Suppose that your neighbor is willing to pay you $ 100 to do some home repairs for her. You would be willing to do the job for $ 80, so you strike a deal. Now suppose that the government levies
• Taxes generally impose an excess burden— a cost beyond the tax revenue collected.
• Excess burden is caused by tax- induced distortions in behavior. It may be examined using either indifference curves or compen-sated demand curves.
• Lump sum taxes do not distort behavior but are unattractive as policy tools. Nevertheless, they are an important standard against which to compare the excess burdens of other taxes.
• Excess burden may result even if observed behavior is unaffected, because it is the compensated response to a tax that determines its excess burden.
• When a single tax is imposed, the excess burden is proportional to the compensated elasticity of demand, and to the square of the tax rate.
• Excess burden calculations typically assume no other distortions. If other distortions exist, the incremental excess burden of a new tax depends on its effects in other markets.
• Subsidies also create excess burdens because they encourage people to consume goods valued less than the marginal social cost of production.
• The differential taxation of inputs creates an excess burden. Such inputs are used “ too little” in taxed activities and “ too much” in untaxed activities. Summary You pack up your gear and leave your neighbor’s home, because it is no longer worthwhile for you to do the job. As a result of your leaving the job, you do not have to pay the $ 25 tax. Relate this scenario to the concept of excess burden.