Question

To finance the street renovation project, the city is considering a couple of options. The first is to impose an "entertainment tax." Because the increased traffic is a result of more people visiting the area, the city would like to charge the visitors for the costs of improving the area instead of forcing the local citizens to pay for all of the improvements. Anything classed as "entertainment" (movies, restaurants, theater, etc.) will be subject to an additional 5 percent tax.

The second option is to require the existing businesses along the street to directly pay for the improvements, because they will be benefiting from them the most. This payment would be in the form of a special tax levied on each business on the street. The tax would be proportional to the square footage of the business—the larger the business, the higher the tax.

I'd like you to critique these proposals, and report back to me with the likely effects of the taxes.

Write a 300- to 500-word report to John Becker. In your report, be sure to

• identify and describe the goals of each tax—that is, what does the city hope to achieve by imposing the taxes?
• identify the beneficiaries of the street improvements
• explain the likely outcome on equilibrium prices and quantity for the local businesses if the entertainment tax is imposed
• describe how much of each tax will be paid by businesses and how much will be paid by consumers. (e.g., how much of the tax will be passed on to the consumer)
• comment on the effectiveness of each tax in terms of achieving the city's goals

Note: When describing the tax incidence, specific numbers are not necessary. Instead, focus on who the city intends to pay the tax and how the tax burden is likely to be distributed among the buyers and sellers. To effectively critique the alternative financing plan, carefully consider the benefits and costs of the plan. Who benefits from the plan, and how much do they benefit? How does that compare with how much the plan costs?

Answer 1

The city is proposing to use an "Entertainment tax" to finance a street renovation project. Thus the local restaurants, theater, etc would be subject to the tax. But it could mean that people visit such locations in less intensity, as they realize they will be charged additional 5%. This will reduce consumption on local goods and services and reduce the number of such locations as businesses will have to eventually pay the tax collected to government authorities, and they will have comparatively less business because of the higher prices on their goods and services. Via the entertainment tax, the city hopes to benefit via tourists visiting and funding the local development, through such a scheme of street renovation, ultimately there will be more number of people visiting the area and thus paying the entertainment tax, which will increase revenue base. If the entertainment tax is imposed than the equilibrium price will be greater, while the equilibrium quantity would be lower because law of demand comes into place, as the price increases the quantity demanded reduces. This will be passed on to the consumers partially if the demand is elastic cause if the burden is completely passed onto the consumers, than the demand would fall drastically. It will be effective in achieving the city's goals as more number of people visiting will lead to greater tax revenue.

The second option would be via a special tax levied on businesses on the street. However the tax being proportional to the area of the business would be wrong as a smaller area would be generating more business, than the larger square foot area locality. Thus the tax will have to be levied based on the level of business/revenue a firm makes so that there isn't any regressive form of taxation. Via this tax, the city would tax the local businesses who benefit the most led by the street renovation as more people will visit and spend on the local businesses. Even in this case the businesses would try to pass on the tax burden partially to consumers, if the business picks up drastically led by the traffic. Even this will be effective, depending on whether businesses are tax compliant, organized and come under the tax base.