Assume that the demand for gasoline is inelastic. The government
imposes a sales tax on gasoline. The tax revenue is used
to fund research into clean fuel alternatives to gasoline, which
will improve the air we all breathe.
a. Who bears more of the excess burden of this tax: consumers
or producers? Show in a diagram who bears how
much of the excess burden.
b. Is this tax based on the benefits principle or the ability-topay
principle? Explain.
a. In the case of an inelastic demand for gasoline, consumers bear more of the excess burden of the tax. This is because when demand is inelastic, consumers are less responsive to changes in price, meaning that they will continue to purchase gasoline even when the price increases due to the tax. As a result, consumers end up paying a larger portion of the tax burden.
To illustrate this in a diagram, the demand for gasoline would be represented by a relatively steep downward-sloping curve, indicating inelasticity. The supply curve would be relatively flat, indicating that producers are able to produce and supply a large quantity of gasoline at a relatively constant cost. The tax would shift the supply curve upwards by the amount of the tax, leading to an increase in the price consumers pay for gasoline.
The diagram would show that consumers bear a greater portion of the excess burden, represented by the area between the original and new supply curves, because the price increase affects them more significantly than it does producers.
b. This tax can be argued to be based on the benefits principle. The benefits principle suggests that individuals should contribute to the funding of public goods and services in proportion to the benefits they receive. In this case, the tax revenue collected from the sales tax on gasoline is used to fund research into clean fuel alternatives, which will improve the air quality that is enjoyed by all individuals.
By imposing the tax on gasoline, the government is targeting the users of a specific product (gasoline) that contributes to air pollution. The tax revenue collected is then used to benefit society as a whole by investing in research for cleaner fuel alternatives. Therefore, it can be argued that this tax is based on the benefits principle as it aims to distribute the burden of funding the research based on the individuals who are directly benefiting from the improvement in air quality.
To determine who bears more of the excess burden of the tax, let's start by understanding the concept of excess burden (also known as deadweight loss). Excess burden refers to the loss of economic welfare caused by inefficient market outcomes, such as taxes.
a. To illustrate the excess burden, we need to analyze the supply and demand of gasoline. Given that the demand for gasoline is inelastic, it means that consumers are relatively unresponsive to changes in price. Inelastic demand implies that consumers continue to purchase gasoline even when the price increases. On the other hand, producers supply gasoline regardless of the price.
When a sales tax is imposed on gasoline, the price paid by consumers increases, while the price received by producers decreases. However, since demand is inelastic, consumers bear most of the burden of the tax. Producers, who are more willing to supply at a lower price, end up receiving a smaller portion of the tax burden.
In a diagram, the excess burden is represented by the area between the supply and demand curves, from the original equilibrium quantity to the new quantity after the tax is imposed. This area represents the loss of consumer and producer surplus due to the tax.
b. The tax in this scenario is based on the benefits principle. The benefits principle suggests that taxes should be levied based on the benefits received by individuals from a government-provided service or good. In this case, the tax revenue is being used to fund research into clean fuel alternatives, which aims to improve the quality of air for everyone. Hence, the tax is imposed on the consumption of gasoline, with the idea that those who consume gasoline should bear the burden of funding the research.
While the tax is based on the benefits principle, it is also indirectly related to the ability-to-pay principle. The ability-to-pay principle suggests that taxes should be levied based on an individual's ability to bear the burden of the tax. In this case, as the demand for gasoline is inelastic, it indicates that consumers have a relatively higher ability to bear the tax burden compared to producers.
Overall, the tax is justified by the benefits principle but also indirectly aligns with the ability-to-pay principle due to the inelastic demand for gasoline.