Effects of Surplus Tax on Production and Consumption

If a market is experiencing consumer deficit, surplus tax can be introduced to fix the case. Consumer deficit, also known as a consumer loss, is the difference between what consumer is willing to pay for a given commodity and the market price of that commodity. It usually occurs when the market price of a commodity is higher than the price that consumers are willing to pay. Surplus tax is the individual sales tax added to the price of certain goods and/or services in the market. The difference between the actual market price of a given good/service and the new price after addition of surplus tax is collected by the government and used to correct consumer deficit (Mankiw, 198).

Surplus tax has a negative impact on both production and consumption of the commodity where it has been imposed, but has a positive impact on consumption and production of goods or services, where consumer deficit existed (Deadweight Loss, 2000). To illustrate this, assume a situation where the price of corn oil is $5. However, consumers are only able to purchase the oil at $3.5. To correct this deficit, the government imposes a surplus tax on diesel where the price of one litre of diesel changes from $2.5 to $3.3. The resulting difference of $0.8 is the surplus tax. Further, assume that before the introduction of surplus tax on diesel, market is experiencing consumer surplus and producer surplus. The consumer is willing to purchase the diesel at $3.1, thus enjoy consumer surplus of $0.6 per litre. On the other side, the producers are willing to offer a litre of diesel at $2, thus enjoy producer surplus of $0.5 per litre.

However, after the introduction of surplus tax, part of both consumer and producer surplus will be lost while the other part is transferred to the government as tax revenue. This will disrupt the old equilibrium and the new equilibrium will have to be attained at a higher point. As the law of demand and supply stipulates: increase in price results into a decrease in demand. Therefore, diesel consumers will reduce their consumption of the product. Decrease in consumption will cause production of diesel to reduce as well. The government will allocate the surplus tax from diesel to consumers of corn oil. This will enable consumers of corn oil to purchase the product at an affordable price, thus increasing their consumption. Increase in consumption of corn oil will result into increased production of corn oil, thus benefiting the producers of corn oil (Deadweight Loss, 2000).

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