A Note on the Concept of Excess Burden

Abstract

It is argued that there has been a shift in the meaning of “excess burden” from Pigou to modern economics, related to what is used as a reference point when the effect of a tax is discussed. Is it the situation before the tax was introduced or what would have happened if a lump sum tax had been used instead? This distinction is important for tax policy, since the latter reference point leads to a larger, sometimes much larger, numerical value for the excess burden. However, the distinction is not often clearly made and this has led to risks for misguided political decisions on taxes. It is further argued that when excess burden and efficiency losses are discussed, economists have neglected to discuss the meaning of “can”, or “possible”, when the Pareto principle is formulated. Is it reasonable to say that welfare “can” be improved by a lump sum tax instead of a “distortionary” tax if, as most economists seem to believe, such a tax is not a realistic alternative? Since conceptual clearness about the excess burden of taxes is important, some suggestions for improving the situation are also presented.