Should before or after tax equilibria point elasticities be calculated when the Laffer effect is considered in a micro market?

Abstract

Purpose

Traditionally, the Laffer effect has been discussed in the context of endogenous growth models or in the case of the labor market with respect to willingness to supply more labor given a tax incentive on wages. The paper adopts an inductive approach to discuss it in the context of a product's market, say automobile industry in Turkey.

Design/methodology/approach

The author revisits the ad valorem tax model on a product and investigates how the elasticities of demand and supply and the tax rate are related to the Laffer effect. The author considers a special case where demand curve is non-linear and the supply curve is completely elastic. This specific model fits the practical case where the Turkish government expected the auto sellers to pass fully the temporary partial tax concession onto the consumers during the global crisis in 2009.

Findings

The author showed that the demand elasticitiy must be calculated neither at the intersection of the initial equilibrium nor that of the final equilibrium points, but somewhere else. The author defined a pass-through coefficient which was different from the classical burden of tax concept, calculating the degree of pass-through of a tax decrease from firms to consumers. Moreover, the author found a one-way relationship between the overall tax revenues of the government and a single sector.

Research limitations/implications

The case of tax revenues where both the demand and supply curves are non-linear and non-extreme must be solved.

Practical implications

The author showed that the government's dual expectation of both boosting the economy, increasing employment and raising its tax revenues can sometimes be consistent given a usual upward sloping supply curve. In the case of a perfectly elastic supply curve, the tax revenues can even be higher with a higher level of equilibrium quantity.

Social implications

The Turkish government aiming to support the production and employment in this leading export industry, may have expected this temporary tax decrease to be passed completely onto the consumers by the producers. However, this did not happen as producers’ prices to the consumers did not decrease as much as the amount of tax. This paper shows that the after tax elasticities and the current level of tax rate must have been compared.

Originality/value

The author pointed out to the importance of being clear in explicitly indicating at which points the elasticities derived from some function (tax revenue function) of equilibria variables (price and quantity) must be interpreted. In this paper, doing many numerical calculations allowed us to notice the proper point of calculation of the demand elasticity, which is the after-tax price along the “no tax demand curve”. Moreover, a pass-through coefficient is defined which is different from the classical burden of tax concept.

Citation

Özçam, A. (2014), "Should before or after tax equilibria point elasticities be calculated when the Laffer effect is considered in a micro market?", Journal of Economic Studies, Vol. 41 No. 6, pp. 754-770. https://doi.org/10.1108/JES-11-2012-0152