Question

In an effort to raise revenue without hurting lower income persons, Congress imposed an excise tax on luxury goods (viz., expensive cars, large yachts, furs, personal aircraft) manufactured in the U.S. The excise tax imposed is represented on the diagram below as S_tax . The revenue government   anticipated it yielding is represented by the rectangle P₁abc (which is the tax per unit, distance ab, times quantity Q₁). The tax, however, did not work as intended. After awhile domestic producers of taxed luxury goods found business tough going and some went out of business. The tax yield actually received by government was much smaller than anticipated. Starting with the diagram below, add to it a consumer demand response that results in a smaller tax yield than the P₁abc anticipated. Using your augmented graphical analysis, explain in (b) what you think consumers did in response to the imposition of the luxury tax. What revenue rectangle represents the tax yield after the consumer response? Need some help to better understand this one please.

Price Stax Pi Quantity Q1

Answer 1

Tax generally reduces the demand for goods. The underlined reason behind is that the imposition of tax increase the price of the commodity and thus the consumer response to this price increase by reducing their demand. The imposition of tax reduces the demand and the government does not get sufficient revenue in the form of tax. The earning through tax depends upon the relative elasticity of demand. If the product has an elastic demand the demand will fall to a great extend and the government w be unable to get sufficient revenue. But on the other hand the products having inelastic demand gives greater scope for the government to get revenue The respective elasticity of demand is shown by the shape of the demand curve. If the demand curve is more flat the demand is more elastic and in such case a rise in price will leads to a large loss in demand. Hence the government cannot get the expected tax revenue The demand curve in Ihc figure is more Па1 in the sense lhal lhe increase in price will lead to the huge fall in price. The effect of tax on the consumer's behaviour and the expected tax revenue and the realized tax revenue can be explained in the following figurc Price Stax PI Quantity The government imposes a tax on the luxury good and anticipag a tax revenue equa to ab per unit. Then the anticipated tax revenue is abxQ1 which is equal to Plabc. But the tax reduces the demand for the luxury goods. Then the demand curve shift to the left from D to D1. Then the quantity demanded decrease to Q2. This fall in demand decrease the tax revenue While imposing the tax the government expects to earn total tax revenue equal to the arca Plabe on the goods Q1. But the imposition of tax reduces thc demand from Q1 to Q2. Thus what actually rcccived aflcr tax is less than what actually expccted. The rectangle defe <Plabec