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TAXATION AND EFFICIENCY
Chapter 15
Excess Burden Defined
Pounds of corn per year
Pounds of barley per year
E1
B1
C1
D
F
A
Cb
Ca
B0
Government levies tax on barley
i
15-*
Effect of Tax on Consumption Bundle
Pounds of corn per year
Pounds of barley per year
E1
B1
C1
D
F
A
Cb
Ca
B0
E2
i
ii
G
15-*
Excess Burden of the Barley Tax
Pounds of corn per year
Pounds of barley per year
E1
B1
C1
D
F
A
Cb
Ca
B0
E2
i
ii
G
H
B3
M
I
Tax Revenues
Equivalent variation
15-*
Questions and Answers
If lump sum taxes are so efficient, why aren’t they widely used
Are there any results from welfare economics that would help us understand why excess burdens arise
15-*
Questions and Answers
Does an income tax entail an excess burden
15-*
Questions and Answers
Pounds of corn per year
Pounds of barley per year
C1
D
F
A
Cb
Ca
B1 = B2
E2
i
ii
E1
J
B3
R
K
If the demand for a commodity does not change when it is taxed, does this mean that there is no excess burden
S
Uncompensated response
Income effect
Substitution effect-compensated effect
Compensated demand curve
15-*
Excess Burden Measurement with Demand Curves
Pounds of barley per year
Price per pound of barley
a
Db
Sb
q1
q2
i
h
S’b
Pb
(1 + tb)Pb
g
f
d
Tax revenues
Excess burden of tax
Excess burden = ηPbq1tb2
15-*
Preexisting Distortions
Theory of the Second Best
Double-dividend hypothesis
15-*
Excess Burden of a Subsidy
Housing services per year
Price per unit of housing services
m
Dh
Sh’
h2
h1
u
q
Sh
(1 – s)Ph
Ph
n
o
r
Excess burden
v
15-*
Excess Burden of Income Taxation
Hours per year
Wage rate per hour
SL
L1
L2
a
g
(1 – t)w
w
f
i
h
Excess burden
d
Excess burden = εωL1t2
15-*
The Allocation of Time Between Housework and Market Work
$
$
0
0’
Hours worked in home per year
Hours worked in market per year
H*
w1
w1
VMPhome
VMPmkt
(1 – t)VMPmkt
H1
a
b
e
c
d
w2
(1 – t)w2
Excess burden = (ΔH)tw2
15-*
Does Efficient Taxation Matter
Why no excess burden budget
Is efficiency the primary objective of government policy
Does excess burden mean a tax is bad
15-*
Chapter 15 Summary
Taxes and subsidies generally impose excess burdens, caused by tax- or subsidy-induced distortions in behavior
Differential taxation of inputs also create excess burdens
Lump sum taxes have no excess burden, although are unattractive for other reasons
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Appendix A – Formula for Excess Burden
A = * base * height
= * (di) * (fd)
fd = Pb = (1 + tb) * Pb – Pb = tb * Pb
di = q
η = ( q/ Pb)(Pb/q)
q = η(q/Pb) Pb
since Pb = tb * Pb
q = η(q/Pb)*(tbPb) = η * q * tb
since di = q
A = (di)(fd)
= (ηqtb)*(tbPb)
= * η * Pb * q * (tb)2
15-*
Appendix B – Multiple Taxes and the Theory of the Second Best
Gallons of gin per year
Gallons of rum per year
Price per gallon of gin
Price per gallon of rum
Dg
Dr
g1
Pg
Dr’
Pr
(1 + tr)Pr
r1
r2
r3
a
b
c
g
h
d
g2
e
f
(1 + tg)Pg
15-*

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