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I have learned that in a perfectly competitive market in the absence of externalities, taxes will impose a deadweight loss upon society, due to reduced market participation by consumers and producers. And that when designing tax codes, policymakers would benefit society the most by minimizing deadweight loss, such as by taxing markets with inelastic supply and demand. My question is why is this deadweight loss considered negative for society? I understand the negative effect on the market specifically, but won't those who decide not to participate in the market being taxed simply spend their money in another market, thus not affecting society as a whole adversely? The money lost to deadweight loss doesn't simply disappear right?

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I understand the negative effect on the market specifically, but won't those who decide not to participate in the market being taxed simply spend their money in another market, thus not affecting society as a whole adversely?

Generally no with an exception of some special cases. Spending them at a different market than they originally wanted is precisely what creates the loss of social welfare and affects society negatively (see Mankiws Principles of Economics pp 153 for more discussion).

What matters is utility not spending. If someone first option is to consume banana, but due to bananas being heavily taxed they pick their second best option of consuming oranges those people are worse off as they are consuming goods that give them less utility.

The deadweight loss is created because the tax inserts a wedge between social benefits and costs of consuming a good and private ones.

Note, via income effects taxes could even in rare cases result in more output and thus money being spent in an economy (for example, when government does not taxes leisure but does taxes all other regular goods, income effect from such taxation could make people to supply more labor to the economy and produce higher output of regular goods, but overall utility of all people together would be lower nonetheless).

One way how this could theoretically be avoided would be a situation where every possible consumption is taxed at exactly the same rate and all taxed money is in some way given back to consumers (to cancel the income effects). Nonetheless, in practice that is nearly impossible since there are many goods such as leisure that are practically impossible to tax. Or governments could use lump sum taxes that are non-distortionary although these are not really applicable to goods markets.

However, note it is more appropriate to say that the tax has negative effect on a welfare of the society. That is not the same as saying it’s bad for the society. Maximizing social welfare is not necessarily moral ideal for everyone. People can legitimately care about equity and other issues even at a cost of living in society with less social welfare.

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  • $\begingroup$ Is "social welfare" an economic term? It seems to me that "welfare" should include the utility of goods produced, but also all the other stuff like equ[al]ity. $\endgroup$
    – user253751
    Oct 28 '21 at 9:01
  • $\begingroup$ @user253751 yes it is an specific economic term that is rigorously defined and not the same as loose vague usage in common non-science English $\endgroup$
    – 1muflon1
    Oct 28 '21 at 9:04
  • $\begingroup$ This? "A cardinal social welfare function is a function that takes as input numeric representations of individual utilities (also known as cardinal utility), and returns as output a numeric representation of the collective welfare." <- this definition allows for a social welfare function to include an inequality penalty, and a redistribution could increase social welfare. $\endgroup$
    – user253751
    Oct 28 '21 at 9:22
  • $\begingroup$ @user253751 no that is social welfare function used by government that depending on its type can have preferences for redistribution but that is not just social welfare/welfare of a society(without any qualifications like Rawlsian social welfare or Benthamite social welfare) have a look at varians micro chapter on welfare economics. Welfare is defined in terms of the total surplus which is constructed from individual utilities. $\endgroup$
    – 1muflon1
    Oct 28 '21 at 10:05
  • $\begingroup$ so Wikipedia is totally wrong on this one and I must find a copy of an actual textbook? $\endgroup$
    – user253751
    Oct 28 '21 at 10:25

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