- Rent control and deadweight loss
- Minimum wage and price floors
- How price controls reallocate surplus
- Price ceilings and price floors
- Price and quantity controls
- The effect of government interventions on surplus
- Taxation and dead weight loss
- Example breaking down tax incidence
- Percentage tax on hamburgers
- Taxes and perfectly inelastic demand
- Taxes and perfectly elastic demand
- Economic efficiency
- Lesson Overview: Taxation and Deadweight Loss
- Tax Incidence and Deadweight Loss
Lesson Overview: Taxation and Deadweight Loss
When a tax is imposed on a market it will reduce the quantity that will be sold in the market. As we learned in a previous lesson, whenever the quantity sold in the market is not the equilibrium quantity, there will be inefficiencies.
- 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.
- 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.
- Because the tax alters the quantity that is sold in the market, it will result in a deadweight loss.
|tax revenue||The dollar amount that is collected from taxing a market|
|consumer's tax burden||the amount of the tax that is paid by consumers. It is the consumer surplus that is taken away by a tax and reallocated to tax revenue.|
|producer's tax burden||the amount of the tax that is paid by sellers. It is the producer surplus that is taken away by a tax and reallocated to tax revenue.|
|tax incidence||how a tax is distributed among buyers and sellers.|
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 does not cause the good's price to increase by . 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 will cause the price consumers pay to increase by some amount less than . 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 below.
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