Excise Tax
What is Excise Tax?
An excise tax is a tax levied on the production or sale of a specific good or service.
Excise taxes are typically applied to goods with negative externalities, like cigarettes or alcohol, to discourage consumption and raise revenue. They shift the supply curve upward by the amount of the tax.
Excise Tax: a worked example
Let Qd = 120 minus 2P and Qs = 2P minus 40. Before any tax, 120 minus 2P = 2P minus 40 gives 160 = 4P, so P = $40 and Q = 40 units. Now impose a $10 per-unit excise tax on sellers. Supply becomes Qs = 2(P minus 10) minus 40 = 2P minus 60. Solving 120 minus 2P = 2P minus 60 gives 180 = 4P, so buyers now pay $45 and quantity falls to 30 units. Sellers keep 45 minus 10 = $35. Buyers absorb $5 of the tax and sellers absorb $5, an even split because the two curves have matching slope magnitudes, which makes demand and supply equally elastic at the original equilibrium. Government revenue is $10 times 30 = $300. Deadweight loss is the triangle one half times $10 times (40 minus 30) = $50, the value lost on the 10 units that no longer trade.
The mistake students make with excise tax
Students assume whoever writes the check to the government bears the tax. Statutory incidence and economic incidence are different things: the same $10 tax produces the same split whether it is collected from sellers or from buyers, because relative elasticity decides the outcome and the more inelastic side pays the larger share. The second habit is computing revenue with the pre-tax quantity, multiplying $10 by 40 units to get $400. Revenue uses the after-tax quantity of 30, giving $300, since the tax itself destroys some trades.
Excise Tax questions
Who really pays an excise tax?
Whoever is least able to walk away pays the larger share of an excise tax. Burden splits by relative elasticity: if demand is more inelastic than supply, buyers absorb more, and if supply is more inelastic, sellers absorb more. With a $10 tax that raises the buyer price from $40 to $45 and drops the seller price to $35, the split is even, which signals equally elastic sides. The law naming the payer does not change that split.
How do you find deadweight loss from an excise tax?
Deadweight loss is the triangle between the demand and supply curves covering the units the tax destroys. Its area equals one half times the tax per unit times the fall in quantity. A $10 tax that cuts quantity from 40 units to 30 produces one half times 10 times 10 = $50. The triangle exists because those 10 units were worth more to buyers than they cost sellers, and the tax stopped them from being traded.
Does an excise tax shift supply or demand?
An excise tax collected from sellers shifts supply left, and the shift is vertical by exactly the tax amount. A $10 tax means sellers need $10 more per unit than before to offer any given quantity. Levy the same tax on buyers instead and demand shifts down by $10, while equilibrium quantity, tax revenue and deadweight loss all come out identical. Only one curve moves in either version, never both at once.
This is the live Supply and Demand sandbox. Drag the curves, or open the full version.
Related terms
Common comparisons
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