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typical response of the government to a program’s failure is to increase its budget

and staff, which means that public sector inefﬁciency just continues on a larger scale.

Furthermore, economists assert that government employees, together with the

special-interest groups they serve, often gain sufﬁcient political clout to block

attempts to pare down or eliminate their agencies. Politicians who attempt to reduce

the size of huge federal bureaucracies such as those relating to agriculture, educa-

tion, health and welfare, and national defence incur sizable political risk because

bureaucrats and special-interest groups will team up to defeat them.

Finally, critics point out that there is a tendency for government bureaucrats to

justify their continued employment by looking for and eventually ﬁnding new

“problems” to solve. It is not surprising that social problems, as deﬁned by gov-

ernment, tend to persist or even expand.

Imperfect Institutions

It is possible to argue that such criticisms of public sector inefﬁciency are exagger-

ated and cynical. Perhaps they are. Nevertheless, they do tend to shatter the concept

of a benevolent government that responds with precision and efﬁciency to the wants

of its citizens. The market system of the private sector is far from perfectly efﬁcient,

and government’s economic function is mainly to correct that system’s shortcom-

ings. But the public sector too is subject to deﬁciencies in fulﬁlling its economic func-

tion. “The relevant comparison is not between perfect markets and imperfect

governments, nor between faulty markets and all-knowing, rational, benevolent

governments, but between inevitably imperfect institutions.”

Because the market system and public agencies are both imperfect, it is some-

times difﬁcult to determine whether a particular activity can be performed with

greater success in the private sector or the public sector. It is easy to reach agreement

on opposite extremes: national defence must lie with the public sector, while com-

puter production can best be accomplished by the private sector. But what about

health insurance? parks and recreation areas? ﬁre protection? garbage collection?

housing? education? It is hard to assess every good or service and to say absolutely

that it should be assigned to either the public sector or the private sector. After all,

the goods and services just mentioned are provided in part by both private enter-

prises and public agencies.

492 Part Four • Microeconomics of Government and Public Policy

Otto Eckstein, Public Finance, 3rd ed. (Englewood Cliffs, N.J.: Prentice-Hall, 1973), p. 17.

● Majority voting can produce voting outcomes

that are inefﬁcient; projects having greater total

beneﬁts than total costs may be defeated and

projects having greater total costs than total

beneﬁts may be approved.

● The paradox of voting occurs when voting by

majority rule does not provide a consistent

ranking of society’s preferences for public goods

and services.

● The median-voter model suggests that under

majority rule and consistent voting preferences,

the voter who has the middle preference will

determine the outcome of an election.

● Public sector failure allegedly occurs as a result

of rent-seeking, pressure by special-interest

groups, shortsighted political behaviour, lim-

ited and bundled choices, and bureaucratic

inefﬁciency.

We now turn from the difﬁculties of making collective decisions about public goods

to the difﬁculties of deciding how those goods should be ﬁnanced.

It is difﬁcult to measure precisely how the beneﬁts of public goods are appor-

tioned among individuals and institutions. We cannot accurately determine how

much citizen Raheed Singh beneﬁts from military installations, a network of high-

ways, a public school system, the national weather bureau, and municipal police

and ﬁre protection.

The situation is different when it comes to paying for those beneﬁts. Studies

reveal with reasonable clarity how the overall tax burden is apportioned. (By “tax

burden” we mean the total cost of taxes imposed on society.) This apportionment

question affects each of us. The overall level of taxes is important, but the average

citizen is much more concerned with his or her part of the overall tax burden.

Beneﬁts Received versus Ability to Pay

There are two basic philosophies on how the economy’s tax burden should be

apportioned.

BENEFITS-RECEIVED PRINCIPLE

The beneﬁts-received principle of taxation asserts that households and businesses

should purchase the goods and services of government in the same way they buy

other commodities. Those who beneﬁt most from government-supplied goods or

services should pay the taxes necessary to ﬁnance them. A few public goods are now

ﬁnanced on this basis. For example, money collected as gasoline taxes is typically

used to ﬁnance some highway construction and repairs. Thus people who beneﬁt

from good roads pay the cost of those roads. Difﬁculties immediately arise, how-

ever, when we consider widespread application of the beneﬁts-received principle.

