COMM 220 Lecture Notes - Lecture 6: Tax Shield, Market Clearing, Byrsonima Crassifolia
2 Dec 2018
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Government intervention takes many forms but often involves manipulation of market prices. Taxes reduce incomes, subsidies lower prices, sometimes for select groups. This results in a misallocation of resources because prices will no longer signal the relative value that people place on different goods and services. But government intervention is not a bad thing so long as its costs do not outweigh its bene ts (to state the obvious). Suppose that interest paid on business loans was not a tax-deductible expense, and that lenders were on not taxed on interest earned from business loans. Point e in the graph is the equilibrium for business loans in this situation. The interest rate is assumed to be eight per cent, and the quantity (dollars) of loans outstanding is 1,000. But then the government decides to change the tax rules. Business loan interest becomes a deductible expense, and the banks will be r. 2000 q(cid:1)$ loans(cid:2) taxed on that same income.
