Lesson Overview: Taxation and Deadweight Loss

Summary

• Regardless of whether a tax is imposed on a buyer or a seller, both will experience a reduction in surplus.
• Tax revenue is the dollar amount of tax collected. For an excise (or, per unit) tax, this is quantity sold multiplied by the value of the per unit tax. Tax revenue is counted as part of total surplus.
  [Explain how total surplus is calculated after a tax]
• Some of the consumer surplus from before the tax will now be part of the tax revenue. The amount of the tax revenue collected that previously belonged to consumer surplus is the consumer's tax burden
• Some of the producer surplus from before the tax will now be part of tax revenue. The amount of the tax revenue collected that previously belonged to producer surplus is the producer's tax burden.
• Tax incidence refers to how a tax is distributed between the buyer and the seller. For instance, if the amount of consumer surplus that is reallocated to tax revenue is greater than the amount of producer surplus that is reallocated to tax revenue, we would say that the incidence of the tax falls more heavily on consumers.
  [Explain tax incidence]
• Because the tax alters the quantity that is sold in the market, it will result in a deadweight loss.

Key terms

Key Equations

Key Model

Things to consider and common errors

• A common misperception is that if a seller is taxed, then the buyer does not pay for this. As we have seen, the buyer pays for a tax through their consumer's tax burden and deadweight loss.
• A tax of $\$X$dollar sign, X does not cause the good's price to increase by $\$X$dollar sign, X. The only circumstance under which this would happen is if demand is perfectly inelastic (the role of elasticity will be explored further in the next lesson). In all other cases, a tax of $\$X$dollar sign, X will cause the price consumers pay to increase by some amount less than $\$X$dollar sign, X. The rest of the tax will be born by producers, who will share in the burden of the tax.
• We can also illustrate the impact of a tax on a market if it is the buyer of the good that is taxed. In this case, demand will decrease by the amount of the tax, as shown in Figure $3$3 below.