● How will the government determine the beneﬁts that individual households

and businesses receive from national defence, education, the court system, and

police and ﬁre protection? Recall that public goods provide widespread

spillover beneﬁts and that the exclusion principle does not apply. Even in the

seemingly straightforward case of highway ﬁnancing, it is difﬁcult to measure

beneﬁts. Owners of cars beneﬁt in different degrees from good roads, but oth-

ers also beneﬁt. For example, businesses beneﬁt because good roads bring

them customers.

● The beneﬁts-received principle cannot logically be applied to income redistri-

bution programs. It would be absurd and self-defeating to ask poor families to

pay the taxes needed to ﬁnance their welfare payments. It would be ridiculous

to think of taxing only unemployed workers to ﬁnance the unemployment

compensation payments they receive.

ABILITY-TO-PAY PRINCIPLE

The ability-to-pay principle of taxation asserts that the tax burden should be appor-

tioned according to taxpayers’ income and wealth. In Canada this means that indi-

viduals and businesses with larger incomes should pay more taxes in both absolute

and relative terms than those with smaller incomes.

What is the rationale of ability-to-pay taxation? Proponents argue that each addi-

tional dollar of income received by a household yields a smaller amount of satisfaction

chapter nineteen • public choice theory and the economics of taxation 493

Apportioning the Tax Burden

<n103dept.matc.edu/

walshj/handouts/

goodtax.htm>

Principles of a

good tax

beneﬁts-

received

principle

The idea that those

who receive the

beneﬁts of goods

and services pro-

vided by govern-

ment should pay

the taxes required

to ﬁnance them.

ability-

to-pay

principle

The idea that those

who have greater

income (or wealth)

should pay a

greater proportion

of it as taxes than

those who have less

income (or wealth).

The Role of

Governments

or marginal utility when it is spent. Because consumers act rationally, the ﬁrst dol-

lars of income received in any period will be spent on high-urgency goods that yield

the greatest marginal utility. Successive dollars of income will go for less urgently

needed goods and ﬁnally for trivial goods and services. This process means that a

dollar taken through taxes from a poor person who has few dollars represents a

greater utility sacriﬁce than a dollar taken through taxes from a rich person who has

many dollars. To balance the sacriﬁces that taxes impose on income receivers, taxes

should be apportioned according to the amount of income a taxpayer receives.

This argument is appealing, but application problems arise here, too. Although

we might agree that the household earning $100,000 per year has a greater ability to

pay taxes than a household receiving $10,000, we don’t know exactly how much

more ability to pay the ﬁrst family has. Should the wealthier family pay the same

percentage of its larger income, and hence a larger absolute amount, as taxes? Or

should it be made to pay a larger fraction of its income as taxes? How much larger

should that fraction be?

There is no scientiﬁc way of measuring someone’s ability to pay taxes—and that’s

the main problem. In practice, the solution hinges on guesswork, the tax views of the

political party in power, expediency, and how urgently the government needs revenue.

Progressive, Proportional, and Regressive Taxes

Any discussion of taxation leads ultimately to the question of tax rates. Note that an

average tax rate is the total tax paid divided by some base against which the tax is

compared.

DEFINITIONS

Taxes are classiﬁed as progressive, proportional, or regressive, depending on the

relationship between average tax rates and taxpayer incomes. We focus on incomes

because all taxes, whether on income or on a product or a building or a parcel of

land, are ultimately paid out of someone’s income.

● A tax is progressive if its average rate increases as income increases. Such a tax

claims not only a larger absolute (dollar) amount but also a larger percentage

of income as income increases.

● A tax is regressive if its average rate declines as income increases. Such a tax

takes a smaller proportion of income as income increases. A regressive tax may

or may not take a larger absolute amount of income as income increases. (You

may want to derive an example to substantiate this conclusion.)

