Question

Suppose you are advising the government on sales tax. Should the government tax inelastic goods such as food and medicine or inelastic goods such as Netflix and Hulu subscriptions if the goal of the tax is not to be distortionary? (In which scenario would the tax have the smallest effect on quantity).

Answer 1

If I am advising the government on sales tax I would suggest the government to tax

• The inelastic goods such as food and medicine but not
• NETFLIX or HULU subscriptions if the goal of the tax is not distortionary

It is because of the simple reason that taxing goods like

• NETFLIX or HULU subscriptions are relatively elastic goods which if taxed can lead to large deadweight losses than compared to inelastic goods such as food and medicine.
• Inelastic goods such as food and medicine are considered necessities and hence people's demand will remain almost the same and tax will have the smallest effect on quantity.

Thus the government should tax Inelastic goods such as food and medicine if the goal of the tax is not to be distortionary

This above figure clearly describes the case as

• Tax on inelastic goods leads to a relatively small amount of deadweight losses ( D2 < D1 )
• Tax on inelastic goods also have the smallest effect on the quantity ( Q0Q2 < Q0 Q1 )