Chapter+8-+Application.+The+costs+of+Taxation



  We have learned some of the effects of taxes on welfare economics in chapter 6. We know that both buyers and sellers are worse off when a good is taxed. However, we need to compare the reduced welfare of buyers and sellers to the amount of revenue the government raises to understand more about how taxes affect economic well being. 

**Words to keep in mind: **
 * Deadweight loss**: The fall in total surplus due to market distortion.

Taxes are often referred as a heated political debate. We all know that government enacts taxes to raise revenue and both buyers and sellers are worse off. However, in this chapter, it is critically important that we must compare the reduced welfare of buyers and sellers to the amount of revenue the government raises in order to see how taxes affect economic well-being.  **How a Tax Affects Welfare: (Deadweight loss graph) ** A tax on a good reduces consumer surplus and producer surplus. Because the fall in producer and consumer surplus exceeds tax revenue, the tax is said to impose a **deadweight loss.** By comparing welfare before and after the tax is enacted, we can see the effects of the tax. Both Consumer surplus and producer surplus decreased. As a result, the tax made buyers and sellers worse off and the government better off. Moreover, the losses to buyers and sellers from a tax exceed the revenue raised by the government.
 * The Deadweight Loss Of Taxation: **

media type="youtube" key="tUSlrQ_4Gw4" height="344" width="425" :This video explains the concept of deadweight loss due to tax. //Why deadweight loss? Who suffers more? Actual vs. Statutory incidence of tax// 
 * Video: Deadweight loss due to tax **

 **The Determinants of the Deadweight Loss ** What determines whether the deadweight loss from a tax is large or small? The price elasticities of supply and demand. The tax has a deadweight loss because it induces buyers and sellers to change their behavior. The greater the elasticities of supply and demand, the greater the deadweight loss of a tax.

<span style="font-family: Verdana,Geneva,sans-serif;">A: Elastic Supply: When supply is relatively elastic, the deadweight loss of a tax is large. B: Inelastic Supply: When supply is relatively inelastic, the deadweight loss of a tax is small. C: Elastic Demand: When demand is relatively elastic, the deadweight loss of a tax is large. D: Inelastic Demand: When demand is relatively inelastic, the deadweight loss of a tax is small.

<span style="font-family: Verdana,Geneva,sans-serif;">Notice that the relatively elastic side pays less amount of tax. Remember that the more elastic the demand curve, the larger the deadweight loss of the tax. <span style="font-family: Impact,Charcoal,sans-serif; font-size: 120%;"> **<span style="color: #883ad9; font-family: Verdana,Geneva,sans-serif; font-size: 120%;">How Deadweight Loss and Tax Revenue Vary with the Size of a Tax ** <span style="font-family: Verdana,Geneva,sans-serif;">This graph is called the **Laffer curve**. This relationship shows how deadweight loss and tax revenue vary with the size of a tax. When the size of the tax is small, it has a small deadweight loss and raises a small revenue. When the size of the tax is large, it has a large deadweight loss and raises large revenue. When the size of the tax is very large, the deadweight loss is very large, but the tax raises small revenue since it has reduced the size of the market. As a result, as the size of a tax grows, the deadweight loss grows. Also, the tax revenue first rises and then falls.

<span style="display: block; font-family: Verdana,Geneva,sans-serif; text-align: center;"> In this chapter, we learned more about taxes. When the government imposes taxes on buyers or sellers of a good, society loses some of the benefits of efficiency. Moreover, when the tax grows, it distorts incentives more and its deadweight loss grows larger. Now, you should have a pretty good basis for understanding the economic impact of taxes.

<span style="font-family: Verdana,Geneva,sans-serif;"><span style="font-family: Impact,Charcoal,sans-serif; font-size: 130%;">Bibliography 8