1、Application:The Costs of TaxationChapter 8Copyright 2001 by Harcourt,Inc.All rights reserved.Requests for permission to make copies of any part of thework should be mailed to:Permissions Department,Harcourt College Publishers,6277 Sea Harbor Drive,Orlando,Florida 32887-6777.The Costs of TaxationHow
2、do taxes affect the economic well-being of market participants?The Costs of TaxationIt does not matter whether a tax on a good is levied on buyers or sellers of the goodthe price paid by buyers rises,and the price received by sellers falls.The Effects of a Tax.Price0QuantityQuantity without taxSuppl
3、yDemandPrice without taxPrice buyers payQuantity with taxSize of taxPrice sellers receiveThe Effects of a TaxuA tax places a wedge between the price buyers pay and the price sellers receive.uBecause of this tax wedge,the quantity sold falls below the level that would be sold without a tax.uThe size
4、of the market for that good shrinks.Tax RevenueT=the size of the taxQ=the quantity of the good soldT Q=the governments tax revenueTax Revenue.Price0QuantityQuantity without taxSupplyDemandPrice sellers receiveQuantity with taxSize of tax(T)Quantity sold(Q)Tax Revenue(T x Q)Price buyers payHow a Tax
5、Affects Welfare.Quantity0PriceDemandSupplyQ1ABCFDEQ2Tax reduces consumer surplus by(B+C)and producer surplus by(D+E)Tax revenue=(B+D)Deadweight Loss=(C+E)Price buyerspay=PB P1Price without tax=PSPrice sellers receive=Changes in Welfare from a TaxWithout TaxWith TaxChangeConsumer SurplusA+B+CA-(B+C)P
6、roducer SurplusD+E+FF-(D+E)Tax RevenuenoneB+D+(B+D)Total SurplusA+B+C+D+E+FA+B+D+F-(C+E)The area C+E shows the fall in total surplus and is the deadweight loss of the tax.How a Tax Affects WelfareThe change in total welfare includes:uThe change in consumer surplus,uThe change in producer surplus,uTh
7、e change in tax revenue.uThe losses to buyers and sellers exceed the revenue raised by the government.uThis fall in total surplus is called the deadweight loss.Deadweight Losses and the Gains from TradeTaxes cause deadweight losses because they prevent buyers and sellers from realizing some of the g
8、ains from trade.The Deadweight Loss.Quantity0Price DemandSupplyQ1PBPrice =P1without tax PSQ2Size of taxLost gains from tradeCost to sellersValue to buyersReduction in quantity due to the taxDeterminants of Deadweight LossWhat determines whether the deadweight loss from a tax is large or small?uThe m
9、agnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price.uThat,in turn,depends on the price elasticities of supply and demand.Tax Distortions and Elasticities.QuantityPriceDemandSupply0When supply isrelatively inelastic,the deadw
10、eight loss of a tax is small.(a)Inelastic SupplySize of taxTax Distortions and Elasticities.QuantityPriceDemandSupply0Size of taxWhen supply isrelatively elastic,the deadweight loss of a tax is large.(b)Elastic SupplyTax Distortions and Elasticities.QuantityPriceDemandSupply0When demand isrelatively
11、 inelastic,the deadweight loss of a tax is small.(c)Inelastic DemandSize of taxTax Distortions and Elasticities.QuantityPriceDemandSupply0Size of taxWhen demand isrelatively elastic,the deadweight loss of a tax is large.(d)Elastic DemandDeterminants of Deadweight LossThe greater the elasticities of
12、demand and supply:u the larger will be the decline in equilibrium quantity and,u the greater the deadweight loss of a tax.The Deadweight Loss DebateSome economists argue that labor taxes are highly distorting and believe that labor supply is more elastic.The Deadweight Loss DebateSome examples of wo
13、rkers who may respond more to incentives:uWorkers who can adjust the number of hours they workuFamilies with second earnersuElderly who can choose when to retireuWorkers in the underground economy(i.e.those engaging in illegal activity)Deadweight Loss and Tax Revenue as Taxes VaryWith each increase
