Question

What is the best predictor of whether reducing a tax in a market will increase or decrease tax revenue? Explain.

Answer 1

People often assume that when government imposes a tax on purchases of some product, producers simply raise the price of the product so that consumers end up paying the tax.how a tax burden is divided between consumers and producers is called tax incidence. Tax incidence depends on the price elasticities of supply and demand.The example of cigarette taxes introduced demonstrated that because demand is inelastic, taxes are not effective at reducing the equilibrium quantity of smoking, and they mainly pass along to consumers in the form of higher prices. Higher prices results in more tax revenue in this case .

: The best predictor is the elasticity of supply and the elasticity of demand in the market. The more elastic supply and demand are in a market, the more taxes in that market distort behavior, and the more likely it is that a tax cut will raise tax revenue.