THE DEAD WEIGHT Loss OF TAXATION

We begin by recalling one of the surprising lessons from Chapter 6: It does not matter whether a tax on a good I levied on buyers or sellers of the good. When a tax is levied on buyers, the demand curve shifts down ward 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 the end, buyers arid sellers share the burden of the tax, 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 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 receive. 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 good causes the size of the market for the good to shrink. These results should be’ familiar from Chapter 6.

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