Holt 7525-9 S15_IT

Ideally, the burden imposed by a tax would be no greater than the funding provided to the
government. Quoting from “The Wealth of Nations” by Adam Smith, “Every tax ought to be so
contrived as both to take out and to keep out of the pockets of the people as little as possible,
over and above what it brings into the treasury of the state…” Realistically, a tax will impose a
burden on the taxpayers larger than the funding provided to the government. This is called
excess burden.
Excess burden – the amount that the burden imposed by a tax exceeds the funding provided by
the tax.
Example 7: The government wants to provide $100 million to fund a new government program. If
a tax is imposed which provides the government with $100 million for the new program and
imposes a burden on the taxpayers of only $100 million, there will be no excess burden.
Any tax is likely to impose excess burden. Some taxes will impose a very large excess burden. A
good (economically efficient) tax is one which imposes as little excess burden as possible.
The sources of excess burden include:
1. The cost for the government to collect the tax. The government will incur costs to
administer and enforce a tax. To minimize the collection cost of a tax, the tax should be as
simple as possible. A general sales tax is an example of a simple tax which is relatively cheap
for the government to collect, while the federal personal income tax is an example of a
complex tax.
Example 8: The government wants to provide $100 million to fund a new government program.
If it costs the government $5 million to collect the tax, it will be necessary to collect $105 million
from the taxpayers in order to fund the program. Thus, there is an excess burden of $5 million.
2. The cost for the taxpayers to comply with the tax. Taxpayers will have to keep certain
records, fill out forms, etc. to comply with a tax. To minimize the compliance cost of a tax, the
tax should be as simple as possible. A general sales tax is an example of a simple tax which is
relatively cheap for the taxpayers to comply with, while the federal personal income tax is an
example of a complex tax.
Example 9: The government wants to provide $100 million to fund a new government program. If
the taxpayers spend thousands of hours keeping the necessary records and filling out the
necessary forms to comply with the tax (or if the taxpayers pay experts to keep the records and
fill out the forms), there will be a compliance cost imposed on the taxpayers. This adds to the tax
burden without adding to the government’s funding, and is thus an excess burden.
3. The deadweight loss of the tax. We saw in Chapter 3 that private market equilibrium is
generally efficient, equalizing marginal benefit and marginal cost, and maximizing the net
benefit of having the market available (the sum of consumer’s surplus and producer’s surplus).
A tax may distort the decisions made in the private market. When a tax distorts the decisions
made in the private market, the tax eliminates mutually beneficial transactions and thus
reduces the net benefit of having the market available. This reduction is the deadweight loss of
the tax.
Example 10: The graphs on the next page represent the market for Good X from Example 12 in
Chapter 3. The first graph shows the amount of consumer’s surplus and producer’s surplus
before a tax is imposed. The sum of consumer’s surplus and producer’s surplus is the net benefit
of having the market available. The market equilibrium is a price of $4 and a quantity of 15 units.
The second graph shows the effect of a $2 per unit tax imposed on the sellers of Good X. The
supply curve shifts vertically upward by the amount of the tax. The after-tax equilibrium is a price
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Taxes, Deficits, and the National Debt 13 - 4