Public Economics Lectures Part 1: Introduction

Effi ciency Cost with Income Effects
EB(t S ) ≃ − 1 2 (tS ) 2 ∂x c /∂t S
∂x c /∂p ∂x c /∂t S
= 1 2 (θc t S ) 2 ε c D
p + t S
With income effects (dx/dZ > 0), making a tax less salient can raise
deadweight loss.
Tax can generate EB > 0 even if dx/dt S = 0
Example: consumption of food and cars; agent who ignores tax on
cars underconsumes food and has lower welfare.
Intuition: agent does not adjust consumption of x despite change in
net-of-tax income, leading to a positive compensated elasticity.
Public Economics Lectures () Part 3: Effi ciency 104 / 105