Excess Burden of Taxation
What is Excess Burden of Taxation?
The excess burden of a tax is the deadweight loss it creates beyond the revenue collected, arising because the tax distorts consumption and production decisions.
A tax drives a wedge between the price buyers pay and sellers receive, shrinking the quantity traded below the efficient level and destroying mutually beneficial transactions. The lost surplus over and above the tax revenue is the excess burden, usually shown as the 'Harberger triangle'. Its size grows with the square of the tax rate and is larger when supply or demand is more elastic, which is why broad, low-rate taxes on inelastic bases are more efficient.
Excess Burden of Taxation: a worked example
Lawn-mowing jobs trade at $40 each, 1,000 a month. Put a $10 tax on each job and the number falls to 850. Revenue is $10 x 850 = $8,500, and the excess burden is the triangle 1/2 x $10 x 150 = $750, the surplus from the 150 jobs that no longer happen. Now double the tax to $20 and quantity falls to 700. Revenue rises to $20 x 700 = $14,000, up roughly 65%, while the excess burden becomes 1/2 x $20 x 300 = $3,000, four times as large. Doubling the rate quadrupled the waste.
The mistake students make with excess burden of taxation
Many people assume the burden of a tax equals the money handed to the government, making a tax a pure transfer with no loss. The revenue is the transfer; the excess burden is the surplus from trades that never took place, and nobody collects it. The related error is judging a tax by how much it raises. A levy on a base that cannot move raises revenue with no excess burden at all, since distortion comes from the behavioral response, not the size of the bill.
Excess Burden of Taxation questions
Why does doubling a tax rate quadruple the deadweight loss?
Deadweight loss quadruples because the Harberger triangle grows in both dimensions at once. Doubling the tax doubles the wedge, which is the triangle's height, and it roughly doubles the fall in quantity, which is its base, so the area scales with the square of the rate. In the lawn-mowing example the loss went from $750 to $3,000. This is the argument for broad taxes at low rates over narrow ones at high rates.
What is the difference between excess burden and tax revenue?
Tax revenue is money moved from taxpayers to the government, so someone still has it. Excess burden is value that disappears, the gains from exchanges the tax priced out of existence. A tax with a large excess burden is not necessarily a large earner, and the reverse holds too. Revenue depends on the rate times the transactions that survive; excess burden depends on the transactions that do not.
Which taxes have the smallest excess burden?
Taxes with the smallest excess burden are those levied on bases that barely respond to being taxed. A lump-sum charge owed regardless of behavior is the limiting case, since nothing a taxpayer does changes the bill, so quantity traded never shifts. Taxes on inelastic goods come close, and a broad base at a low rate beats a narrow base at a high rate because the loss grows with the square of the rate.
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