When there is a collection of taxes that is a price one party, then it will see a change in the transactions. It would see a different price from that of the other parties. This way there can be economic inefficiency and can lead to market failure.
How Is There Inefficiency?
The taxations have an ability to change the incentives that are given to the people. This is the main reason as to how the economic efficiency is changing. Though the politicians may or may not understand the effects of taxes, the economists are fascinated with it. Let us see the efficiency implications in case of the excise tax.
What Is an Excise Tax?
It is something that is put on a specific item. To make it simple, it is sales tax. It can be of two types. It can be a tax per unit or it can be an ad valorem tax. In the case of the per unit tax, it is fixed and in the second case, it is generally a percentage of the value of the good. Though they are a minor source of income to the government in most cases, they do help the government. Let us consider the picture given below to find out more about the excise tax.
In this picture, there are demand and supply curves that are shown in the case of a competitive market. In this case, the marginal costs are assumed to be constant. In such cases, the supply curve is found to be horizontal.
Before the imposition of the tax, the price is P1 and the quantity sold would be q1. The wedge in existence would be the one denoting the per unit tax. This is shown by the shift of supply curve to a higher level. This would be the supply at taxed prices. The supply curve shows how the reaction of the sellers is to the price which they see. Supply with tax line shows the reaction of the sellers to the prices as seen by the buyers.
Due to the taxes, the quantity at equilibrium becomes q2 and the price becomes P2, though the sellers receive only P1. The amount that goes to the government would be (P2-P1) times q2.
Excise Tax Homework Help