Deadweight costs of taxation
For goods supplied in a perfectly competitive market, tax reduces economic efficiency, by introducing a deadweight loss. In a perfect market, the price of a particular economic good adjusts to make sure that all trades which benefit both the buyer and the seller of a good occur. After introducing a tax, the price received by the seller is less than the cost to the buyer. This means that fewer trades occur and that the individuals or businesses involved gain less from participating in the market. This destroys value, and is known as the 'deadweight cost of taxation'.
The deadweight cost is dependent on the elasticity of supply and demand for a good.
Most taxes—including income tax and sales tax—can have significant deadweight costs. The only way to completely avoid deadweight costs in an economy which is generally competitive is to find taxes which do not change economic incentives, such as the land value tax,[17] where the tax is on a good in completely inelastic supply, a lump sum tax such as a poll tax which is paid by all adults regardless of their choices, or a windfall profits tax which is entirely unanticipated and so cannot affect decisions.