Chapter 8 - Application: The Costs of Taxation

8-1 The Deadweight Loss of Taxation

How a Tax Affects Market Participants

• Buyers and sellers are hurt by the taxing of goods because the costs to them are exceeded by the revenue raised by the government.
• Whether a tax is levied on buyers and sellers or not, the impact of a tax on a market outcome remains the same.
• Taxes on goods result in markets that include those goods shrinking.
• Tax revenue tells how much the public benefits from the tax.
• Welfare without a tax - total surplus is the area between supply and demand up to equilibrium.
• Welfare with a tax - total surplus is consumer surplus + producer surplus + tax revenue.
• Deadweight loss: the fall in total surplus that results from a market distortion, such as the tax.

Deadweight Losses and the Gains from Trade

• Taxes typically cause deadweight losses, refraining buyers and sellers from realizing the gains of trading.

8-2 The Determinants of the Deadweight Loss

• More deadweight losses result in greater elasticity because people react more to changes in prices.
• The gains from trade are less than taxes.
• The underground economy is when people engage in illegal economic activity, such as drug trades.

8-3 Deadweight Loss and Tax Revenue as Taxes Vary

• As taxes rise, so does the deadweight loss.
• When attempting to reduce high taxes, the tax revenue would actually increase. When taxes are cut, people are encouraged to increase their quantity of labor.
• Greater elasticity calls for more of an increase in tax revenue.

8-4 Conclusion

• Microeconomics: how to design a successful tax system while balancing equality and efficiency.
• Macroeconomics: how taxes influence the economy and how policymakers use the system to stabilize the economy.