AP_Krugman_Textbook

In considering the total amount of inefficiency caused by a tax, we must also take

into account something not shown in Figure 50.12: the resources actually used by the

government to collect the tax, and by taxpayers to pay it, over and above the amount of

the tax. These lost resources are called the administrative costsof the tax. The most

familiar administrative cost of the U.S. tax system is the time individuals spend filling

out their income tax forms or the money they spend on accountants to prepare their

tax forms for them. (The latter is considered an inefficiency from the point of view of

society because accountants could instead be performing other, non-tax-related serv-

ices.) Included in the administrative costs that taxpayers incur are resources used to

evade the tax, both legally and illegally. The costs of operating the Internal Revenue

Service, the arm of the federal government tasked with collecting the federal income

tax, are actually quite small in comparison to the administrative costs paid by taxpay-

ers. The total inefficiency caused by a tax is the sum of its deadweight loss and its ad-

ministrative costs.

Some extreme forms of taxation, such as the poll taxinstituted by the government of

British Prime Minister Margaret Thatcher in 1989, are notably unfair but very efficient.

A poll tax is an example of a lump-sum tax,a tax that is the same for everyone regard-

less of any actions people take. The poll tax in Britain was widely perceived as much less

fair than the tax structure it replaced, in which local taxes were proportional to prop-

erty values.

Under the old system, the highest local taxes were paid by the people with the

most expensive houses. Because these people tended to be wealthy, they were also

best able to bear the burden. But the old system definitely distorted incentives to en-

gage in mutually beneficial transactions and created deadweight loss. People who

were considering home improvements knew that such improvements, by making

their property more valuable, would increase their tax bills. The result, surely, was

that some home improvements that would have taken place without the tax did not

take place because of it. In contrast, a lump-sum tax does not distort incentives. Be-

cause under a lump-sum tax people have to pay the same amount of tax regardless of

their actions, it does not cause them to substitute untaxed goods for a good whose

price has been artificially inflated by a tax, as occurs with an excise tax. So lump-sum

taxes, although unfair, are better than other taxes at promoting economic efficiency.

508 section 9 Behind the Demand Curve: Consumer Choice

figure 50.12

The Deadweight Loss of a Tax

A tax leads to a deadweight loss because it cre-

ates inefficiency: some mutually beneficial trans-

actions never take place because of the tax,

namely the transactions QE−QT. The yellow area

here represents the value of the deadweight loss:

it is the total surplus that would have been gained

from the QE−QTtransactions. If the tax had not

discouraged transactions—had the number of

transactions remained at QE—no deadweight loss

would have been incurred.

QE Quantity

S

E

D

Price

QT

PE

PC

PP

Excise

tax = T

Deadweight loss

Theadministrative costsof a tax are the
resources used by government to collect the
tax, and by taxpayers to pay (or to evade) it,
over and above the amount collected.

Alump-sum taxis a tax of a fixed amount
paid by all taxpayers.