● A tax is proportional if its average rate remains the same regardless of the size

of income.

We can illustrate these ideas with the personal income tax. Suppose tax rates are

such that a household pays 10 percent of its income in taxes regardless of the size of

its income. This is a proportional income tax. Now suppose the rate structure is such

that a household with an annual taxable income of less than $10,000 pays 5 percent

in income taxes; a household with an income of $10,000 to $20,000 pays 10 percent;

one with a $20,000 to $30,000 income pays 15 percent; and so forth. This is a pro-

gressive income tax.

Finally, suppose the rate declines as taxable income rises: you pay 15 percent if

you earn less than $10,000; 10 percent if you earn $10,000 to $20,000; 5 percent if you

earn $20,000 to $30,000; and so forth. This is a regressive income tax.

494 Part Four • Microeconomics of Government and Public Policy

progressive

tax

A tax whose

average tax rate

increases as the

taxpayer’s income

increases and

decreases as the

taxpayer’s income

decreases.

regressive

tax

A tax whose

average tax rate

decreases as the

taxpayer’s income

increases and

decreases as the

taxpayer’s income

decreases.

propor-

tional tax

tax whose average

tax rate remains

constant as the

taxpayer’s income

increases or

decreases.

In general, progressive taxes are those that fall

relatively more heavily on those with high in-

comes; regressive taxes are those that fall rela-

tively more heavily on the poor. (Key Question 7)

APPLICATIONS

Let’s examine the progressivity, or regressivity,

of several taxes. In Table 19-2 you will ﬁnd the

yields of the main taxes in Canada and what

these yields are as a percentage of gross domes-

tic product.

Personal Income Tax The federal personal in-

come tax is progressive, with marginal tax rates

(those assessed on additional income) ranging

from 17 to 29 percent. In 2000 the federal in-

come tax was 17 percent on the ﬁrst $30,004;

26 percent for income between $30,005 and

$60,008; and 29 percent for income above $60,009.

Rules that allow individuals to deduct from

income contributions to their registered retire-

ment saving plan (RRSP) tend to make the tax less progressive than these marginal

rates suggest. Nevertheless, average tax rates rise with income. Table 19-2 shows

that the personal income tax is by far the largest source of government revenue.

Sales Taxes At ﬁrst thought, a general sales tax with, for example, a 5 percent rate

would seem to be proportional, but in fact it is regressive with respect to income. A

larger portion of a low-income person’s income is exposed to the tax than is the case

for a high-income person; the rich pay no tax on the part of income that is saved,

whereas the poor are unable to save. For example, “Low-income” Goldstein has an

income of $15,000 and spends it all. “High-income” Jones has an income of $300,000

but spends only $200,000 and saves the rest. Assuming a 5 percent sales tax applies

to all expenditures of each individual, we ﬁnd that Goldstein pays $750 (5 percent

of $15,000) in sales taxes and Jones pays $10,000 (5 percent of $200,000). But Gold-

stein pays $750/$15,000 or 5 percent of income as sales taxes, while Jones pays

$10,000/$300,000 or 3.3 percent of income as sales tax. The general sales tax, there-

fore, is regressive.

Corporate Income Tax The federal corporate income tax is essentially a proportional

tax with a ﬂat 28 percent tax rate in 2000. But this assumes that corporation owners

(shareholders) bear the tax. Some tax experts argue that at least part of the tax is

passed through to consumers in the form of higher product prices. To the extent that

this occurs, the tax is like a sales tax and is thus regressive.

