366
Well, it's going to look
something like this.

00:06:56.366 --> 00:06:59.165
Notice that the wage
paid by buyers of labor,

00:06:59.165 --> 00:07:01.209
that's the wage paid
by the firms --

00:07:01.209 --> 00:07:03.247
that goes up only a little bit.

00:07:03.247 --> 00:07:05.206
On the other hand,
the wage received

00:07:05.206 --> 00:07:07.593
by the suppliers of labor,
that is the wage

00:07:07.593 --> 00:07:11.498
which the workers end up with,
that goes down by a lot.

00:07:11.498 --> 00:07:14.940
And this makes perfect sense
when we have a very inelastic

00:07:14.940 --> 00:07:16.436
supply of labor.

00:07:16.436 --> 00:07:19.048
The laborers can't escape
the tax and, therefore,

00:07:19.048 --> 00:07:22.338
they end up bearing
most of the burden of the tax.

00:07:22.338 --> 00:07:24.595
This doesn't mean, by the way,
that we shouldn't have

00:07:24.595 --> 00:07:26.463
social security taxes.

00:07:26.463 --> 00:07:29.181
It may in fact be a good way
of forcing people to save

00:07:29.181 --> 00:07:31.329
for their own future,
but this does mean

00:07:31.329 --> 00:07:33.829
it is not a free lunch
for the workers.

00:07:33.829 --> 00:07:37.082
The workers' wages will drop
because of the tax.

00:07:37.082 --> 00:07:39.586
If we didn't have
the social security tax,

00:07:39.586 --> 00:07:42.677
wages for most workers
would in fact be higher.

00:07:42.677 --> 00:07:46.444
Here's one more application,
health insurance mandates.

00:07:46.444 --> 00:07:48.903
Suppose that the government
requires employers

00:07:48.903 --> 00:07:51.530
to provide health insurance
to their workers

00:07:51.530 --> 00:07:53.899
as is now the case
for many employers

00:07:53.899 --> 00:07:55.956
under the Affordable Care Act.

00:07:55.956 --> 00:07:57.380
Who's going to pay for this?

00:07:57.380 --> 00:07:59.121
Who will end up paying for this?

00:07:59.121 --> 00:08:02.915
Is it primarily the employers
or primarily the workers?

00:08:02.915 --> 00:08:06.344
It's really just the same analysis
as we had before.

00:08:06.344 --> 00:08:09.834
A health insurance mandate
is quite similar to a tax.

00:08:09.834 --> 00:08:13.178
A health insurance mandate
simply means that the employers

00:08:13.178 --> 00:08:16.512
have to pay a higher wage,
but that's just, then,

00:08:16.512 --> 00:08:18.302
the same as a tax.

00:08:18.302 --> 00:08:20.848
What we just saw
is that if labor supply

00:08:20.848 --> 00:08:24.901
is less elastic than labor demand,
which in many cases makes sense,

00:08:24.901 --> 00:08:27.326
then in that case most
of the mandate

00:08:27.326 --> 00:08:29.963
will actually be paid for
by the workers.

00:08:29.963 --> 00:08:31.833
Real wages will fall.

00:08:31.833 --> 00:08:35.843
Again this doesn't necessarily mean
that the mandate is a bad idea

00:08:35.843 --> 00:08:37.673
but it does mean
it's not a free lunch

00:08:37.673 --> 00:08:38.810
for the workers.

00:08:38.810 --> 00:08:41.193
The workers end up paying
for their health care

00:08:41.193 --> 00:08:43.685
through the medium of lower wages.

00:08:44.033 --> 00:08:45.991
Taxes have a couple
of other effects

00:08:45.991 --> 00:08:48.791
including the raising of revenue
and also creating

00:08:48.791 --> 00:08:50.253
some dead weight loss.

00:08:50.253 --> 00:08:53.227
Those are what we're going
to look at in the next lecture.

00:08:54.450 --> 00:08:56.124
- [Narrator] If you want
to test yourself,

00:08:56.124 --> 00:08:58.528
click Practice questions.

00:08:58.528 --> 00:09:01.654
Or if you're ready to move on,
just click Next Video.

00:09:01.654 --> 00:09:05.626
♪ [music] ♪