The Two Burdens of Taxation
A tax normally does two things. It takes money from the taxpayers, and it
changes their behaviour. The money taken away from taxpayers is used
to finance government activity. So, while the money taken from
taxpayers, called the direct burden of the tax, is clearly a cost to
taxpayers, it is not a cost to society overall; it is merely a transfer of
resources within the economy.
When a tax changes behaviour, however, there are costs to taxpayers as
well as to society overall. The cost that results from the induced changes
in behaviour is called the excess burden and reflects the allocative
inefficiency or deadweight loss of the tax.
The direct burden of a tax is the amount paid by taxpayers. The excess burden reflects the
allocative inefficiency of the tax.Figure 18-2 shows an example that illustrates this important distinction.
Suppose your provincial government imposes a $2 excise tax on the
purchase of compact discs. (We recognize that CDs are a little “old
school,” but it’s just an example!) Suppose further that you are a serious
music lover and that this tax does not change your quantity demanded of
CDs—that is, your demand for them is perfectly inelastic and hence you
continue to buy your usual five CDs per month. In this case, you pay $10
in excise taxes per month, and you therefore have to reduce your
consumption of other goods (or your saving) by $10 per month.
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