In this experiment, three people are assigned to a single role.

Find your
teammates and sit together.
Remember: You are competing against the other teams.

The Players and the Goals

In this experiment, each team controls a firm that
sells to a group of consumers.
FIRMS select what price to charge.
Lower price means consumers purchase more
units.
Higher price means consumers purchase fewer
units.

The Players and the Goals

Goal: make the most profit possible.
Profit = Revenue Cost

(Price per unit) (Units

sold)
($1) (Units sold)

(Tax per unit) (Units

Sold)

Example
You will see a demand
schedule like the one to
the right.
The chart shows the
number of units you will
sell depending on what
price you decide to
charge.
For example, if you
charge $0.50, you will
sell 940 units.
You must choose what
price to charge for your
product so as to
maximize your profit.

Example
Suppose you charge
$10.00 per unit.
How many units will
you sell?
750
What is your revenue?
($10.00) (750) =
$7,500
What is your cost?
($1.00) (750) = $750
What is your profit?
$7,500 $750 = $6,750

Example
Suppose you charge
$20.00 per unit.
How many units will
you sell?
550
What is your revenue?
($20.00) (550) =
$11,000
What is your cost?
($1.00) (550) = $550
What is your profit?
$11,000 $550 =
$10,450
6

Example
Suppose you charge
$30.00 per unit.
How many units will
you sell?
350
What is your revenue?
($30.00) (350) =
$10,500
What is your cost?
($1.00) (350) = $350
What is your profit?
$11,000 $550 =
$10,150
7

Example

Suppose you charge

$10.00 per unit.

Profit = $6,750

Suppose you charge

$20.00 per unit.

Profit = $10,450

Suppose you charge

$30.00 per unit.

Profit = $10,150

Of these three prices,

$20.00 is the best price
to charge.

Round 1
Choose the
price you will
charge for
your product.
Every unit
you sell costs
you $1 to
produce.
There is no
tax.

Round 1

10

Statutory vs. Economic Tax Burden (or tax

incidence)

Statutory tax burden is the amount of tax collected from a

person.
Economic tax burden is the amount of tax paid by a person.
Example:

With no taxes, the price of gas is $3.00 per gallon.

The government imposes a 50 cent per gallon tax on gasoline.

The tax is collected from the producer.

In response to the tax, the producer raises the price of gas to

$3.50.
Who bears the statutory and economic burdens of the tax?
Statutory burden is on the producer, but economic burden is on
11
the
consumer.

Statutory vs. Economic Tax Burden (or tax

incidence)

Statutory tax burden is the amount of tax collected from a

person.
Economic tax burden is the amount of tax paid by a person.
Example:

With no taxes, the price of gas is $3.00 per gallon.

The government imposes a 50 cent per gallon tax on gasoline.

The tax is collected from the producer.

In response to the tax, the producer does not change the price
of gas.
Who bears the statutory and economic burdens of the tax?
Statutory burden is on the producer and economic burden is on
12
the
producer.

Statutory vs. Economic Tax Burden (or tax

incidence)

Statutory tax burden is the amount of tax collected from a

person.
Economic tax burden is the amount of tax paid by a person.
Example:

With no taxes, a person earns $50,000 per year.

The government imposes a $10,000 income tax.

The tax is collected from the worker.

In response to the tax, the employer gives the worker a $5,000

raise.
Who bears the statutory and economic burdens of the tax?
Statutory burden is on the worker, but economic burden is
shared
between the worker and the employer.

13

Statutory vs. Economic Tax Burden (or tax

incidence)

Statutory tax burden is the amount of tax collected from a

person.
Economic tax burden is the amount of tax paid by a person.
Example:

With no taxes, a person earns $50,000 per year.

The government imposes a $10,000 Social Security tax.

$5,000 of the tax is withheld from the workers pay check. The
employer
is required to pay the other $5,000.
In response to the tax, the employer cuts the workers salary by
$5,000.
Who bears the statutory and economic burdens of the tax?
Statutory burden is shared by the worker and employer, but

14

Sales/Excise Tax
When the government imposes a tax, the price the consumer
pays is no longer the same as the price the producer
receives.

Example: $10 per unit tax.

