Question

As the Size of a Tax rises, the deadweight loss_________ A) Rises, and Tax revenue first rises, and then Falls. Please Give a Detailed Explanation to this Answer

Answer 1

As the size of a tax rises, the deadweight loss rises, and tax revenue first rises and then falls.

It's true that as the size of a tax rises, the deadweight loss rises. Deadweight loss equals to the loss of consumer surplus for buyers plus the loss of producer surplus for sellers who do not participate in the market due to high price of the product or service, this results in a loss of total surplus for the economy. Deadweight loss rises as the tax size rises, because consumer looses in terms of consumer surplus and the producer looses in terms of producer surplus and it happens due to rise in price. Increased price because of high tax rate enables consumers to buy less and producers to produce less as they are not getting enough price to cover their economic costs. Because these buyers and sellers do not participate in the market, the deadweight loss rises and they do not contribute to the tax, so the government does not receive the portion of deadweight loss.

Tax revenue varies with the proportion of the tax as a percentage of the price of the product. A moderate tax rate results the most tax revenue. As the tax rate increases or decreases tax revenue will be less. The government only gets a small portion of the price, when there is a low tax rate. When tax rate is high, the selling quantity is low, so when it is multiplied by the high tax rate, it gives less revenue. Tax revenue first rises and then falls because people purchase a product when they badly need it, this increases tax revenue of the government because people have to buy it with an increased tax. But afterwards, consumers will not show interest to buy the same product if there is no such urgency, this results in decrease in tax revenue. Increase in tax rate, results in increase in price of the products and services resulting no participation of buyers and sellers in transaction, this in turn decreases tax revenue of the government gradually.