Application The Costs of Taxation

axes are often a source of heated political debate. In 1776, the anger of the American colonists over British taxes sparked the American Revolu tion. More than two Centuries later, the American political parties continue to debate the proper si/e and shape of the tax system. Yet no one would deny that some level of taxation is necessary As Oliver Wendell Holmes |r. once said. Taxes are what we pay for civilized society.'

Because taxation has such a major impact on the modern economy, we return to the topic several times throughout this book as we expand the sot of tools we have at our disposal. We began our study of taxes in Chapter 6. There we saw how a tax on a good affects its price and the quantity sold and how the forces of supply and demand divide the burden of a tax between buyers and sellers. In this chapter, we extend this analysis and look at how taxes affect welfare, the economic well-being of participants in a market. In other words, we see how high the price of civilized society can be.

I he effects of taxes on welfare might at first seem obvious. The government enacts taxes to raise revenue, and tha t revenue must come out of someone's pocket. As we saw in Chapter 6, both buyers and sellers are worse off when a good is taxed: A tax raises the price buyers pay and lowers the price sellers receive. Yet to understand more fully how taxes affect economic well-being, we must compare the reduced welfare of buyers and sellers to the amount of revenue the government raises. The tools of consumer and producer surplus allow us to make this comparison. 'Ihe analysis will show that the cost of taxes to buyers and sellers exceeds the revenue raised by the government,

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