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tax wedge


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A summary of the distortion in choices caused by a tax. The tax wedge measures the extent to which taxation causes the relative prices of two commodities to deviate from the efficient value. For example, a tax on income causes a wedge between the price of consumption relative to the wage rate and the marginal rate of transformation between consumption and labour. It does not cause a wedge between the price of one commodity relative to the price of another and the corresponding marginal rate of transformation. As a second example, a tax on the interest from savings causes a wedge in the choice between consumption today and consumption tomorrow, but not in the choice between labour today and consumption today.

Subjects: Economics.


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