6.1.2 Tax revenue

This graph shows how taxes affect the welfare of market participants rather than the quantity and price of goods. The relationship between tax revenue and tax rate is analyzed, as well as the parameters determining the distribution of the tax burden between consumers and producers. In order to illustrate the relevant effects, the supply and demand curve can be shifted using the cross, designated market equilibrium. The slopes can be regulated using the controllers on the bottom, designated supply- or demand- elasticity.
As already explained above, the effects of a tax on the seller are identical to the effects on the buyer, therefore, in the analysis of the effects on welfare, the shifts in the supply and demand curve do not have to be plotted.
The distribution of the economic tax burden depends on the elasticity of supply and demand. The more elastic side (flat curve) – i.e. the one more flexible in adjusting its demanded or offered quantity in case of price changes – bears the smaller part of the tax burden. The inelastic, inflexible side (steep curve) bears the higher share. This can be observed in the graph, when the slope of one of the two curves is changed and the changed distribution of the tax burden is considered. The orange bar represents the tax to be borne by the consumers (difference between the price paid with tax and the equilibrium price on the market without tax). The dark green bar represents the tax to be borne by the producers (difference between the net price received on the market with tax and the equilibrium price on the market without tax).
By levying a tax, the welfare of all actors involved changes. As explained above, the welfare of consumers is reduced because they have to pay a higher price for the good. As well, the welfare of producers is reduced because of the lower price they receive for the good. In addition, both sides suffer welfare losses due to the decrease in the quantity sold, because some consumers (producers) leave the market due to the increased (decreased) effective prices. The state, which collects the tax, benefits.
We will examine the changes on the basis of consumer- and producer- surplus as well as the tax revenues.
The state receives tax revenue equal to the quantity sold times the tax rate per good. This tax revenue is shown by the red area. The consumer- and producer- surplus decrease as the tax rate increases. The tax revenues correspond exactly to the welfare loss of the consumers and producers remaining in the market. The state receives exactly the difference between the old market price and the new effective purchase price from the consumers and the difference between the old market price and the new effective sales price from the producers. However, the welfare loss of those producers and consumers who leave the market is not compensated by tax revenues, since there is no taxable transaction. This results in a real welfare loss (grey and grey-green triangle).
If the tax increases, the price received by the sellers decreases and the price to be paid by the buyers increases. The higher the tax, the lower the supply and demand for the taxed good. The net welfare loss for the state as a whole rises as the level of tax increases. If the tax wedge becomes very large, it turns into an incentive for actions of evasion such as cigarette smuggling.