Tax Elasticity

Introduction

• Tax elasticity refers to changes in tax revenue in response to changes in tax rates.
• Tax elasticity is the degree to which the increase in the tax rate causes a change in the tax base. 

Principles of Tax Elasticity

• Tax elasticity is thought of as being more prevalent at higher rates. This means that when tax rates are first increased, the tax base isn’t negatively affected. However, once the rates go higher, the negative impact on the tax rate becomes more apparent
• The elasticity of tax rates is observed more in the long run. This means that if taxes are raised for short periods of time by the government to make some quick money, the impact is not that severe.

Important Terms

• Inelastic Taxes: These are taxes where a change in the tax rate has little or no effect on the tax base. Taxes levied on sin goods such as cigarettes and liquor generally fall in this category. Since the demand for these products remains more or less unchanged, increasing the tax rate leads to an increase in the tax revenue.
• Unitary Elastic Taxes: Unitary elastic taxes do not actually exist. As per the Unitary elastic taxes, the percentage change in the tax rate is exactly offset by the percentage change in the tax base. E.g., a 10% increment in the tax rate will cause a 10% decrease in the tax base. Since the tax revenue is the product of tax rate and tax base, it remains unchanged. The increase in one is exactly offset by the decrease in the other.