The consumer pays $35 per unit, but the producer receives
only $25 per unit.
We call the $35 the consumer price or the price including
tax and the $25 the producer price or the price excluding
15
tax.

Round 2: Statutory Tax Burden is on

Consumers

In this round, consumers will pay an additional $5 per unit tax.

The price consumers pay is the price you charge (the producer
price) plus $5.
The statutory tax burden is on the consumer.

16

Round 2
In this round,
consumers
will pay an
additional $5
per unit tax.
The consumer
price is the
price you
charge plus
the $5 tax.
If you charge,
$7, how many
units will
consumers
buy?
77
What is your
profit?
($7)(77) ($1)(77) = $532

17

Round 2
Choose the
price you will
charge for
your product
(the price
excluding
tax).
The consumer
price is the
price you
charge plus
$5.
Every unit
you sell costs
you $1 to
produce.
18

Round 2

19

Round 2

20

Round 3: Statutory Tax Burden is on Producers

In this round, producers will pay a $5 per unit tax for every
unit they sell.
The price consumers pay is the price you charge.
The statutory tax burden is on the producer.

21

Round 3
In this round,
producers will
pay a $5 per
unit tax.
Your cost per
unit is now $6
($1 per unit
to produce
plus $5 per
unit tax).
If you charge,
$7, how many
units will
consumers
buy?
101
What is your
profit?
($7)(101) ($6)(77) = $245

22

Round 3
Choose the
price you will
charge for
your product.
The consumer
price is the
price you
charge.
Every unit
you sell costs
you $6.

23

Round 3

24

Round 3

25

Round 3

26

Luxury versus Necessity

Consumption of luxury goods is more sensitive to price
changes.
Consumption of necessity goods is less sensitive to price
changes.
Example:

At a price of $10 per ticket, Howie will see 10 movies per year.

If the price rises to $12, Howie will cut back to 5 movies per
year.
20% rise in price results in a 50% reduction in consumption
Howies consumption is highly sensitive to price changes.
For Howie, movies are a luxury good.

27

Luxury versus Necessity

Consumption of luxury goods is more sensitive to price
changes.
Consumption of necessity goods is less sensitive to price
changes.
Example:

At a price of $10 per ticket, Rob will see 10 movies per year.

If the price rises to $12, Rob will cut back to 9 movies per year.

20% rise in price results in a 10% reduction in consumption

Robs consumption is less sensitive to price changes.
For Rob, movies are a necessity good.

28

Round 4
Choose the
price you will
charge for
your product.
The consumer
price is the
price you
charge.
Every unit
you sell costs
you $6.

29

Round 4

30

Round 4

31

Round 4

32

How to increase tax revenue

In an attempt to increase tax revenue, the government

increases the tax from $5 per unit to $15 per unit.

33

Round 5
Choose the
price you will
charge for
your product.
The consumer
price is the
price you
charge.
Every unit
you sell costs
you $16.

34

Round 5

35

Round 5

36

Round 5

37

Round 5

38

How to increase tax revenue

In an attempt to increase tax revenue even further, the

government increases the tax from $15 per unit to $25 per
unit.

39

Round 6
Choose the
price you will
charge for
your product.
The consumer
price is the
price you
charge.
Every unit
you sell costs
you $26.

40

Round 6

41

Round 6

42

Round 6

43

Round 6

44

Does it work this way in the real

world?

45

Who bears the economic burden of

the Social Security tax?

46

Source:

Social Security Administration and the U.S. Bureau of Labor Statistics.

47

Average annual wage growth when SS tax increases = 1.0%

Average annual wage growth when SS tax does not change =
1.3%

Source:

Social Security Administration and the U.S. Bureau of Labor Statistics.

48

Average annual wage growth when SS tax increases = 1.0%

Average annual wage growth when SS tax does not change =
1.3%
Increasing SS tax slows average wage growth by
0.3%.

When SS tax rate increases, it increases (on average) by

0.3%

Employer passes on employers half of SS

tax increases to the worker in the form of
lower wages.

49

Does increasing Social Security tax

increase Social Security tax
revenues?

50

Source:

U.S. Bureau of Labor Statistics.

51

Source:

U.S. Bureau of Labor Statistics.