Property Taxes Most economists conclude that property taxes on buildings are

regressive for the same reasons as are sales taxes. First, property owners add the tax

to the rents that tenants are charged. Second, property taxes, as a percentage of

income, are higher for low-income families than for high-income families because

the poor must spend a larger proportion of their incomes for housing. This alleged

regressivity of property taxes may be increased by differences in property-tax rates

from municipality to municipality. In general, property-tax rates are higher in

poorer areas to make up for lower property values.

chapter nineteen • public choice theory and the economics of taxation 495

TABLE 19-2 TAX REVENUE

SOURCES OF

CANADIAN

GOVERNMENTS,

1997–98

Billions of Percent

dollars of GDP

Personal income taxes 160.2 16.7

Corporation income taxes 33.9 3.5

Sales taxes 73.1 7.6

Property and related taxes 35.6 4.0

Other taxes 70.7 7.4

Total tax revenues 373.5 39.2

Source: Statistics Canada, <www.statcan.ca/english/

Pgdb/State/Government/govt01a.htm>, 1999.

Visit www.mcgrawhill.ca/college/mcconnell9 for data update.

<sbinfocanada.about.com/

aboutcanada/

sbinfocanada/library/

weekly/aa032101a.htm>

Provincial tax comparison

for small businesses

Determining whether a particular tax is progressive, proportional, or regressive is

complicated, because those on whom taxes are levied do not always pay the taxes.

We, therefore, need to try to locate the ﬁnal resting place of a tax, or the tax inci-

dence. The tools of elasticity of supply and demand will help. Let’s focus on a hypo-

thetical excise tax levied on wine producers. Do the producers really pay this tax, or

do they shift it to wine consumers?

Elasticity and Tax Incidence

In Figure 19-2, S and D represent the pretax market for a certain domestic wine; the

no-tax equilibrium price and quantity are $4 per bottle and 15 million bottles. Sup-

pose that government levies an excise tax of $1 per bottle at the winery. Who will

actually pay this tax?

DIVISION OF BURDEN

Since the government imposes the tax on the sellers (suppliers), we can view the tax

as an addition to the marginal cost of the product. Now sellers must get $1 more for

each bottle to receive the same per-unit proﬁt they were getting before the tax. While

sellers are willing to offer, for example, ﬁve million bottles of untaxed wine at $2 per

bottle, they must now receive $3 per bottle (= $2 plus the $1 tax) to offer the same

ﬁve million bottles. The tax shifts the supply curve upward (leftward) as shown in

Figure 19-2, where S

is the after-tax supply curve.

The after-tax equilibrium price is $4.50 per bottle, whereas the before-tax equi-

librium price was $4. So, in this case, consumers pay half the $1 tax as a higher price;

496 Part Four • Microeconomics of Government and Public Policy

Tax Incidence and Efﬁciency Loss

FIGURE 19-2 THE INCIDENCE OF AN EXCISE TAX

Tax $1

510152025

Quantity

(millions of bottles per month)

Price (per bottle)

An excise tax of a speci-

ﬁed amount, here $1 per

unit, shifts the supply

curve upward by the

amount of the tax per

unit: the vertical dis-

tance between S and S

This results in a higher

price (here $4.50) to

consumers and a lower

after-tax price (here

$3.50) to producers.

Thus consumers and

producers share the

burden of the tax in

some proportion (here

equally at $.50 per unit).

tax inci-

dence

The

person or group

who ends up paying

a tax.

producers pay the other half in the form of a lower after-tax per-unit revenue. That

is, after remitting the $1 tax per unit to government, producers receive $3.50, or 50

cents less than the $4 before-tax price. So, in this case, consumers and producers

share the burden of the tax equally: producers shift half the tax to consumers in the

form of a higher price and bear the other half themselves.

Note also that the equilibrium quantity declines because of the tax levy and the

higher price that it imposes on consumers. In Figure 19-2 that decline in quantity is

from 15 million bottles to 12.5 million bottles per month.

ELASTICITIES

If the elasticities of demand and supply were different from those shown in Figure

19-2, the incidence of tax would also be different. Two generalizations are relevant.

First, with a speciﬁc supply, the more inelastic the demand for the product, the larger is

the portion of the tax shifted to consumers. To verify this, sketch graphically the extreme

cases in which demand is perfectly elastic and perfectly inelastic. In the ﬁrst case,

the incidence of the tax is entirely on sellers; in the second, the tax is shifted entirely

to consumers.

