EKN310 Chapter 12 Notes
Tax Efficiency, Administrative Efficiency and Flexibility
Introduction to Chapter 12
What you should know from this chapter
• What tax efficiency is
• How to use indifference curves to compare excess burdens of different
taxes
• How consumer surplus is used to determine the magnitude of excess
burden
• What administrative efficiency is and how it can be enhanced
• What tax evasion is and how it can be countered
• Explain tax flexibility
Tax Efficiency and Excess Burden
Previously, in Chapter 11, the properties of a good tax were discussed,
especially:
Equity → how taxes affect the distribution of income
• Tax incidence (who actually carries the burden) was used to assess equity:
• If the poor carry the burden → tax is regressive (pro-rich)
• If the rich carry the burden → tax is progressive (pro-poor)
Now Chapter 12 focuses on:
Efficiency Tax efficiency → how taxes affect the allocation of resources in the
economy.
Taxes can distort:
• prices
• production decisions
• consumption decisions
• labour supply
• investment decisions
, If taxes distort resource allocation: inefficiency arises → creating an excess
burden.
Excess burden:
Þ burden in addition to the direct tax burden that is greater than necessary
to generate a certain amount of tax revenue.
Þ Also called: welfare loss / deadweight loss
Þ It measures the loss in wellbeing caused by taxes that distort prices and
economic choices.
Excess Burden Using Indifference Curve Analysis
Basic assumptions:
• Assume two goods: X and Y
#
• Under Pareto efficiency: !"#!" = !"%!" = #!
"
• MRS = marginal rate of substitution
• MRT = marginal rate of transformation
• This means consumers and producers allocate resources efficiently.
Effect of a tax on X:
• Suppose a tax is imposed on X.
• Price of X becomes: (1 + ))+!
#! (%&')#!
• So, the relative price changes from: to
#" #"
• Consumers now substitute away from X toward Y (bc X is now more
expensive)
• This changes:
- consumption patterns
- production patterns
- allocation of resources
• Result: welfare loss.
Even if no direct tax is imposed on Y, Y is indirectly affected because consumers
reallocate spending.
Two Approaches to Excess Burden:
1) Indifference curve approach – used to compare the price-distorting
effects of different taxes.
Tax Efficiency, Administrative Efficiency and Flexibility
Introduction to Chapter 12
What you should know from this chapter
• What tax efficiency is
• How to use indifference curves to compare excess burdens of different
taxes
• How consumer surplus is used to determine the magnitude of excess
burden
• What administrative efficiency is and how it can be enhanced
• What tax evasion is and how it can be countered
• Explain tax flexibility
Tax Efficiency and Excess Burden
Previously, in Chapter 11, the properties of a good tax were discussed,
especially:
Equity → how taxes affect the distribution of income
• Tax incidence (who actually carries the burden) was used to assess equity:
• If the poor carry the burden → tax is regressive (pro-rich)
• If the rich carry the burden → tax is progressive (pro-poor)
Now Chapter 12 focuses on:
Efficiency Tax efficiency → how taxes affect the allocation of resources in the
economy.
Taxes can distort:
• prices
• production decisions
• consumption decisions
• labour supply
• investment decisions
, If taxes distort resource allocation: inefficiency arises → creating an excess
burden.
Excess burden:
Þ burden in addition to the direct tax burden that is greater than necessary
to generate a certain amount of tax revenue.
Þ Also called: welfare loss / deadweight loss
Þ It measures the loss in wellbeing caused by taxes that distort prices and
economic choices.
Excess Burden Using Indifference Curve Analysis
Basic assumptions:
• Assume two goods: X and Y
#
• Under Pareto efficiency: !"#!" = !"%!" = #!
"
• MRS = marginal rate of substitution
• MRT = marginal rate of transformation
• This means consumers and producers allocate resources efficiently.
Effect of a tax on X:
• Suppose a tax is imposed on X.
• Price of X becomes: (1 + ))+!
#! (%&')#!
• So, the relative price changes from: to
#" #"
• Consumers now substitute away from X toward Y (bc X is now more
expensive)
• This changes:
- consumption patterns
- production patterns
- allocation of resources
• Result: welfare loss.
Even if no direct tax is imposed on Y, Y is indirectly affected because consumers
reallocate spending.
Two Approaches to Excess Burden:
1) Indifference curve approach – used to compare the price-distorting
effects of different taxes.
