In economics, the excess burden of taxation, also known as the distortionary cost or deadweight loss of taxation, is an additional social cost that goes beyond the number of dollars collected in tax. Distortions occur because people or firms change their behaviour in order to reduce the amount of tax they must pay. Excess burdens can be measured using the average cost of funds or the marginal cost of funds (MCF). Face-to-face trading interactions among on the New York Stock Exchange trading floor Economics, may just involve more otriches than you think social science, studies the production, distribution, and consumption of commodities. ...

An equivalent kind of inefficiency can also be caused by subsidies that change the relative prices of different goods.

Examples

An extreme example of a distortionary cost is a welfare trap. Suppose that an unemployed person named Jane is subsisting on a minimal welfare payment. Jane considers taking a job that would require her to work for tens of hours per week, but remunerate her with tens of thousands of dollars a year. She finds the hourly wage persuasive. But in some real-world cases, people like Jane move from the welfare system to the tax system if they take the job, effectively being taxed 70% or 80% of the dollars they earn. Jane may rationally decide that it would be better to stay on welfare and have a great deal more free time. The welfare trap is a name for a situation in which taxation and welfare systems create strong incentives for people to stay on social welfare payments. ...

Society is losing out, however. If everyone agreed in this one case to let Jane pay no tax on her new job, but cut her welfare payments in half, then everyone would be better off. Jane would likely be better off because she now has a much higher income (it is usually assumed that she wouldn't take the job if she wasn't going to be better off). The government (and therefore other taxpayers) are definitely better off, because Jane's cost to the welfare system has been sliced in half. It is this possibility for a Pareto improvement that leads to the burden being called a "deadweight loss". In economics, a deadweight loss (also known as excess burden) is a permanent loss of well being to society that can occur when equilibrium for a good or service is not Pareto optimal, (that at least one individual could be made better off without others being made worse off). ...

Although it is less obvious, a similar deadweight loss will occur if the government taxes apples but not oranges, thereby encouraging Jane to eat more oranges.

Measures of the excess burden

The cost of a distortion is usually measured as the amount that would have to be paid to the people affected by it, in order to make them indifferent to its presence. An indifference curve is a graph showing combinations of goods for which a consumer is indifferent, that is, it has no preference for one combination versus another, as they render the same level of satisfaction for the consumer. ...

The average cost of funds is the total cost of distortions divided by the total revenue collected by a government. In contrast, the marginal cost of funds (MCF) is size of the distortion that accompanied the last dollar of funds raised (ie, the rate of change of distortion with respect to revenue). In most cases, the MCF increases as the amount of tax collected increases. In mathematics, a derivative is defined as the instantaneous rate of change of a function and the process of finding the derivative is called differentiation. ...

The standard position in economics is that the costs in a cost-benefit analysis for any tax-funded project should be increased according to the marginal cost of funds, because that is close to the deadweight loss that will be experienced if the project is added to the budget, or to the deadweight loss removed if the project is removed from the budget. Cost-benefit analysis is the process of weighing the total expected costs vs. ...

Distortion and redistribution

In the case of progressive taxes, the distortionary effects of a tax may be accompanied by other benefits: the redistribution of dollars from wealthier people to poorer people who obtain more benefit from them. A progressive tax, or graduated tax, is a tax that is larger as a percentage of income for those with larger incomes. ...

In fact almost any tax measure will distort the economy from the path or process that would have prevailed in its absence (land value taxes are a notable exception). For example a sales tax applied to all goods will tend to discourage consumption of all the taxed items, and an income tax will tend to discourage people from earning money in the category of income that is taxed (if they can manage to avoid being taxed). Some people may move out of the work force (to avoid income tax); some may move into the cash or black economies (where incomes are not revealed to the tax authorities). Land value taxation (LVT) is the policy of raising state revenues by charging each landholder a portion of the value of a site or parcel of land that would exist even if that site had no improvements. ... A sales tax is a state or locality imposed percentage tax on the selling or renting of certain property or services. ... An income tax is a tax levied on the financial income of persons, corporations or other legal entities. ... The or underground market is the part of economic activity involving illegal dealings, typically the buying and selling of merchandise or services (for example sexual services in many countries) illegally. ...