14、in the tax rate,the deadweight loss of the tax rises even more rapidly than the size of the tax.Deadweight Loss and Tax Revenue.PBQuantityQ20PriceQ1DemandSupplyTax revenuePSDeadweightloss(a)Small TaxDemandSupplyTaxrevenuePBQuantityQ20PriceQ1PSDeadweightlossDeadweight Loss and Tax Revenue.(b)Medium T
15、axTax revenuePBQuantityQ20PriceQ1DemandSupplyPSDeadweightlossDeadweight Loss and Tax Revenue.(c)Large TaxDeadweight Loss and Tax RevenueuFor the small tax,tax revenue is small.uAs the size of the tax rises,tax revenue grows.uBut as the size of the tax continues to rise,tax revenue falls because the
16、higher tax reduces the size of the market.Deadweight Loss and Tax Revenue Vary with the Size of the Tax.(a)Deadweight LossDeadweightLoss0Tax SizeDeadweight Loss and Tax Revenue Vary with the Size of the Tax.(b)Revenue(the Laffer curve)TaxRevenue0Tax SizeDeadweight Loss and Tax Revenue Vary with the
17、Size of the TaxuAs the size of a tax increases,its deadweight loss quickly gets larger.uBy contrast,tax revenue first rises with the size of a tax;but then,as the tax gets larger,the market shrinks so much that tax revenue starts to fall.The Laffer Curve and Supply-Side EconomicsuThe Laffer curve de
18、picts the relationship between tax rates and tax revenue.uSupply-side economics refers to the views of Reagan and Laffer who proposed that a tax cut would induce more people to work and thereby have the potential to increase tax revenues.SummaryuA tax on a good reduces the welfare of buyers and sell
19、ers of the good.And the reduction in consumer and producer surplus usually exceeds the revenues raised by the government.SummaryuThe fall in total surplus the sum of consumer surplus,producer surplus,and tax revenue is called the deadweight loss of the tax.SummaryuTaxes have a deadweight loss becaus
20、e they cause buyers to consume less and sellers to produce less.uThis change in behavior shrinks the size of the market below the level that maximizes total surplus.SummaryuAs a tax grows larger,it distorts incentives more,and its deadweight loss grows larger.uTax revenue first rises with the size o
21、f a tax.uEventually,however,a larger tax reduces tax revenue because it reduces the size of the market.Graphical ReviewThe Effects of a Tax.Price0QuantityQuantity without taxSupplyDemandPrice without taxPrice buyers payQuantity with taxSize of taxPrice sellers receiveTax Revenue.Price0QuantityQuanti
22、ty without taxSupplyDemandPrice sellers receiveQuantity with taxSize of tax(T)Quantity sold(Q)Tax Revenue(T x Q)Price buyers payHow a Tax Affects Welfare.Quantity0PriceDemandSupplyQ1ABCFDEQ2Tax reduces consumer surplus by(B+C)and producer surplus by(D+E)Tax revenue=(B+D)Deadweight Loss=(C+E)Price bu
23、yerspay=PB P1Price without tax=PSPrice sellers receive=The Deadweight Loss.Quantity0Price DemandSupplyQ1PBPrice =P1without tax PSQ2Size of taxLost gains from tradeCost to sellersValue to buyersReduction in quantity due to the taxTax Distortions and Elasticities.QuantityPriceDemandSupply0When supply
24、isrelatively inelastic,the deadweight loss of a tax is small.(a)Inelastic SupplySize of taxTax Distortions and Elasticities.QuantityPriceDemandSupply0Size of taxWhen supply isrelatively elastic,the deadweight loss of a tax is large.(b)Elastic SupplyTax Distortions and Elasticities.QuantityPriceDeman
25、dSupply0When demand isrelatively inelastic,the deadweight loss of a tax is small.(c)Inelastic DemandSize of taxTax Distortions and Elasticities.QuantityPriceDemandSupply0Size of taxWhen demand isrelatively elastic,the deadweight loss of a tax is large.(d)Elastic DemandDeadweight Loss and Tax Revenue
26、.PBQuantityQ20PriceQ1DemandSupplyTax revenuePSDeadweightloss(a)Small TaxDemandSupplyTaxrevenuePBQuantityQ20PriceQ1PSDeadweightlossDeadweight Loss and Tax Revenue.(b)Medium TaxTax revenuePBQuantityQ20PriceQ1DemandSupplyPSDeadweightlossDeadweight Loss and Tax Revenue.(c)Large TaxDeadweight Loss and Tax Revenue Vary with the Size of the Tax.(a)Deadweight LossDeadweightLoss0Tax SizeDeadweight Loss and Tax Revenue Vary with the Size of the Tax.(b)Revenue(the Laffer curve)TaxRevenue0Tax Size