Figure 19-3 contrasts the more usual cases where demand is either relatively elas-

tic or relatively inelastic in the relevant price range. With elastic demand in panel (a),

a small portion of the tax (P

– P

) is shifted to consumers, and most of the tax (P

– P

)

is borne by the producers. With inelastic demand in panel (b), most of the tax (P

– P

)

is shifted to consumers, and only a small amount (P

– P

) is paid by producers. In both

graphs the per-unit tax is represented by the vertical distance between S

and S.

Note also that the decline in equilibrium quantity (Q

– Q

) is smaller when

demand is more inelastic. This is the basis of our previous applications of the elas-

ticity concept: Revenue-seeking legislatures place heavy excise taxes on liquor, cig-

arettes, automobile tires, telephone service, and other products whose demand is

thought to be inelastic. Since demand for these products is relatively inelastic, the

tax does not reduce sales by much, so the tax revenue stays high.

Second, with a speciﬁc demand, the more inelastic the supply, the larger is the portion

of the tax borne by producers. When supply is elastic [Figure 19-4(a)], the producers

chapter nineteen • public choice theory and the economics of taxation 497

FIGURE 19-3 DEMAND ELASTICITY AND THE INCIDENCE OF AN

EXCISE TAX

(a) Tax incidence and elastic

demand

(b) Tax incidence and inelastic

demand

Tax

Panel (a): If demand

is elastic in the rele-

vant price range,

price rises modestly

to P

) when an

excise tax is levied.

Hence, the producer

bears most of the tax

burden. Panel (b): If

demand is inelastic,

the price to the buyer

increases substan-

tially (P

to P

) and

most of the tax is

shifted to consumers.

shift most of the tax (P

– P

) to consumers and bear only a small portion (P

– P

)

themselves. But where supply is inelastic [Figure 19-4(b)], the reverse is true: the

major portion of the tax (P

– P

) falls on sellers, and a relatively small amount

– P

) is shifted to buyers. The equilibrium quantity also declines less with an

inelastic supply than it does with an elastic supply.

Gold is an example of a product with an inelastic supply and one where the bur-

den of an excise tax (such as an extraction tax) would mainly fall on producers. Con-

versely, because the supply of baseballs is relatively elastic, producers would pass

on to consumers much of an excise tax on baseballs.

Efﬁciency Loss of a Tax

We just observed that producers and consumers typically each bear part of an excise

tax levied on producers. Let’s now look more closely at the overall economic effect

of the excise tax. Consider Figure 19-5, which is identical to Figure 19-2 but contains

the additional detail we need for our discussion.

TAX REVENUES

In our example, a $1 excise tax on wine increases its market price from $4 to $4.50

per bottle and reduces the equilibrium quantity from 15 million bottles to 12.5 mil-

lion. Government tax revenue is $12.5 million (= $1 × 12.5 million bottles), an

amount shown as the rectangle efac in Figure 19-5. The elasticities of supply and

demand in this case are such that consumers and producers each pay half this total

amount, or $6.25 million apiece (= $.50 × 12.5 million bottles). The government uses

this $12.5 million of tax revenue to provide public goods and services. So this trans-

fer of dollars from consumers and producers to government involves no loss of

well-being to society.

EFFICIENCY LOSS

The $1 tax on wine does more than require consumers and producers to pay $12.5

million in taxes; it also reduces the equilibrium amount of wine produced and

498 Part Four • Microeconomics of Government and Public Policy

FIGURE 19-4 SUPPLY ELASTICITY AND THE INCIDENCE OF AN

EXCISE TAX

(a) Tax incidence and elastic

supply

(b) Tax incidence and inelastic

supply

Tax

Panel (a): With elastic

supply, an excise tax

results in a large

price increase (P

), and the tax is,

therefore, paid mainly

by consumers. Panel

(b): If supply is inelas-

tic, the price rise is

small (P

to P

), and

sellers bear most of

the tax.

consumed by 2.5 million bottles. The fact that consumers and producers demanded

and supplied 2.5 million more bottles of wine before the tax means that those

2.5 million bottles provided beneﬁts in excess of their production costs. This is clear

from the following analysis.

