The Deadweight Loss Of Taxation

We begin by recalling one of the surprising lessons from Chapter 6: The outcome is the same whether a tax on a good is levied 011 buyers or sellers of the good. When a tax is levied on buyers, the demand curve shifts downward by the size of the tax; when it is levied on sellers, the supply curve shifts upward by that amount. In either case, when the tax is enacted, the price paid by buyers rises, and the price received by sellers falls. In tin; end, the elasticities of supply and demand determine how the tax burden is distributed between producers and consumers. This distribution is the same regardless of how it is levied,

Figure 1 shows these effects. To simplify our discussion, this figure does not show a shift in either the supply or demand curve, although one curve must shift. Which curve shifts depends on whether the tax is levied on sellers (the supply curve shifts) or buyers (the demand curve shifts). In this chapter, we can keep the analysis general and simplify the graphs by not bothering to show the shift. The key result for our purposes here is that the tax places a wedge between the price buyers pay and the price sellers rcceive. Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax. In other words, a tax on a gotxi causes the size of the market for the good to shrink. These results should be familiar from Chapter 6.

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