how consumers and producers respond to changes in price significantly influences the deadweight loss of taxation when demand or supply is inelastic deadweight loss tends to be higher in these cases consumers and producers may find it challenging to adjust their behavior in response to tax induced price changes 
tax elasticity or the degree to which the tax base responds to changes in tax code also plays a factor if individuals or businesses can easily adjust their behavior to minimize tax liabilities deadweight loss may be more pronounced this is because the more flexible a consumer can be to avoid a tax the more opportunities there are for the deadweight loss to occur imagine a situation with very high tax rates this was the case during the prohibition era which is discussed towards the end of this article when rates are very high consumer behavior may be discouraged or materially altered to avoid these rates this may have a greater likelihood of resulting in unintended consequences or lost revenue different taxes can influence economic behavior and deadweight losses in different ways taxes on consumption may affect spending patterns as consumer may no longer want to consume a good if it is more expensive alternatively consumers may seek illegal methods of consuming the good to avoid the tax altogether in perfectly competitive markets deadweight loss may be more evident consider a situation where there are a bunch of different small companies competing in the same industry deadweight loss may be more likely to occur as consumers can hop from one company to another to avoid a single implication from a single firm in a market structure like a monopoly it may be harder for a consumer or producer to avoid an unfavorable outcome due to the large number of small firms while monopolies may exhibit different patterns the degree of competition and market power shapes how taxes affect economic agents and market outcomes last the availability of substitute goods can matter if consumers can easily switch to alternative goods or services in response to a tax the impact on the original product may be more significant think about if the government imposed a specific tax to a certain geographical region consumers could in theory move to a different area this area could have less or no tax than what was assessed before because the consumer was able to move or substitute where they lived they could pose harm to the fiscal plan special considerationstaxation reduces the returns from investments wages rents and entrepreneurship this in turn reduces the incentive to invest work deploy property and take risks but it also encourages taxpayers to spend time and money trying to avoid their tax burden diverting valuable resources from other productive uses most governments levy taxes disproportionately on different people goods services and activities this distorts the natural market distribution of resources the limited resources will move from their otherwise optimal use away from heavily taxed activities and into lightly taxed activities which may not be advantageous to all the economics of taxation also apply to other forms of government financing if a government finances activities through bonds rather than taxation deadweight loss is only delayed higher future taxes must be levied to pay off the bond debt the deadweight loss of inflation is nuanced inflation reduces the economy s production volume in three ways deficit spending means borrowing which only delays deadweight loss of taxation to some future date when the debt must be repaid hypothetical example of deadweight loss of taxationhere s a hypothetical example to show how the deadweight loss of taxation works let s say the mythical city state of braavos imposes a flat 40 income tax on all of its citizens the government stands to collect an additional 1 2 trillion a year through this new tax that big chunk of money which is now going to the government of braavos is no longer available for spending on consumer goods and services or for consumer savings and investment suppose consumer spending and investments decline at least 1 2 trillion and total economic output declines by 2 trillion in this case the deadweight loss is 800 billion the 2 trillion total output less 1 2 trillion consumer spending or investing equals a deadweight loss of 800 billion real world example of deadweight loss of taxationduring the prohibition era in the united states the government looked to slow alcohol consumption by imposing heavy taxes on alcoholic beverages the demand for alcohol exhibited both elastic and inelastic components with some consumers still willing to pay higher prices despite the taxes this inelastic demand led to the emergence of a black market as consumers and producers sought alternatives to buying alcohol legally 3heavy taxes and legal restrictions reduced consumer surplus similarly producer surplus diminished as legal producers encountered restrictions and illegal producers faced legal consequences the combination of these two meant both legal and illegal markets coexisted an unintended consequence of the tax as this meant the government potentially lost out on taxes it would have otherwise collected it s estimated that the federal government lost 11 billion in tax revenue from this course of action 4there are a lot of intricacies around the economics of the prohibition era at its core the government enacted a tax that resulted in it losing income as businesses departed legal markets though you can claim the government may have steered some away from alcohol arguably its primary goal there were financial implications it may not have planned for 