Segment ab of demand curve D in Figure 19-5 indicates the willingness to pay—the

marginal beneﬁt—associated with each of the 2.5 million bottles consumed before

(but not after) the tax. Segment cb of supply curve S reﬂects the marginal cost of each

bottle of wine. For all but the very last one of these 2.5 million bottles, the marginal

beneﬁt (shown by a point on ab) exceeds the marginal cost (shown by a point on cb).

Not producing all 2.5 million bottles of wine reduces well-being by an amount repre-

sented by the triangle abc. The area of this triangle identiﬁes the efﬁciency loss of the

tax (also called the deadweight loss of the tax). This loss is society’s sacriﬁce of net ben-

eﬁt, because the tax reduces production and consumption of the product below their

levels of economic efﬁciency at which marginal beneﬁt and marginal cost are equal.

ROLE OF ELASTICITIES

Most taxes create some degree of efﬁciency loss, but just how much depends on the

supply and demand elasticities. Glancing back at Figure 19-3, we see that the efﬁ-

ciency loss area abc is greater in panel (a), where demand is relatively elastic, than

in panel (b), where demand is relatively inelastic. Similarly, area abc is greater in

panel (a) of Figure 19-4 than in panel (b), indicating a larger efﬁciency loss where

supply is more elastic. Other things equal, the greater the elasticities of supply and

demand, the greater the efﬁciency loss of a particular tax.

Two taxes yielding equal revenues do not necessarily impose equal costs on soci-

ety. The government must keep this fact in mind when designing a tax system to

chapter nineteen • public choice theory and the economics of taxation 499

FIGURE 19-5 EFFICIENCY LOSS OF A TAX

Tax $1

Tax paid

by consumers

Efficiency

loss

0 5 10 15 20 25

Price (per bottle)

Quantity

(millions of bottles per month)

Tax paid

by producers

The levy of a $1 tax

per bottle of wine

increases the price

per bottle from $4 to

$4.50 and reduces the

equilibrium quantity

from 15 million to 12.5

million. Tax revenue

to the government is

$12.5 million (area

efac). The efﬁciency

loss of the tax arises

from the 2.5 million

decline in output;

the amount of that

loss is shown as

triangle abc.

efﬁciency

loss of a

tax

The loss of

net beneﬁts to soci-

ety because a tax

reduces the produc-

tion and consump-

tion of a taxed good

below the level of

allocative efﬁciency.

ﬁnance beneﬁcial public goods and services. In general, government should mini-

mize the efﬁciency loss of the tax system in raising any speciﬁc dollar amount of tax

revenue.

QUALIFICATIONS

We must acknowledge, however, that there may be other tax goals as important, or

even more important, than minimizing efﬁciency losses from taxes. Here are two

examples:

1. Redistributive goals Government may want to impose progressive taxes as a

way to redistribute income. A 10 percent excise tax placed on selected luxuries

would be an example. Because the demand for luxuries is elastic, substantial efﬁ-

ciency losses from this tax are to be expected. However, if government concluded

that the beneﬁts from the redistribution effects of the tax would exceed the efﬁ-

ciency losses, then it would levy the luxury tax.

2. Reducing negative externalities The government may have intended the $1 tax

on wine in Figure 19-5 to reduce the consumption of wine by 2.5 million bottles. It

may have concluded that such consumption of alcoholic beverages produces cer-

tain negative externalities. Therefore, it might have purposely levied this tax to

shift the market supply curve such that the price of wine increased and the amount

of resources allocated to wine declined, as in Figure 19-3(b). (Key Question 9)

Probable Incidence of Taxes in Canada

Let’s look now at the probable incidence of each of the major sources of tax revenue

in Canada.

