Chapter+8+(The+Costs+of+Taxation)

Chapter 8 (Application: The Costs of Taxation)

Introduction



source: http://www.cartoonstock.com/newscartoons/cartoonists/gri/lowres/grin684l.jpg

Taxes have been one of the sources of heated political debate. Due to its effects on the economy, it is very important to know about the tax and its impacts. As you know, tax is implied by the government and it is used to raise revenue. Therefore when the tax is implied on a good, then it raises the price buyers pay and lowers the price sellers receive. Taxation distorts the market economy and it leaves impacts on people’s welfare.

The Deadweight Loss of Taxation

Source: http://upload.wikimedia.org/wikipedia/commons/thumb/5/51/TaxWithTax.svg/200px-TaxWithTax.svg.png

Depending on where the tax is levied on, the supply or demand curve shifts. However when a tax is levied on a product, the size of the market for that good shrinks because taxes distort the market condition.

The deadweight loss occurs when a tax is levied on a good. Therefore the consumer surplus and the producer surplus both decrease. Since both surpluses are decreased, the total surplus also decreases. Compared to the welfare without a tax, it is clear that taxation has changed the welfare worse.


 * Tax Revenue = Quantity sold (Q) x Size of tax (T)

Changes in Welfare

Buyers and Sellers are WORSE OFF The Government is BETTER OFF The changes in consumer surplus and producer surplus are both negative. The losses to buyers and sellers form a tax exceed the revenue raised by the government. When a tax raises the price of a product, the market tends to have less incentives from buyers and producers.

Source: http://www.econmodel.com/classic/terms/surplus2.png

The Determinants of the Deadweight Loss

The elasticity of the graph determines the size of the deadweight loss. If the curve is more inelastic in demand curves, then there is smaller deadweight loss. Similarly, if the curve is more inelastic in supply curves, then the quantity supplied changes a little. Therefore, you can conclude that the greater the elasticities of the curves, the greater the deadweight loss of a tax.**

The marginal tax rate: the tax on the last dollar of earnings

Deadweight Loss and Tax revenue as taxes vary

source:  0li.tripod.com/06/ tax_rates_laffer_curve.gif

Taxes don’t remain the same for long periods of time. When the size of a tax changes, the deadweight loss also changes. Unlike the tax revenue, the deadweight loss rises continuously rises when the size of a tax rises. However when the tax becomes too large, the tax revenue drops. Therefore when you draw a graph of tax revenue, you get the Laffer Curve.

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source: http://kr.youtube.com/watch?v=jvPPH-8fpIY


 * Questions and Answers**

Q1. How do you calculate the Tax revenue?

A1. Tax revenue: Quantity sold x Size of Tax

Q2. What does the elasticity of the graph determine?

A2. The size of the dead weight loss.

Q3. What is the marginal tax rate?

A3: the tax on the last dollar of earnings

Q4. Is this true or false? : Taxes remain the same for long periods of time.

A4: False