Chapter 8: Taxation and Economic Welfare

Whereas chapter 6 was explaining how taxes affected the market, chapter 8 depicts how taxes affect economic welfare, and the two together form a bigger picture. An important thing to remember is that it doesn't matter who the tax is levied on, the determinant of who bears the tax burden between the producers and buyers depends on the elasticities of supply and demand. That leads us to learn that upon taxation, the losses to buyers and sellers from a tax exceed the revenue raised by the government. That fall in total surplus when a market outcome is distorted is called deadweight loss, as a result of people responding to incentives. It's also clear to see that the most dangerous effect of taxation is the canceling of transactions between buyers and sellers, resulting in no increase in revenue for the government (the intended effect) and a decrease in the size of the market. I got a little confused when Mankiw started talking about figure 4 and explaining that taxation caused a loss of benefit at every point on the graph, not because I didn't understand the concept, but because it wasn't depicted well on the graph. Mankiw's next lesson was pretty simple though, the greater the elasticities of supply and demand, the greater the deadweight loss of a tax. This makes sense because elasticity is a measure of how willing producers and buyers are to stay in the market in response to a price change, and a tax is nothing more than a price change. I also found it interesting that the labor tax debate can basically be boiled down to if one thinks the supply of labor is elastic or inelastic. All in all, this chapter was somewhat difficult at points, but nowhere close to a Stockman article. 2/3 for difficulty.