Excess Burden

Published Apr 28, 2024

Definition of Excess Burden

Excess burden, also known as the burden of taxation, refers to the cost to society created by market inefficiency in tax policy. This inefficiency occurs when the implementation of a tax distorts the way resources are allocated in the economy, causing decisions to be made that would not have been made if the market were functioning without the tax. The excess burden is the economic loss that society suffers as a result of this inefficiency, above and beyond the actual tax revenue collected by the government.

Example

Consider the case of a tax imposed on the sale of cigarettes. The intention behind the tax might be to reduce smoking rates, which could lead to a healthier population. When the tax is applied, the price of cigarettes increases, leading to a decrease in the quantity of cigarettes demanded. Some smokers may quit smoking due to the higher prices, leading to a desired outcome from a public health perspective.

However, the excess burden arises because the higher tax also causes consumers to alter their behavior in ways that are not efficient from an economic standpoint. For example, smokers might start purchasing cigarettes in bulk from lower-tax jurisdictions or switch to other, potentially more harmful substances that are not taxed in the same way. Additionally, there might be a decrease in consumer surplus for those who continue to smoke despite the higher prices, as well as a loss in producer surplus for cigarette manufacturers. The sum of these effects represents the excess burden of the cigarette tax.

Why Excess Burden Matters

Understanding the concept of excess burden is crucial for policymakers when designing tax systems. The goal is to generate the necessary revenue for government projects and services while minimizing undesirable economic distortions. A well-designed tax policy should aim to balance the need for revenue against the potential for creating excess burdens.

For example, broad-based taxes on consumption (like a general sales tax) are often favored over taxes on specific goods (like cigarettes) because they are less likely to cause significant distortions in consumer behavior. Additionally, when possible, taxes that align with correcting negative externalities (like carbon taxes for their environmental benefits) can lead to a reduction in excess burdens by encouraging socially beneficial behavior changes.

Frequently Asked Questions (FAQ)

Can excess burden ever be eliminated?

While it is nearly impossible to eliminate all excess burden due to the inherent distortions taxes introduce into the economy, it can be minimized through careful tax policy design. The key is to structure taxes in a way that causes the least alteration to economic behavior, hence limiting inefficiency and societal loss.

How do economists measure excess burden?

Economists measure excess burden through complex mathematical models that estimate the changes in consumer and producer behavior resulting from a tax. These models consider factors such as the elasticity of demand and supply, which reflect the sensitivity of consumers and producers to changes in price. The area between the supply and demand curves in economic graphs, which changes due to taxation, can often visually represent the excess burden.

Is there a relationship between the size of a tax and its excess burden?

Yes, there is a relationship between the size of a tax and its excess burden. Generally, the excess burden of a tax increases more than proportionally as the tax rate increases. This means that doubling a tax rate often more than doubles the excess burden. This non-linear relationship is due to the increased behavioral changes and distortions that occur at higher tax rates.

Can some taxes have a lower excess burden than others?

Yes, the type of tax and its structure greatly affect the size of its excess burden. Taxes that are broad-based and applied uniformly across a wide range of goods and services typically have a lower excess burden compared to taxes that target specific products or behaviors. This is because broad-based taxes are less likely to distort individual choices and market outcomes significantly.

Understanding and minimizing the excess burden of taxation is a fundamental concern in economic policy, aiming to enhance societal welfare by ensuring that the necessary resources for public goods and services are raised in the most economically efficient way possible.