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
 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
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:
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
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
SOCIAL SECURITY TAX &
FEDERAL INCOME TAX
• Case Study
• Taxes on labor earnings
• As tax increases, deadweight loss rises more quickly
than size of tax
• Level of tax revenue will eventually fall
LAFFER CURVE
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