1. TAXATION AND EFFICIENCY
Chapter 15

2. Government levies tax on barley
Excess Burden Defined
Government levies tax on barley A
Pounds of corn per year Ca Cb E1 C1 i F D B0 B1
Pounds of barley per year

3. Effect of Tax on Consumption Bundle
Pounds of corn per year G Ca E2 Cb E1 C1 i ii F D B0 B1
Pounds of barley per year

4. Excess Burden of the Barley Tax
Pounds of corn per year G Ca
Tax Revenues H M
Equivalent variation E2 Cb E1 C1 i ii F I D B0 B3 B1
Pounds of barley per year

5. 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?
15-5

6. Questions and Answers
Does an income tax entail an excess burden?
15-6

7. Questions and Answers
If the demand for a commodity does not change when it is taxed, does this mean that there is no excess burden? A
Uncompensated response
Income effect
Substitution effect-compensated effect
Compensated demand curve
Pounds of corn per year E1 Ca i J R E2 Cb S C1 ii F K D
B1 = B2 B3
Pounds of barley per year

8. Excess Burden Measurement with Demand Curves
Excess burden = ½ ηPbq1tb2
Price per pound of barley
Tax revenues
Excess burden of tax
(1 + tb)Pb
S’b g f h d i Pb Sb Db q2 q1
Pounds of barley per year

9. Preexisting Distortions
Theory of the Second Best
Double-dividend hypothesis

10. Excess Burden of a Subsidym
Price per unit of housing services
Excess burden n o v Ph Sh q r u
(1 – s)Ph
Sh’ Dh h1 h2
Housing services per year

11. Excess Burden of Income Taxation
Excess burden = ½ εωL1t2
Excess burden SL
Wage rate per hour f i d w
(1 – t)w g h a L2 L1
Hours per year

12. The Allocation of Time Between Housework and Market Work
Excess burden = ½ (ΔH)tw2 $ $
(1 – t)VMPmkt b w2 a w1 w1
(1 – t)w2 e
VMPmkt
VMPhome d c
Hours worked in home per year H* H1
Hours worked in market per year 0’

13. 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?

14. 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

15. Appendix A – Formula for Excess Burden
A = ½ * base * height
= ½ * (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 = ½(di)(fd)
= ½(ηqtb)*(tbPb)
= ½ * η * Pb * q * (tb)2

16. Appendix B – Multiple Taxes and the Theory of the Second Best
Price per gallon of gin
Price per gallon of rum f c
(1 + tg)Pg
(1 + tr)Pr g b h Pr a d Pg e
Dr’ Dg Dr g2 g1 r3 r2 r1
Gallons of gin per year
Gallons of rum per year