THE DEADWEIGHT OF TAXATION

We begin by recalling one of the surprising lessons. It does not matter whether a tax on a good is levied on 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 the end buyers and sellers share the burden of the tax regardless of how it is levied.

To simplify our discussion this 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 shows the shift. The key result for our purposes here is that 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 result should be familiar.