PERSONAL INCOME TAX

The incidence of the personal income tax generally is on the individual because

there is little chance for shifting it. But there might be exceptions. Individuals and

groups who can control the price of their labour services may be able to shift a part

of the tax. Dentists, lawyers, and other professional people who can readily increase

their fees may do so because of the tax. Unions might regard personal income taxes

as part of the cost of living and, as a result, strengthen their bargaining resolve for

higher wages when personal income tax rates rise. If they are successful, they may

shift part of the tax from workers to employers, who, by increasing prices, shift the

wage increase to the public. Generally, however, the individual on whom the tax is

initially levied bears the burden of the personal income tax.

CORPORATE INCOME TAX

The incidence of the corporate income tax is much less certain. The traditional view

is that a ﬁrm currently charging the proﬁt-maximizing price and producing the

proﬁt-maximizing output will have no reason to change price or output when a tax

on corporate income (proﬁt) is imposed. The price and output combination yield-

ing the greatest proﬁt before the tax will still yield the greatest proﬁt after a ﬁxed

percentage of the ﬁrm’s proﬁt is taken away via an income tax. In this view, the com-

pany’s stockholders (owners) must bear the burden of the tax through lower divi-

dends or a smaller amount of retained earnings.

However, economists recognize that where a small number of ﬁrms control a

market, producers may be able to shift part of their corporate income tax to con-

sumers through higher prices and to resource suppliers through lower prices and

500 Part Four • Microeconomics of Government and Public Policy

wages. That is, some ﬁrms may be able to use their monopoly power as product sell-

ers and monopsony power as resource buyers to reduce the actual amount of the tax

paid by their corporate stockholders.

There is no consensus among experts on the overall incidence of the corporate

income tax. Stockholders, customers, and resource suppliers may share the tax bur-

den in some unknown proportion.

SALES AND EXCISE TAXES

A sales tax is a general excise tax levied on a wide range of consumer goods and serv-

ices, whereas a speciﬁc excise tax is one levied only on a particular product. Sales taxes

are usually transparent to the buyer, whereas excise taxes are often hidden in the price

of the product. An example of a general sales tax is the federal Goods and Services Tax

(GST) which is levied on most goods and services sold across Canada. Sellers often

shift both kinds of taxes partly or largely to consumers through higher product prices.

There may be some difference in the extent to which sales taxes and excise taxes are

shifted, however. Because a sales tax covers a much wider range of products than an

excise tax does, consumers have little chance to resist the price boosts that sales taxes

entail. They cannot reallocate their expenditures to untaxed, lower-priced products.

Therefore, sales taxes tend to be shifted from producers in their entirety to consumers.

Excise taxes, however, fall on a select list of goods. Therefore, the possibility of

consumers turning to substitute goods and services is greater. An excise tax on the-

atre tickets that does not apply to other types of entertainment might be difﬁcult to

pass on to consumers via price increases. Why? The answer is provided in Figure

19-3(a), where demand is elastic. A price boost to cover the excise tax on theatre tick-

ets might cause consumers to substitute alternative types of entertainment. The

higher price would reduce sales so much that a seller would be better off to bear all,

or a large portion of, the excise tax. (See Global Perspective 19.1 for a comparison of

taxes on goods and services in various countries.)

chapter nineteen • public choice theory and the economics of taxation 501

19.1

United States

Japan

Britain

Taxes on Goods and Services

(Percentage of Total Tax Receipts)

Germany

Netherlands

France

Canada

Sweden

Italy

0 5 10 15 20 25 30 35

Source: Organisation for Economic Co-operation

and Development data, <www.oecd.org/>.

<www.taxpayer.com/

opinioneditorials/

nationalpost/

jan5-1999.htm>

Gasoline and taxes

Taxes on goods and

services as a percentage

of total tax revenues,

selected nations

Compared with our major trad-

ing partner, the United States,

Canada relies more heavily on

goods and services taxes—sales

taxes, value-added taxes, and

speciﬁc excise taxes. (A value-

added tax applies only to the

difference between the value

of a ﬁrm’s sales and the value of

its purchases from other ﬁrms.)