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1、,Application:The Costs of Taxation,Chapter 8,Copyright 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 Taxation
2、,How do taxes affect the economic well-being of market participants?,The Costs of Taxation,It 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.,Price,0,Quantity,Supply,Demand
3、,The Effects of a Tax,A tax places a wedge between the price buyers pay and the price sellers receive.Because of this tax wedge,the quantity sold falls below the level that would be sold without a tax.The size of the market for that good shrinks.,Tax Revenue,T=the size of the tax,Q=the quantity of t
4、he good sold,TQ=the governments tax revenue,Tax Revenue.,Price,0,Quantity,Quantity without tax,Supply,Demand,Price sellers receive,Quantity with tax,Price buyers pay,How a Tax Affects Welfare.,Quantity,0,Price,Demand,Supply,Q1,Q2,Tax reduces consumer surplus by(B+C)and producer surplus by(D+E),Tax r
5、evenue=(B+D),Deadweight Loss=(C+E),Changes in Welfare from a Tax,Without Tax,With Tax,Change,Consumer Surplus,A+B+C,A,-(B+C),Producer Surplus,D+E+F,F,-(D+E),Tax Revenue,none,B+D,+(B+D),Total Surplus,A+B+C+D+E+F,A+B+D+F,-(C+E),The area C+E shows the fall in total surplus and is the deadweight loss of
6、 the tax.,How a Tax Affects Welfare,The change in total welfare includes:The change in consumer surplus,The change in producer surplus,The change in tax revenue.The losses to buyers and sellers exceed the revenue raised by the government.This fall in total surplus is called the deadweight loss.,Dead
7、weight Losses and the Gains from Trade,Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade.,The Deadweight Loss.,Quantity,0,Price,Demand,Supply,Q1,PB,Price=P1without tax,PS,Q2,Determinants of Deadweight Loss,What determines whether the de
8、adweight loss from a tax is large or small?The magnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price.That,in turn,depends on the price elasticities of supply and demand.,Tax Distortions and Elasticities.,Quantity,Price,Demand
9、,Supply,0,(a)Inelastic Supply,Tax Distortions and Elasticities.,Quantity,Price,Demand,Supply,0,(b)Elastic Supply,Tax Distortions and Elasticities.,Quantity,Price,Demand,Supply,0,(c)Inelastic Demand,Tax Distortions and Elasticities.,Quantity,Price,Demand,Supply,0,(d)Elastic Demand,Determinants of Dea
10、dweight Loss,The greater the elasticities of demand and supply:the larger will be the decline in equilibrium quantity and,the greater the deadweight loss of a tax.,The Deadweight Loss Debate,Some economists argue that labor taxes are highly distorting and believe that labor supply is more elastic.,T
11、he Deadweight Loss Debate,Some examples of workers who may respond more to incentives:Workers who can adjust the number of hours they workFamilies with second earnersElderly who can choose when to retireWorkers in the underground economy(i.e.those engaging in illegal activity),Deadweight Loss and Ta
12、x Revenue as Taxes Vary,With each increase 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.,PB,Quantity,Q2,0,Price,Q1,Demand,Supply,PS,(a)Small Tax,Demand,Supply,PB,Quantity,Q2,0,Price,Q1,PS,Deadweight Loss and Tax Reve
13、nue.,(b)Medium Tax,PB,Quantity,Q2,0,Price,Q1,Demand,Supply,PS,Deadweight Loss and Tax Revenue.,(c)Large Tax,Deadweight Loss and Tax Revenue,For the small tax,tax revenue is small.As the size of the tax rises,tax revenue grows.But as the size of the tax continues to rise,tax revenue falls because the
14、 higher tax reduces the size of the market.,Deadweight Loss and Tax Revenue Vary with the Size of the Tax.,(a)Deadweight Loss,DeadweightLoss,0,Tax Size,Deadweight Loss and Tax Revenue Vary with the Size of the Tax.,(b)Revenue(the Laffer curve),TaxRevenue,0,Tax Size,Deadweight Loss and Tax Revenue Va
15、ry with the Size of the Tax,As the size of a tax increases,its deadweight loss quickly gets larger.By 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 Economics,The Laf
16、fer curve depicts the relationship between tax rates and tax revenue.Supply-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.,Summary,A tax on a good reduces the welfare of buy
17、ers and sellers of the good.And the reduction in consumer and producer surplus usually exceeds the revenues raised by the government.,Summary,The fall in total surplus the sum of consumer surplus,producer surplus,and tax revenue is called the deadweight loss of the tax.,Summary,Taxes have a deadweig
18、ht loss because they cause buyers to consume less and sellers to produce less.This change in behavior shrinks the size of the market below the level that maximizes total surplus.,Summary,As a tax grows larger,it distorts incentives more,and its deadweight loss grows larger.Tax revenue first rises wi
19、th the size of a tax.Eventually,however,a larger tax reduces tax revenue because it reduces the size of the market.,The Effects of a Tax.,Price,0,Quantity,Supply,Demand,Tax Revenue.,Price,0,Quantity,Quantity without tax,Supply,Demand,Price sellers receive,Quantity with tax,Price buyers pay,How a Tax
20、 Affects Welfare.,Quantity,0,Price,Demand,Supply,Q1,Q2,Tax reduces consumer surplus by(B+C)and producer surplus by(D+E),Tax revenue=(B+D),Deadweight Loss=(C+E),The Deadweight Loss.,Quantity,0,Price,Demand,Supply,Q1,PB,Price=P1without tax,PS,Q2,Tax Distortions and Elasticities.,Quantity,Price,Demand,
21、Supply,0,(a)Inelastic Supply,Tax Distortions and Elasticities.,Quantity,Price,Demand,Supply,0,(b)Elastic Supply,Tax Distortions and Elasticities.,Quantity,Price,Demand,Supply,0,(c)Inelastic Demand,Tax Distortions and Elasticities.,Quantity,Price,Demand,Supply,0,(d)Elastic Demand,Deadweight Loss and
22、Tax Revenue.,PB,Quantity,Q2,0,Price,Q1,Demand,Supply,PS,(a)Small Tax,Demand,Supply,PB,Quantity,Q2,0,Price,Q1,PS,Deadweight Loss and Tax Revenue.,(b)Medium Tax,PB,Quantity,Q2,0,Price,Q1,Demand,Supply,PS,Deadweight Loss and Tax Revenue.,(c)Large Tax,Deadweight Loss and Tax Revenue Vary with the Size of the Tax.,(a)Deadweight Loss,DeadweightLoss,0,Tax Size,Deadweight Loss and Tax Revenue Vary with the Size of the Tax.,(b)Revenue(the Laffer curve),TaxRevenue,0,Tax Size,
