Welcome back to week 12 of the power of markets course. In this session we look at another input market application the specifically social security a system that prevails in a lot of countries around the globe. It was started during the great depression in the United States and inastensibly to benefit individuals when post-retirement, so that they have a steady source of income. The way it was set up is, with a tax that funded the benefits, both on employers, and employees, the tax being equally split. And nowadays, the tax rate is 7.65%. On both employees and employers. So if a worker earns $20,000 per year, a $1,530 comes from employee's paychecks and $1,530 is collected from their employer's as well. Now, again, the bene-, the way it's structured is, to share the burden of paying for the benefits between firms, and to employees. What we'll see in this session, though, is who the government actually collects the money from, is irrelevant. What really matters is the elasticities of supply and demand. As we saw several weeks ago. And that insite applies to input markets, just like it does to output markets. So it's who can run away from the tax more quickly? Is it employees, or is it employers? And we'll first look at developing this insight, and then also show why economists believe employees end up, paying pretty much all of the Social Security tax. And this has insights for the current debate on medical care, and who should afford, who should pay for the benefits associated with medical, expanded medical benefits. It doesn't, matter in those cases as well who the tax is collected from, but again on the elasticities of supply, and demand. To see this, let's look at figure 18.3. And initially lets assume that the supply and demand in the labor market is D, and S. With equilibrium wage, being ten dollars, and the equilibrium employment level being L1. Now let's assume first that the government said look we're just going to collect all this money from employers and what we're going to do is levy a tax of $2 per hour worked by employees for firms. In that case what the tax does is it lowers the height of the demand curve, the most that employers are willing to pay for every unit of labor. If they get taxed $2 per unit the height of this curve gets reduced by $2 at every unit of labor. So it will downward shift this demand curve to D prime. What'll happen to the equilibrium with the lower demand curve will end up instead of L1 and a wage of $10 will end up same supply curve but lower demand curve of D prime at an intersection of point B. Lower employment level, L2. And now there will be a discrepancy between what employers pay to the government, and what employees keep. The amount that workers get paid, WA subscript A is going to be $8.50, $1.50 lower then before the $10 wage that they were earning prior to the tax. What do employers end up paying they end up paying $8.50 to the workers. Plus an additional $2 per hour to the government. So there total payment is determined by the underlying demand curve without the effect of the tax. They end up paying $8.50 to the workers and an additional $2 to the government. So the cost to employers, in this situation has grown by 50 cents per hour, whereas workers have borne 75% of the two dollar tax, their after-tax wage has gone down to $8.50. Now, let's erase that, and assume instead of taxing employers, the government decided to tax employees. The height of the supply curve represents at each unit the minimum employees need to be paid to supply that hour of work. So now assume the government says look we're going to collect $2 from you employees for every hour you work. The new supply curve is two dollars higher at each unit of output than it was before, cause now, the government demands two dollars more from employees for each hour of work. The new equilibrium would be where this higher supply curve of S prime intersects the unchanged demand curve at point A. And again there'll be a discrepancy between what employers end up paying and what employees end up keeping. Employers aren't taxed in this situation by the government. The higher cost of work and the lower employment level. Employment is reduced again to L2 as in the case where the government taxed employers. Employers pay the same $10.50 with the higher cost of labor, and after you net out the fact that employees have to turn over $2 per hour to the government. They end up at the same $8.50 they were before. The fundamental point its irrelevant who the government collects the tax from what it fundamentally depends like we saw several weeks earlier were elasticizes of supply and demand. The second insight is that social security regardless of who the tax is collected from largely ends up being paid by workers. Why, because social security is broadly applied. And when we look at social security being applied broadly across industries, firms, occupations. That same tax rate, accumulative of, 13.3%. The supply of labor relevant for that analysis is very to close to perfectly inelastic. So if employers are stuck, er, sorry. If employees are stuck in this market. If the supply of labor is virtually inelastic. Then even if the government collected, all the money from employers, shifted down, the relevant demand curve for labor, it would be employees that would take the hit. Wages would fall by the full, or close to the full $2.00 per hour worked. $8, whereas employers would still end up paying $10, $2 of which would get netted to the government. So, again, elasticity supply and demand determine incidence. And because of what we know about the breadth of the Social Security legislation's applicability, its employees that end up shouldering the burden.
