Question

5. What are the costs of taxation? Provide a detailed discussion.

Answer 1

• Taxes are usually imposed by the government as a means of earning revenues.
• These taxes Increase inefficiencies in the market economy as it decreases the surpluses and Increases the losses.
• When a tax is levied in a market economy, the quantity purchased by the consumer's fall and the quantity sold by the firm's also fall.
• This means that the demand of customers and the supply by firms fall thus shifting the demand and supply curve towards left.
• When a tax is imposed on consumer's, they will be less Willing to pay a higher amount for the goods they are willing to purchase because taxes Increase the prices of all goods and services more than the price they are willing to pay. This will cause their demands to fall.
• Similarly when a tax is imposed on producers, they face higher marginal costs of production, which forces them to produce less and supply less which further decreases the quantity supplied by the firm's.
• This will hence lead to a loss in both consumer surplus and producer surplus due to taxes which is termed as deadweight loss.
• The tax revenues earned by the government by imposing taxes will hence exceed the consumer surplus and the producer surplus due to the deadweight loss.
• This will cause many firms and consumer's start to leave the markets and thus the markets shrinks in size.
• The government can extract more and more revenue's from the firm's and consumers for a certain point of time but as markets starts to shrink in size when taxes grow, the tax revenues start to fall.