WHO PAYS THE LUXURY TAX?

In 1990 Congress adopted a new luxury tax on items such as yachts airplanes furs jewelry and expensive cars. The goal of the tax was to raise revenue from those who could most easily afford to pay. Because only the rich could afford to buy such extravagances taxing luxuries seemed a logical way of taxing the rich.

Yet when the forces of supply and demand took over the outcome was quite different from what Congress intended. Consider for example the market for yachts. The demand for yachts is quite elastic. A millionaire can easily not buy a yacht she can use the money to buy a bigger house take a European vacation or leave a larger bequest to her heirs. By contrast the supply of yachts is relatively inelastic at least in the short run. Yacht factories are not easily converted to alternative uses and workers who build yachts are not eager to change careers in response to changing market conditions.

Our analysis makes a clear prediction in this case. With elastic demand and inelastic supply the

burden of a tax falls largely on the suppliers. That is a tax on yachts place a burden largely on the firms and workers who build yachts because they end up getting a lower price for their product. The workers however are not wealthy. Thus the burden of a luxury tax falls more on the middle class than on the rich.

The mistaken assumptions about the incidence of the luxury tax quickly become apparent after the tax went into effect. Suppliers of luxuries made their congressional representatives well aware of the economic hardship they experienced and Congress repealed most of the luxury tax in 1993.

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RENT CONTROL IN THE SHORT RUN AND LONG RUN

One common example of a price ceiling is rent control. In many cities the local government places a ceiling on rents that landlords may charge their tenants. The goal of this policy is to help the poor by making housing more affordable. Economists often criticize rent control arguing that it is a highly inefficient way to help the poor raise their standard of living. One economists called rent control the best way to destroy city other than bombing. The adverse effects of rent control are less apparent to the general population because these effects occur over many years. In the short run landlords have a fixed number of apartments to rent and they cannot adjust this number quickly as market conditions change. Moreover the number of people searching for housing in a city may not be highly responsive to rents in the short run because people take time to adjust their housing arrangements. Therefore the short-run supply and demand for housing are relatively inelastic.

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If you have ever received a paycheck you probably noticed that taxes were deducted from the amount you earned. One ot these taxes is called FICA an acronym for the Federal Insurance Contribution Act. The federal government uses the revenue from the FICA tax pay for Social Security and Medicare the income support and healthcare programs for the elderly. FICA is an example of a payroll tax which is a tax on the wages that firms pay their workers. In 2005 the total FICA tax for the typical worker was of earnings. Who do you think bears the burden of this payroll tax firms or workers. When Congress passed this legislation it tried to mandate a division of the tax burden. According to the law half of the tax is paid by firms and half is paid by workers. That is half of the tax is paid out of firms revenues and half is deducted from workers paychecks. The amount that shows up as a deduction on your pay stup is the worker contribution. Our analysis of tax incidence ho

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