For example, in Western nations the relatively affluent are taxed partly to provide the money used to assist the relatively poor. As a result of the taxes (and associated subsidies to the poor), incentives are changed for both groups. The relatively rich are discouraged from declaring income and from earning marginal (extra) income, because they know that any additional money that they earn and declare will be taxed at their highest marginal tax rates. At the same time the poor have an incentive to conceal their own taxable income (and usually their assets) so as to increase the likelihood of their receiving state assistance. It can be argued that the distortion of incentives (the move away from a fiscally neutral stance that does not affect incentives) does more harm than good.

One of the main distortions sometimes said to have arisen in the USA and the UK as a result of tax policy is the creation of a permanent underclass, dependent on welfare and discouraged (by the tax system) from seeking work and betterment. In some countries the tax system can be badly designed to deal with such issues, e.g. sometimes the marginal tax rate that applies to earned income (as someone takes work attempting to escape from unemployment and welfare) is so high that the persons take-home income (post-tax and after taking account of any benefits or welfare receipts) does not increase as a result of taking work. This is known as the welfare trap. A social class is, at its most basic, a group of people that have similar social status. ... In the tax system and in economics, the marginal tax rate refers to the increase in ones tax obligation as ones taxable income rises: marginal tax rate = Δ(tax obligation)/Δ(taxable income) This can be measured either by looking at the published tax tables (to get the official marginal... The welfare trap is a name for a situation in which taxation and welfare systems create strong incentives for people to stay on social welfare payments. ...

There was an example of distortion of the economy by tax policy some years ago in the UK when cars supplied by employers to their employees were taxed at advantageous rates (e.g. encouraging the growth of company car fleets). Over several years the distortion grew to the point that the majority of cars used by working families were company cars and the dealership structures, and even the types of cars used, altered to adjust to the tax regime.

Deliberate distortion

In some cases, the fiscal distortion is deliberate, so as to compensate for externalities. "Sin taxes" on alcohol, tobacco, pornography... may be levied so as to discourage excessive consumption. Such an approach is often preferable to outright prohibition, since prohibition incites trafficking, often resulting in crime. Similarly, taxes, such as a carbon tax, may be levied on the issuing of pollutants, in order to incite corporations to adopt cleaner methods of production. A Pigovian tax is a tax levied to correct the negative externalities of an activity. ... In economics, an externality is the effect of a transaction between two parties on a third party who is not involved in the carrying out of that transaction. ... Functional group of an alcohol molecule. ... Species Nicotiana acuminata Nicotiana alata Nicotiana attenuata Nicotiana benthamiana Nicotiana clevelandii Nicotiana excelsior Nicotiana forgetiana Nicotiana glauca Nicotiana glutinosa Nicotiana langsdorffii Nicotiana longiflora Nicotiana obtusifolia Nicotiana paniculata Nicotiana plumbagifolia Nicotiana quadrivalvis Nicotiana repanda Nicotiana rustica Nicotianasuaveolens Nicotiana sylvestris Nicotiana tabacum Nicotiana tomentosa Ref: ITIS 30562 as of August 26, 2005... Pornographic movies Pornography (from Greek πόρνη (porni) prostitute and γραφή (grafi) writing), more informally referred to as porn or porno, is the representation of the human body or sexual activity with the goal of sexual arousal. ... Prohibition is any of several periods during which the manufacture, transportation, import, export, and sale of alcoholic beverages is restricted or illegal. ... Trafficking is a term to describe a transnational illegal activity, involving transporting, usually smuggling drugs, transporting small arms or people. ... A carbon tax is a tax on energy sources which emit carbon dioxide into the atmosphere. ... Pollutants are substances which directly or indirectly damage us or the environment. ...

Other notes

Excess burdens were first discussed by Adam Smith. Adam Smith, FRSE, (baptised and probably born June 5, 1723 O.S. (June 16 N.S.) – July 17, 1790) was a Scottish political economist and moral philosopher. ...

Not all distortions are bad: Pigovian taxes create distortions that correct for externalities and therefore have a negative MCF. A Pigovian tax is a tax levied to correct the negative externalities of an activity. ... An externality occurs in economics when a decision (for example, to pollute the atmosphere) causes costs or benefits to individuals or groups other than the person making the decision. ...

Georgism is a political philosophy that advocates land value taxation because (amongst other reasons) it is non-distortionary. Georgism, named after Henry George (1839-1897), is a philosophy and economic ideology that follows from the belief that everyone owns what they create, but everything supplied by nature, most importantly land, belongs equally to all humanity. ... Land Value Taxation (LVT) is the policy of raising state revenues by charging each landholder a portion of the assessed site-only value of the unimproved land. ...