Economics: The Costs of Taxation

Difficulty: 1/3 (Talks about the application of concepts discussed in earlier chapters)
Review: 5/5 (Mankiw does a great job of providing real world examples of the discussion of tax)

Earlier, the book described the detrimental effects of taxes, shrinking the market and reducing efficiency. But taxes are necessary for funding education, enforcement, and more.

Now, we learn how to measure the benefits and losses from the tax. The money the government gets is called tax revenue, the area of the rectangle with a height equivalent to the size of the tax and a width equivalent to the quantity demanded after the tax. Of course, since the market shrinks, total surplus is also reduced; the amount of total surplus lost is known as the deadweight loss of tax, represented by the triangle with the three points: the equilibrium, the price buyers pay, and the price sellers receive.

The deadweight loss occurs because some buyers are discouraged by the increased cost from the tax. The size of the deadweight loss is affected by the elasticities of supply and demand, and the size of the tax.

The Laffer curve represents the shape of the tax revenue as tax size increases. This concept sparked much debate in the United States as government policymakers wondered if they were taxing too much and discouraging labor or taxing too little to provide the government more revenue for helping the nation.