Professor Ho offers a primer on how to think about measuring the impact of taxes

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The impact of a tax on a sector is measured by its effect on supply and demand. The area below the demand curve is the benefits consumers get from consumption. The area below the supply curve is the profits producers get from consumption. Therefore the area between the supply and demand represents the total benefits in terms of consumer value (known as consumer surplus) and producer profits.

Introducing a tax creates a wedge between what consumers have to pay and the actual cost of production. This increases the price to consumers and reduces the output of producers. This leaves a triangle known as the Dead Weight Loss or Harberger’s Triangle, of lost economic opportunities.

As tax revenues from a sector are increased, the dead weight loss grows. For a small tax, we are still at the tip of the triangle, so the increase in dead weight loss is small. But in a heavily taxed sector, we are now at the base of the triangle, and so the dead weight loss is higher.

The Ramsay principle of optimal taxes however notes that this effect depends on the slope of supply and demand. If the slope of supply and demand in a given sector are relatively inelastic (closer to vertical) which means the quantity supplied and the quantity demanded do not change very much when prices change, then taxes have a relatively small effect on quantity, and thus have smaller dead weight loss. Thus such sectors should be targeted.