52

Does increasing the capital gains tax

rate increase tax revenues?

53

Source:
Gwartney, J.D. and R.G. Holcombe, 1997. Optimal Capital Gains Tax Policy. Report to the Joint
Economic Committee of the United States Congress.

54

Source:
Gwartney, J.D. and R.G. Holcombe, 1997. Optimal Capital Gains Tax Policy. Report to the Joint
Economic Committee of the United States Congress.

55

Two possible goals for tax policy:

1. Raise revenue.
2. Redistribute income.

56

Can we tax the rich by taxing things

that rich people buy?

57

1990 Deficit Reduction Law: The Luxury Tax

Goal: Raise tax revenue by raising taxes on the rich.
Means: 10% excise tax on recreational planes.
Result: 80 fewer planes sold
$130 million lost sales
480 lost jobs
Estimated tax revenue:
Actual tax revenue:

$6 million.

$530,000.

Economic burden of the tax fell almost entirely on the

poor.
Government gained $1,100 for every job a worker lost.
Source: Joint Committee on Taxation, Methodology and Issues in the Revenue Estimating Proecess (JCX-2-95),
January 23, 1995.

58

Can we get more money from the

rich by taxing their income at a
higher rate?

59

In early 1920s, the top income tax

rate was decreased from 73% to
24%.

60

Top Income Tax Rate Cut from 73% to 24% in Early 1920s

61

In early 1960s, the top income tax

rate was decreased from 90% to
70%.

62

Top Income Tax Rate Cut from 90% to 70% in Early 1960s

63

In early 1980s, the top income tax

rate was decreased from 50% to
28%.
Lower bracket income taxes were
also decreased.

64

Top Income Tax Rate Cut from 50% to 28% in Early 1980s

65

What to do?
The rich are getting richer while the
poor are getting poorer.

66

20%

Income Distribution for 1980 (in 2003$)

18%

14%
12%
10%
8%
6%
4%
2%

> $100,000

$75,000 $100,000

$50,000 $75,000

$35,000 $50,000

$25,000 $35,000

$15,000 $25,000

0%

< $15,000

% of Households

16%

1980
Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2006, Table 673.

67

20%

Income Distribution for 2003 (in 2003$)

18%

14%
12%
10%
8%
6%
4%

1980

$75,000 $100,000

$50,000 $75,000

$35,000 $50,000

$25,000 $35,000

$15,000 $25,000

0%

> $100,000

2%

< $15,000

% of Households

16%

2003

Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2006, Table 673.

68

In 1980, the lower 80% of

households earned 56% of all
income.
By 2003, the lower 80% of
households earned only 50% of all
income.

Source: Statistical Abstract of the United States, U.S. Bureau of the Census, 2008, Table 675.
69

In which world would each person rather

live?

In world #1, Person 10 earns 11% of all income.

In world #2, Person 10 earns 15% of all income.

(prices are the same in the two worlds)

70

In World #1, the lower 80% of

households earned 80% of all
income.
In World #2, the lower 80% of
households earned only 70% of all
income.

71

In which world would each person rather

live?

World #3s income distribution is the same as World

#1s.

(prices are the same in the two worlds)

72

73

74

75

76

Expected Tax and Benefits for Median Worker

$60,000
$50,000
$40,000
$30,000
$20,000

Expected annual Social Security tax

payments

$10,000

100

97

94

91

88

85

82

79

73
76

70

67

64

61

58

55

52

46
49

43

40

37

34

31

28

25

22

$0
($10,000)
($20,000)

Expected annual Social Security

benefits

($30,000)
Compiled from data published in 2003 Statistical Abstract of the United States, U.S. Bureau of the Census, and provided by the Social Security
Administration

77
77

$320,000

$270,000

This chart assumes that 100% of the

workers current Social Security taxes
are diverted to a private investment
account yielding an 8% annual return.

Expected annual benefits from privatized

account

$220,000

$170,000

$120,000

$70,000

77

73

69

65

61

57

53

49

45

41

37

33

29

25

21

17

13

($30,000)

$20,000

Expected annual Social Security tax

payments

Compiled from data published in 2003 Statistical Abstract of the United States, U.S. Bureau of the Census, and provided by the Social Security
Administration

78
78