Figure 18-2 Direct and Excess Burdens of an Excise Tax
The allocative inefficiency of a tax is measured by its excess burden.
The excess burden is greater the more elastic is demand. Part (i) shows
your demand for CDs. It is perfectly inelastic at five CDs per month.
When the government imposes an excise tax of $2 per CD, the price rises
from $15 to $17. Your quantity demanded is unchanged, so you pay $10
per month in taxes. The direct burden of the tax
is $10; but because your quantity of CDs demanded is unchanged, there
is no excess burden.
Part (ii) shows your friend’s demand. Her quantity demanded falls from
two CDs per month to zero as a result of the tax. Since she pays no tax
(because she buys no CDs), she bears no direct burden of the tax. But
because she has lost consumer surplus, she bears an excess burden from
the tax.
Part (iii) shows the entire market demand, made up of you, your friend,
and many other people. There is both a direct burden, the dark shaded
area, and an excess burden, the light shaded area. The more elastic is the
demand curve, the larger is the excess burden of the tax.
The direct burden to you of this excise tax is $10 because that is what you
pay to the government in taxes. There is no excess burden to you because
the tax does not cause you to reduce your purchases of CDs. The absence
of any excess burden from this tax is just another way of saying that there
($ 2 taxperCD × 5 CDs)