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The Costs of Taxation

The Costs of Taxation. Mr. Barnett University High AP Microeconomics. Deadweight Loss of Taxation. How a tax affects market participants Drives a wedge between the price that the buyer pays and the price the sellers receives . Deadweight Loss . We can measure the effects of a tax

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The Costs of Taxation

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  1. The Costs of Taxation Mr. Barnett University High AP Microeconomics

  2. Deadweight Loss of Taxation • How a tax affects market participants • Drives a wedge between the price that the buyer pays and the price the sellers receives

  3. Deadweight Loss • We can measure the effects of a tax • On consumers by examining the change in consumer surplus • On suppliers by looking at the change in producer surplus • What about he government! • Gov’t is 3rd party and receives benefit from tax • Gets total revenue of T x Q • Taxes help pay for roads, police, firefighters, etc

  4. Deadweight Loss • Welfare without a tax • Consumer surplus is equal to: • Producer surplus is equal to: • Total surplus is equal to: • Welfare with a tax • Consumer surplus is equal to: • Producer surplus is equal to: • Tax revenue is equal to: • Total surplus is equal to: • Changes in Welfare • Consumer surplus changes by: • Producer surplus changes by: • Tax revenue changes by: • Total surplus changes by:

  5. Deadweight Loss • Deadweight Loss: The fall in total surplus that results from a market distortion, such as a tax. • Taxes cause deadweight losses because they prevent buyers and sellers from benefiting from trade • Why does this occur? • Because quantity decreases! Many beneficial trades for buyers and sellers will not take place b/c of tax

  6. Determinants of Deadweight Loss • The price elasticities of supply and demand determine size of deadweight loss from a tax • The greater the elasticities of supply and demand, the greater the deadweight loss due to a tax

  7. Social Security Tax & Federal Income Tax • Case Study • Taxes on labor earnings

  8. As tax increases, deadweight loss rises more quickly than size of tax • Level of tax revenue will eventually fall

  9. Laffer Curve

  10. Supply Side Economics • Economic theory that says lowering barriers in the market will result in lower prices for consumers with an increased supply of goods and services • Adopted by Reagan as part of Reaganomics • Believed US was on right side of Laffer Curve • Claimed that lower tax rates would result in an increase of government tax revenue • Marginal tax rate reduced from 71% to 31% • Tax revenue did increase from 1980 ($885B) to 1990 ($1.93T) • Controversial

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