Economic analysis provides the basis for examining the impact various policies have on both consumers and producers. The effects of raising revenue through taxation of a good, known as imposing an excise tax, represents one such scenario that benefits from economic analysis. With careful analysis, policymakers can weigh the benefits of increased revenue against possible adverse outcomes.
In economics, consumer surplus refers to the net gain that a customer receives when she purchases a specific good at a specific price. It represents the difference between the actual price paid for a good and the price a consumer would be willing to pay to purchase the good. For instance, placing an item on sale allows consumers to experience an increase in consumer surplus when they make a purchase. One factor that can influence consumer surplus is the implementation of an excise tax. With the imposition of an excise tax, the overall price paid for a good will naturally increase. At a higher price level, demand for the good drops, resulting in a reduction in consumer surplus.
Producer surplus represents the benefit the seller gains from selling a good at a specific price. This can be illustrated by a firm receiving a price above the price it would actually accept for the good. As is the case with consumer surplus, producer surplus decreases in response to an excise tax on a good. This is due to the reduction in the quantity sold as the relative price of the good increases with an excise tax.
Government benefits from the imposition of an excise tax through the collection of tax revenues. These revenues can be used to fund federal, state or local initiatives and programs. On the other hand, excise taxes generally cause what is considered a dead-weight loss to society. Dead-weight loss refers to the number of units not sold because of the excise tax.
One thing to consider when analyzing the effect of an excise tax on a good is the elasticity of the good in question. The quantity of elastic goods demanded or supplied is influenced by price, while the quantity of inelastic goods demanded or supplied is not easily influenced by price. Therefore, an excise tax on an elastic good is likely to have a greater impact on consumer and producer surplus than an excise tax on an inelastic good.