If tax revenues are used to help people, then how does a tax create a deadweight loss?
What will be an ideal response?
As a result of the higher price and lower output from the tax, consumer surplus is smaller. After the tax, sellers receive a lower price, so producer surplus is smaller. However, some of the loss in consumer and producer surpluses is transferred in the form of tax revenues to the government, which can be used to reduce other taxes, fund public projects, or be redistributed to others in society. This transfer of society’s resources is not a loss from society’s perspective. This deadweight loss from the tax is the reduction in producer and consumer surpluses minus the tax revenue transferred to the government. That is, the fall in consumer and producer surplus exceeds the gain in tax revenues and creates the deadweight loss of the tax.
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