Multiple Choice
After the government imposes an excise tax on a market, what determines the amount of government revenue collected from the tax?
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6. Introduction to Taxes and Subsidies
Introducing Taxes and Tax Incidence
Multiple Choice
Suppose the government increases the size of a tax by 20 percent. The deadweight loss from that tax:
A
increases by less than 20 percent
B
increases by exactly 20 percent
C
remains unchanged
D
increases by more than 20 percent
Verified step by step guidance1
Recall the formula for deadweight loss (DWL) from a tax, which is generally proportional to the square of the tax rate. Mathematically, DWL \( \propto t^2 \), where \( t \) is the tax rate.
Understand that if the tax rate increases by 20%, the new tax rate becomes \( t_{new} = 1.2 \times t \).
Substitute the new tax rate into the deadweight loss relationship: \( DWL_{new} \propto (1.2 \times t)^2 = 1.44 \times t^2 \).
Compare the new deadweight loss to the original: the deadweight loss increases by a factor of 1.44, which is a 44% increase, greater than the 20% increase in the tax rate.
Conclude that because deadweight loss increases with the square of the tax rate, a 20% increase in the tax rate leads to a more than 20% increase in deadweight loss.
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