Question

The city of Hamiltown decides to build a new basketball stadium to attract the team from Jacksondale (NB: this is almost always a bad decision for cities as extensive research on the local economic effects of sporting events has shown). One economic adviser suggests that the stadium should be financed by a 2 year sales tax of 10%, while another adviser recommends that the stadium be financed by a 20 year sales tax of 1%. Assume the interest rate is zero. Which approach will yield a more efficient outcome? Why?

Answer 1

Given that the interest rate is zero, both the financing approach would yield the same amount. But from economics point of view, we know that a sale tax like any other taxes reduces an economic situation into an inefficient one. The loss of such efficiency is caused by the deadweight loss. Higher the size of tax, regardless of the incidence of tax and considering unchanged elasticities of supply and demand, larger is the deadweight loss and the resultant inefficiency of outcome. Thus, levying a sales tax of 10% for 2 years will cause more inefficient outcome.